Category Archive for: Taxes [Return to Main]

Sunday, December 10, 2006

Summers: Restoring Fairness

Larry Summers tells politicians to listen to their populist mandate and manage it wisely as they search for a way to distribute income more equitably, and he encourages corporations to cooperate. "The place to start," he says, "is by restoring the progressivity of the tax system":

Only fairness will assuage the anxious middle, by Lawrence Summers, Commentary, Financial Times (free): ...Coming from very different parts of the country and very different political perspectives, the new members of Congress have in common that they have all heard from the anxious middle class. They feel under enormous pressure to respond not just to the economic insecurity that middle-class voters feel, but also to voters’ resentment at what they see as disproportionately prospering corporate elites. If the new Congress sees itself as having a mandate for anything in the economic area, it is for policies that “stand up” for ordinary Americans against the threat they perceive from corporate and moneyed interests.

These populist impulses have roots much deeper than campaign rhetoric. In the past, real wages and corporate profitability have moved together... The unique feature of the current expansion is the divergence between the fortunes of capital and the fortunes of labour. While workers normally receive about three-quarters of corporate income, ... the Economic Policy Institute has calculated that, since 2001, labour has received only about one-quarter of the increase ..., as real wages have failed to keep pace with productivity growth. ...

These economic and political trends are and should be of great concern to the business community as well as to policymakers. They have led to populist policy proposals that cut against the grain of the market system by, for example, limiting free trade agreements, restricting outsourcing or limiting the ability of successful companies to expand.

The track record of such populist proposals is dismal. They rarely achieve their objectives and come with huge collateral costs. ... Yet it would not be a sufficient response for business or government simply to explain why populist policies would be counterproductive and to suggest ... a “stay the course” strategy, perhaps with increased attention to the displaced. If the anxious middle’s concerns about fairness are this serious when the unemployment rate is 4.4 per cent, they will be far greater whenever the economy next turns down.

This puts a premium on finding measures that go with ... the market system while also responding to concerns about fairness. The place to start is by restoring the progressivity of the tax system – an area where much can be accomplished before considering changes to the rate structure.

It is neither fair nor efficient to audit disproportionately the tax returns of those in the bottom half of the income distribution at a time when most of the $500bn tax gap comes from those with high incomes. There is no policy justification for allowing the erosion of corporate income tax through pervasive use of corporate tax shelters and manipulation of transfer price rules. Not only does this cost the government revenue, it also puts undue competitive pressure on companies that want to meet obligations to their workers.

Much more can done in a range of areas, from disclosure of executive compensation, to ensuring that the government leverages the volume of its purchases, to making financing of education at every level more equitable, to making sure that businesses continue to take responsibility for their workers’ healthcare costs.

When, as now, concerns become sufficiently serious, those with bad ideas always win out over those with no ideas.

John Kennedy famously challenged Americans: “Ask not what your country can do for you. Ask what you can do for your country.” In the years ahead, this question will be put with increasing force to US corporations. A great deal depends on the vigour with which it is answered.

Saturday, December 09, 2006

Falling State Corporate Income Taxes

Why have state corporate income taxes bee falling over the last 25 years? The San Francisco Fed looks for the answer:

The Mystery of Falling State Corporate Income Taxes, by Daniel Wilson, FRBSF Economic Letter: The share of corporate profits in the U.S. collected by state governments via the corporate income tax has fallen sharply in the past quarter century. Some commentators have even referred to this as the "disappearance" of the state corporate income tax (SCIT). Such claims, of course, are an exaggeration—after all, a longer perspective reveals that the share of profits collected by state corporate income taxes was actually lower in the 1960s than it is now. Nonetheless, state public finance experts and state policymakers surely are correct in noting that, since around 1980, corporate income taxes have become an increasingly smaller share of total state tax revenues and a smaller share of businesses' costs.

This Economic Letter attempts to unravel the mystery of falling state corporate income taxes by analyzing the primary determinants of these taxes and reviewing how they have changed in the last 25 years.

Continue reading "Falling State Corporate Income Taxes" »

Wednesday, December 06, 2006

An Interview With David Card

David Card is interviewed about a wide variety of topics in his research. Here are bookmarks to specific topics:

Interview with David Card, by Douglas Clement, The Region, Minneapolis Fed, December 2006 (Interview: October 17, 2006): David Card seems like a pretty mild-mannered guy. True, he speaks with conviction, but it is confidence backed by meticulous research and tempered with open acknowledgment of the limits of that research. Card, an economist at the University of California, Berkeley, is the antithesis of a zealot.

Nonetheless, by virtue of the topics he investigates, he has frequently found himself in the center of the nation's most incendiary controversies. And in many cases, Card's findings have been at odds with the conventional wisdom. Raising the minimum wage modestly is likely to have a negligible impact on employment levels, he has found.

Immigration has only a minor impact on wages of native-born workers. But it would be wholly inaccurate to say he's been drawn into these debates. In fact, he has scrupulously avoided taking advocacy positions. A public stance, he believes, might raise doubt as to the rigor of his methods and the impartiality of his findings—two qualities he does defend zealously.

In 1995, Card was awarded the John Bates Clark Medal, given every two years to an outstanding American economist under 40 years of age. In granting the award, the American Economic Association highlighted Card's ingenious use of “natural experiments”—naturally occurring instances of the phenomena under study.

To study the impact of minimum wage legislation, for instance, Card looked at fast-food jobs in New Jersey and Pennsylvania. To understand immigration, he examined the 1980 Mariel boat lift, when Miami's labor force increased by 7 percent. In a just-released paper on unemployment benefits and job search behavior, he scrutinized data from Austria, where workers on the job for 36 months or longer get generous severance.

“If one unifying principle runs through David Card's work,” observes Harvard economist Richard Freeman, “it is a belief in the power of empirical economic science—in the ability to use statistics creatively to make inferences about how the economy operates.”

Continue reading "An Interview With David Card" »

Tuesday, November 28, 2006

Changes in the Distribution of Income and Taxes

New IRS data yields an updated look at how the distribution of income has changed over time, and at the winners and losers from tax cuts:

’04 Income in U.S. Was Below 2000 Level, by David Cay Johnston, NY Times: Despite significant gains in 2004, the total income Americans reported to the tax collector..., adjusted for inflation, was still below its peak in 2000, new government data shows. ... Total reported income, in 2004 dollars, fell 1.4 percent, but because the population grew during that period average real incomes declined more than twice as much, falling ... 3 percent...

Since 2004, the Census Department has found, the income of the typical American household has grown ... but at a slow pace that, until recent months, had barely kept ahead of inflation. The tax data, while not as up to date, helps spell out whose incomes were most affected in the recent downturn and why.

The overall income declines ... came despite a series of tax cuts that President Bush and Congressional Republicans promoted as the best way to stimulate both short- and long-term growth... The tax cuts contributed to a big decline in individual income tax receipts, which fell at a rate 14 times that of the drop in incomes.

In 2004 individual income tax receipts were 21.6 percent smaller than in 2000 — and indeed smaller than they were in 1997, the new I.R.S. report shows. ... [R]ather than pay for themselves through economic growth, the Bush tax cuts, at least through 2004, were financed with borrowed money. ...

A White House spokesman, Tony Fratto, said the decline in income through 2004 was a predictable result of “what we all know now was a bubble economy with inflated asset values, which is why $7 trillion of equity in the stock markets evaporated.” ...

Over all, average incomes rose 27 percent in real terms over the quarter-century from 1979 through 2004. But the gains were narrowly concentrated at the top and offset by losses for the bottom 60 percent of Americans, those making less than $38,761 in 2004.

The bottom 60 percent of Americans, on average, made less than 95 cents in 2004 for each dollar they reported in 1979, analysis of the I.R.S. data shows.

The next best-off group, the fifth of Americans on the 60th to 80th rungs of the income ladder, averaged 2 cents more income in 2004 for each dollar they earned in 1979.

Only those in the top 5 percent had significant gains. The average income of those on the 95th to 99th rungs of the income ladder rose by 53 percent, almost twice the average rate.

A third of the entire national increase in reported income went to the top 1 percent — and more than half of that went to the top tenth of 1 percent, whose average incomes soared so much that for each dollar, adjusted for inflation, that they had in 1979 they had $3.48 in 2004.

Because of cuts in the tax rate, the top tenth of 1 percent did even better than their rising incomes alone would suggest. For each inflation-adjusted dollar they had after tax in 1979 they had $3.94 left after taxes in 2004.

For the bottom 60 percent, their income taxes were so small in 1979 that the cuts did little to change their after-tax incomes. While their pretax average incomes fell by a nickel on the dollar from 1979 to 2004, their after-tax incomes fell by a fraction of a penny less.

Thursday, November 23, 2006

Milton Friedman's Social Welfare Program

Not everyone realizes that Milton Friedman is the "architect of the most successful social welfare program of all time":

The Other Milton Friedman: A Conservative With a Social Welfare Program by Robert Frank, Economic Scene, NY Times: Milton Friedman ... was the patron saint of small-government conservatism. Conservatives who invoke his name in defense of Social Security privatization and other cutbacks in the social safety net might thus be surprised to learn that he was also the architect of the most successful social welfare program of all time.

Market forces can accomplish wonderful things, he realized, but they cannot ensure a distribution of income that enables all citizens to meet basic economic needs. His proposal, which he called the negative income tax, was to replace the multiplicity of existing welfare programs with a single cash transfer — say, $6,000 — to every citizen. A family of four with no market income would thus receive an annual payment from the I.R.S. of $24,000. For each dollar the family then earned, this payment would be reduced by some fraction — perhaps 50 percent. A family of four earning $12,000 a year, for example, would receive a net supplement of $18,000 (the initial $24,000 less the $6,000 tax on its earnings). [giving a total income of 30,000]

Mr. Friedman... was above all a pragmatist... If the main problem of the poor is that they have too little money, he reasoned, the simplest and cheapest solution is to give them some more. He saw no advantage in hiring armies of bureaucrats to dispense food stamps, energy stamps, day care stamps and rent subsidies.

As always, Mr. Friedman’s policy prescriptions were shaped by his desire to minimize adverse economic incentives, a feature that architects of earlier welfare programs had largely ignored. Those programs ... typically reduced a family’s benefits ...[with] each increment in earned income. ...[A] family ... might see its total benefits fall by $2 for each extra dollar it earned. ...[N]o formal training in economics was necessary to see that working didn’t pay. In contrast, someone who worked additional hours under Mr. Friedman’s plan would always take home additional after-tax income.

The negative income tax was never adopted in the end, because of concern that a payment large enough to support an urban family of four might induce many to go on the dole. ... Instead, Congress adopted the earned-income tax credit, essentially the same program except that only people who were employed received benefits. ...[T]he earned-income tax credit has proved far more efficient than conventional programs, just as Mr. Friedman predicted. Yet because it covers only those who work, it cannot be the sole weapon in society’s antipoverty arsenal.

This month, economic populists like Jim Webb, Jon Tester and others were elected to Congress on pledges to strengthen the social safety net. In pursuing this task, they should take seriously Milton Friedman’s concern about incentives. How might they expand support for the unemployed without undermining work incentives?

One possibility is government-sponsored employment coupled with negative income tax payments that are too small to live on... For others, government would stand as an employer of last resort. With adequate supervision and training, even the unskilled can perform many useful tasks. They can plant seedlings on eroding hillsides, for example, or remove graffiti from public spaces. ... Coupled with low negative income tax payments, wages from public service or private employment could lift everyone from poverty. This combination would provide no incentive to go on the dole.

Mr. Friedman, of course, would not have welcomed an expansion of the federal bureaucracy. But ... guaranteeing employment at low wages would require no such expansion. By inviting companies to bid for program contracts, government could harness market forces to control costs.

In the face of huge budget deficits, is such a program affordable? In ... 1943, ... Mr. Friedman proposed a progressive consumption tax as the best source of revenue to meet critical national objectives. ... High tax rates on consumption by the wealthy, Mr. Friedman argued, would generate additional revenue with only minimal sacrifice. So if providing greater economic security for low- and middle-income families is an important national objective, ... there are ways to pay the bill.

By all accounts, Mr. Friedman was a generous and compassionate man, someone more keenly aware of good luck’s contribution to individual prosperity than many of his disciples. Careful students of his work will be inspired not to dismantle the social safety net but to make it more effective.

Tuesday, November 14, 2006

Pigouvian Redistribution

There has been a lot of support lately for the ideas that Arthur Cecil Pigou (1877-1959) set forth in his book The Economics of Welfare. Pigou held the chair of political economy at Cambridge (succeeding Alfred Marshall) and was the leading neoclassical economist of his day. The book is an attempt to provide a theoretical basis for government intervention to improve social conditions. His introduction of Pigouvian taxes is part of that effort.

I wonder if the Pigou fans who have been so enthusiastic about Pigouvian taxes will also endorse other ideas from his book. For example, here's part of his argument for redistributing income from the rich to the poor. It could, perhaps, serve as the Pigouvian Redistribution Club's manifesto:

[I]t is evident that any transference of income from a relatively rich man to a relatively poor man of similar temperament, since it enables more intense wants, to be satisfied at the expense of less intense wants, must increase the aggregate sum of satisfaction. The old "law of diminishing utility" thus leads securely to the proposition: Any cause which increases the absolute share of real income in the hands of the poor, provided that it does not lead to a contraction in the size of the national dividend from any point of view, will, in general, increase economic welfare.

This conclusion is further fortified by another consideration. Mill wrote: "Men do not desire to be rich, but to be richer than other men. The avaricious or covetous man would find little or no satisfaction in the possesion of any amount of wealth, if he were the poorest amongst all his neighbours or fellow-countrymen." More elaborately, Signor Rignano writes: "As for the needs which vanity creates, they can be satisfied equally well by a small as by a large expenditure of energy. ... In reality a man's desire to appear 'worth' double what another man is worth, that is to say, to possess goods (jewels, clothes, horses, parks, luxuries, houses, etc.) twice as valuable as those possessed by another man, is satisfied just as fully, if the first has ten things and the second five, as it would be if the first had a hundred and the second fifty."

Now the part played by comparative, as distinguished from absolute, income is likely to be small for incomes that only suffice to provide the necesaries and primary comforts of life, but to be large with large incomes. In other words, a larger proportion of the satisfaction yielded by the incomes of rich people comes from their relative, rather than from their absolute, amount. This part of it will not be destroyed if the incomes of all rich people are diminished together. The loss of economic welfare suffered by the rich when command over resources is transferred from them to the poor will, therefore, be substantially smaller relatively to the gain of economic welfare to the poor than a consideration of the law of diminishing utility taken by itself suggests.

Saturday, November 11, 2006

What Happened to the Surplus?

Greg Mankiw:

What happened to the surplus?, by Greg Mankiw: Remember 2001, when the federal government was projecting huge surpluses, and people were worrying what we would do when the government debt was completely paid off? Well, it looks like we solved that problem!*

How did we do it? The table above, from economist J. Edward Carter based on CBO data, shows the causes of the change from a ten-year surplus of $5.6 trillion to a ten-year deficit of $2.9 trillion -- a swing of $8.5 trillion. The biggest factor was increased spending, of which increased defense spending was the largest piece. The second biggest factor was changed economic and technical assumptions (that is, the forecasters were wrong).

The tax cuts amounted to $1.8 trillion of the $8.5 trillion--about a fifth. And even that amount is an overestimate, because it most likely relies on static assumptions. A dynamic analysis that allows for a feedback of lower taxes to more rapid growth would reduce the share of the budget swing attributed to tax cuts.

Reasonable people can disagree about whether the Bush tax cuts were advisable, but don't let anyone tell you that the tax cuts were the main reason the surplus of 2001 disappeared.

* Before some commenter flames me: yes, this sentence is tongue-in-cheek.

I'm confused what we are supposed to take away from this. If the message is that the tax cuts did not do much to contribute to deficit the problem, then I certainly disagree - 1.8 trillion, assuming that's an accurate figure, is no small bump in the budget over the 10 year period examined (2002-2011, so part of this is a forecast and thus subject to questions about the underlying assumptions - these are not actual numbers - note: see the update below).

The claim is that the 1.8 trillion is only 20% of the total change in the budget, but the NRO article Greg refers to denies that the baseline figure used in the calculation of a 20% share is even relevant:

Clue #1: The $5.6 trillion surplus was a mirage. It never existed. The CBO based its surplus estimate on the existing tax and spending laws and on an economic forecast that simply did not stand the test of time.

Clue #2: Even if the CBO’s economic and technical assumptions had been accurate, and even if President Bush had not championed tax relief, and even if the country had not been dragged into a global war on terrorism, the projected surplus never would have materialized.

Why is it being used as a baseline to calculate the impact of tax cuts if, as the article says:

So, what do the clues reveal about the missing $5.6 trillion surplus? 1) It never existed. 2) It never would have existed. 3) Policymakers never intended for it to exist.

So, a non-existent figure is used to make the point that 1.8 trillion is just a drop in the bucket? Why is the 20% figure relevant - shouldn't it reflect actual instead of projected numbers? What am I missing?

Suppose you take out the part that forecasters missed, the 2.5 trillion from "technical adjustments and revised economic assumptions," from the 8.1 trillion surplus. That leaves 8.5-2.5=6.0 trillion swing in the budget given the assumptions underlying the forecasts through 2011. The tax cuts are then 1.8/6.0 = 30% of the total. That's a pretty good chunk of the swing in the budget. That spending was increased by a bit over twice that amount doesn't reduce its magnitude.

Update: This notice appears with the article:

BELATED FULL DISCLOSURE

It has been pointed out elsewhere on the web that one of our pieces today was written by someone described as “an economist in Washington, D.C.” He, in fact, works for the Department of Labor. He signed the piece with a byline he’s been using for years. Not for the first time, we — wrongly — assumed the author had left government when we were approached with unsolicited pieces. We were wrong to assume. His piece now makes note of this explanation/disclosure/apology. As a practice, we don’t publish pieces from people who work in government without disclosing it. We were remiss here and apologize to our readers.

Thursday, November 09, 2006

401(not okay) Accounts?

Are 401(k) accounts the best way to save for retirement given the uncertainties about future government liabilities and tax rates?:

In Retirement Planning, There Is Nothing Certain About Death and Taxes By Austan Goolsbee, Economic Scene, NY Times: For millions of Americans, November means open enrollment time — the brief period when employees make their choices about next year’s benefits, including 401(k) savings.

If you are one of the millions of people trying to decide about 401(k)s, you have probably heard about the dangers of investing too much into your own company’s stock and have compared the risks of investing in stocks versus bonds. You may even have asked co-workers for hints about what to do.

You probably have not given much thought to political tax risk, however, or perhaps have even heard of it. Yet the purely political question of what will happen to tax rates over the next 30 years has become one of the most important factors in thinking about tax-deferred savings accounts...

Future increases in tax rates potentially threaten to significantly reduce the value of your retirement savings and may even mean that you should not save in 401(k) accounts at all.

To understand why, think about the traditional advantages of a tax-favored account like a 401(k). ... You get to put money into the account without paying income tax on it this year and you do not have to pay taxes as it builds up. You just pay income tax on the full amount at the very end when you finally pull out the money in retirement. ...

But the lurking catch is that the tax you will pay on your account will be at the rate in place when you retire, not the rate now. And that may be very different.

Budget analysts unanimously agree that the current fiscal situation of the country is unsustainable. According to the latest numbers from the Government Accountability Office, the total fiscal gap facing this country in the future is about $60 trillion, and some budget experts suggest even that is an underestimate...

While future budget policy seems far removed from your company’s open enrollment, you had better pay attention. How the government decides, ultimately, to balance its budget will have a tremendous impact on your retirement savings. If income tax rates double between now and when you retire, the value of your 401(k) may be cut in half. ...

Will it be taxes or spending? No one knows. And that is exactly the point for your 401(k). Political uncertainty is an extremely important type of risk ... If you think the government will raise income tax rates in the future but will keep capital gains and dividend tax rates low, you may not want to invest in a 401(k) at all. Paying your income tax and then investing money in the stock market may leave you better off in your retirement than investing in the supposedly tax-advantaged savings accounts.

To be clear, if your employer gives you a generous match for the money you put into your 401(k), that will tend to outweigh any tax risk and so you may as well take the free money and invest. Similarly, if you are the kind of person who invests only in bonds, so you have lots of interest payments, you should stick with the 401(k). If you need the restrictions of the 401(k) to keep you from spending your retirement savings, again, just go ahead and ignore the tax risks.

But if you are one of the millions of people who did not answer “yes” to any of those questions, you should be thinking about the reality of tax risk. One way to avoid such risk would be to put your retirement savings into a Roth I.R.A. Unlike the 401(k), you pay the income taxes on the money when you put it into the Roth rather than when you take it out... The problem is that if your family income is more than $160,000 a year, you are not eligible. And even if you are eligible, you cannot put more than about $5,000 a year into a Roth account. ...

So what’s a hard-working American to do? You really do not have the information you need. You will have to guess...

Markets should incorporate expected future tax liabilities into the price of the asset along with a risk premium to compensate for any uncertainties about future tax rates. Perhaps markets aren't pricing the risk correctly, there are some who make that argument, but so far financial markets in their collective wisdom appear surprisingly unconcerned about the impact of future government liabilities.

Friday, November 03, 2006

Whe Gets the Cookies?

From the Tax policy Center via the Budget Blog, the distribution of tax cuts since 2001:

Distribution of Tax Cuts, by John Irons, Budget Blog, Center for American Progress: The Tax Policy Center recently released an updated estimate of the distribution of benefits from the tax changes enacted from 2001-2006. For example average benefits for

  • Low income (10-20k): $183
  • Middle quintile (2006): $748
  • Incomes > $1 million: $111,567

For more see: Tax Policy Center...

Tuesday, October 31, 2006

What Tax Cut?

John Berry makes a point worth repeating. He says the administration's claim that it cut taxes is wrong:

Bush Makes Up for Tax Cuts With More Spending, by John M. Berry, Bloomberg: ...Over substantial Democratic opposition, Bush and a Republican-controlled Congress have cut taxes significantly over the past six years. The problem is that -- with plenty of cooperation from Democrats -- they have also greatly increased spending.

From fiscal 2001 to 2006, federal outlays shot up 42 percent, more than double the 19 percent increase over the previous five years.

In the short run, you can cut taxes and spend more. In the long run, as Nobel laureate economist Milton Friedman has potently argued, to spend is to tax.

Continue reading "What Tax Cut?" »

Sunday, October 22, 2006

Supply-Side Economics: Used and Abused

Jonathan Chait has a question for the president. If it's true that tax cuts raise tax revenues as he claims, and if it's also true that he has restrained spending like he says he has in his speeches, then why do we still have such a large deficit?

Bush's Silly Budget Logic, by Jonathan Chait, Commentary, LA Times: Alan D Viard, a former Bush White House economist currently at the conservative American Enterprise Institute, recently told the Washington Post: "Federal revenue is lower today than it would have been without the tax cuts. There's really no dispute among economists about that."

He's right. There's no dispute among economists. Conservative, moderate or liberal, every credentialed economist agrees that the Bush tax cuts caused revenues to drop. There is, however, a dispute between economists and pseudo-economists. Supply-siders may be laughed at by real economists, but they still enjoy a strong following among politicians, including, alas, the president of the United States. Here is what President Bush said a week and a half ago:

"They said that we had to choose between cutting the deficit and keeping taxes low — or another way to put it, that in order to solve the deficit we had to raise taxes. I strongly disagree with those choices. Those are false choices. Tax relief fuels economic growth, and growth — when the economy grows, more tax revenues come to Washington. And that's what's happened. It makes sense, doesn't it?"

Well, no, it doesn't make any sense at all. Bush, of course, is correct that tax revenues have risen over the last few years. This is normal.

Except in certain extreme theoretical conditions, tax cuts cause revenues to fall, and tax hikes cause them to rise. The economy also can affect revenues. During an expansion, revenues can rise unusually fast, and during a recession, they can drop unusually fast. ...

In the same speech in which he claimed that his tax cuts have caused revenues to rise, Bush bragged that he's "restraining spending." So why do we still have a deficit? I mean, he says he's kept spending down, he's caused revenues to skyrocket and the economy is going great guns. Why are we still in the red?

And if Bush's own economists say his tax cuts caused revenue to drop — and Viard isn't the only one — then how can he continually get away with insisting the opposite?

As the evidence against the Laffer curve continues to accumulate, it's getting harder to sell the myth that tax cuts pay for themselves, or at least I hope it is. Because of that, tax-cut advocates will likely retreat to an efficiency argument to support their cause.

One note. Jonathan Chait says:

Supply-siders may be laughed at by real economists...

Not quite. There are real economists that are supply-side advocates. But supply-side economics has been misused and misrepresented to suit political ends and that has tarnished its reputation, something that could have been avoided if those "real economists" had voiced strong opposition to claims made on behalf of the theory that were clearly wrong or wishful thinking at best.

Supply-side economics in the right hands, those of qualified real business cycle theorists who are interested in how the world works rather than supporting an ideology or political party, has a lot to offer. For example, I read an interesting paper last week ("A Theory of Demand Shocks") that combines a real business cycle framework with a new classical style Lucas island model information structure, where the information extraction problem concerns productivity shocks. But that is just the tip of a large iceberg of very good research on real business cycles.

My view is that the debate over which view is correct - real business cycle stories of aggregate fluctuations or new Keynesian style microfounded friction models - is not all that productive. My objection comes when people dismiss the demand side entirely. I believe both supply and demand shocks are important sources of aggregate fluctuations and that models synthesizing New Keynesian - Real Business Cycle theoretical models by imposing rigidities or other frictions on a real business cycle structure (augmented with an enhanced demand side) is ultimately where we will end up.

Wednesday, October 18, 2006

Still Searching for Laffer's Curve

An email brings an IMF working paper on flat taxes. According to this research, "there is no sign of Laffer-type behavioral responses" from tax reform. That's bad news for the supply-side advocates still searching for tax-cuts of mass deficit destruction:

The “Flat Tax(es)”: Principles and Evidence Prepared by Michael Keen, Yitae Kim, and Ricardo Varsano, September 2006: Abstract One of the most striking tax developments in recent years, and one that continues to attract considerable attention, is the adoption by several countries of a form of “flat tax.” Discussion of these quite radical reforms has been marked, however, more by assertion and rhetoric than by analysis and evidence. This paper reviews experience with the flat tax, seeking to redress the balance. It stresses that the flat taxes that have been adopted differ fundamentally, and that empirical evidence on their effects is very limited. This precludes simple generalization, but several lessons emerge: there is no sign of Laffer-type behavioral responses generating revenue increases from the tax cut elements of these reforms; their impact on compliance is theoretically ambiguous, but there is evidence for Russia that compliance did improve; the distributional effects of the flat taxes are not unambiguously regressive, and in some cases they may have increased progressivity, including through the impact on compliance; adoption of the flat tax has not resolved common challenges in taxing capital income; and it may have strengthened, not weakened, the automatic stabilizers. Looking forward, the question is not so much whether more countries will adopt a flat tax as whether those that have will move away from it.

New Economist discusses the paper in more detail.

Tuesday, October 17, 2006

Raise Taxes on the Poor?

Greg Mankiw is right. I don't embrace this:

Phelps on Taxes, by Greg Mankiw: Ned Phelps, the latest econ Nobelist, talks to the Wall Street Journal and gives some policy advice that neither political party will embrace:

WSJ: Barring a breakthrough in productivity, how can the U.S. solve the problem of its impending obligations? Should it raise taxes or cut Social Security benefits?

Prof. Phelps: Over the last couple decades, the federal government has virtually abolished taxation of a wide swath of people with smallish incomes. This was a mistake, because we need all the tax revenue we can get. It's inefficient to have low marginal tax rates on low incomes, because people with upper middle incomes and high incomes get the same breaks, but they don't get any incentive to work harder. What you want to do is give tax breaks that give people an incentive to earn income that would not otherwise be earned. So in my view, President Bush should have restored the taxes on the low-income people rather than lowering the taxes on the high-income people.

I see. We set aside equity and raise taxes on the poor making it harder for them to get by day to day. Because of that, we increase government spending and transfer payments to the poor to help them, essentially giving them their money back. Finally, we complain about the increased government resources devoted to the poor.

Good strategy. Phelp's does have a plan for those extra revenues from raising taxes on those with "smallish incomes," give the money to firms so they can employ those with "smallish incomes":

WSJ: Would that be economically just, especially at a time when the gap between the rich and the poor has been growing?

Prof. Phelps: I think economic justice is all about pay rates at the low end relative to those in the middle. So the government needs a lot of tax revenue to meet the problem of low-wage workers. Too many people in America suffer joblessness, and when they are employed they can't earn a decent living. I've been advocating a solution: subsidies that would be paid to companies for the ongoing employment of low-wage workers. The resulting increase in the demand for those workers would pull up their employment and ultimately give a big boost to their paychecks.

We should just let them keep the money to begin with and, if there are subsidies to low-wage workers, fund them with (gasp) taxes levied on people a little higher in the income distribution.

Phelps: Tax Cuts are Not the Answer

More from Edmund Phelps. In this Project Syndicate commentary, he cautions that tax cuts do not affect unemployment rates in the long-run and therefore, contrary to the claims of many supply-side advocates, tax cuts will not permanently reduce unemployment rates in Europe:

The false hopes of tax cuts, by By Edmund Phelps, Project Syndicate: There is a movement in medicine to require that applications for licenses to sell a new drug be "evidence-based." By contrast, trained economists view their discipline as having already achieved this scientific standard. After all, they express their ideas with mathematics and arrive at quantitative estimates of implied relationships from empirical data.

But economics is not evidence-based in selecting its theoretical paradigms. Economic policy initiatives are often taken without all the empirical pretesting that could have been done.

A notorious example is postwar macroeconomic policymaking under the ... neo-Keynesians... Like the radicals, the neo-Keynesians did not engage their challengers with empirical testing. The efficacy of high demand was a matter of faith. Yet events in the 1970s put that faith to a cruel test. When supply shocks hit the U.S. economy, the neo-Keynesians' response was to pour on more demand, believing it would revive employment. There was little recovery -- only faster inflation.

The current era offers a parallel. Although policy has since shifted to reflect supply-side economics and real business-cycle theory, the new paradigm builders and promoters display the same antipathy to checking data for serious error. ...

[S]upply-siders [have] jumped to the daring conclusion that a permanent cut in tax rates on labor would encourage more work permanently -- with no diminution of effectiveness.

Larry Summers and I both doubted that this could be generally true. If every increase in the after-tax wage rate gave a permanent boost to the amount of labor supplied, we reasoned, steeply rising after-tax wages since the mid-19th century would have brought an extraordinary increase in the length of the workweek and in retirement ages. But both have fallen, and in continental Europe unemployment is higher.

In my view, this core tenet of supply-side economics rests on a simple blunder. What matters for the amount of labor supplied is the after-tax wage rate relative to income from wealth. While after-tax wage rates soared for more than a century, the wealth and the income it brought grew just as fast.

To be sure, if tax rates were decreased permanently this year, there would initially be a strongly positive effect on labor supplied. But there would also be a positive effect on saving and thus on wealth next year and beyond. In the long run, wealth could tend to increase in the same proportion as after-tax wages. The effect on work would vanish.

We must proceed cautiously. In standard analyses, the tax cut brings a reduction in government purchases of goods and services, like defense. But a tax cut could instead contract the welfare state -- social assistance and insurance, which constitute social wealth. In that case, the tax cut, while gradually increasing private wealth, would decrease social wealth. The issue is an empirical one.

Research I did with Gylfi Zoega a decade ago confirmed that cuts in taxes on labor boost employment in the short run. But what about the long run? Do large long-run effects of tax rates show up in international differences in employment?

In 1998 we examined data ... for a correlation between national unemployment rates in the mid-1990s and tax rates on labor. We found none. In 2004, we looked at labor-force participation rates and again at unemployment. Still no correlation. ...

Neoliberals are now telling continental Europe that tax cuts on labor can dissolve high unemployment. But the effectiveness of such tax cuts would be largely, if not wholly, transitory -- especially if the welfare state was spared. In two decades' time, high unemployment would creep back.

The false hopes raised by cutting taxes would have diverted policymakers away from fundamental reforms that are necessary if the Continent is to achieve the dynamism on which high rates of innovation, abundant job creation, and world-class productivity depend.

Tuesday, October 10, 2006

Stockholm's Congestion Tax

Sweden's new center-right government has decided to implement a congestion tax:

Sweden watch, by Andrew Leonard: ...The recent electoral victory by a center-right coalition [in Sweden] resulted in many predictions of a swift turn to Milton Friedmanism... But take a look at one of the first major decisions by the new government, ... the reinstitution of a congestion tax in Stockholm. Since members of the coalition campaigned against the tax, and since in a referendum on the tax held at the same time as the general election the majority of voters who lived outside of Stockholm voted against it, the decision came as a bit of a surprise.

Why the change of heart? Simple, really. A trial of the tax conducted for six months earlier this year resulted in lower traffic and cleaner air. Then, after the the trial ended, congestion started to build up again. So, in other words, the tax worked. And in Sweden, whether you're on the right or the left, you like things that work.

The government's plan is to devote revenue from the tax to completing a ring road around the city, which is disappointing to environmentalists. But in the meantime, ... one in five new cars purchased in Stockholm this spring was a "clean car" -- running at least partially on electricity or alcohol -- and thus exempt from the congestion tax.

Perhaps the most telling stat: At the start of the trial, 55 percent of Stockholm residents opposed it. But after a few months sans traffic jams and breathing cleaner air, only 41 percent were against it. ...

Tuesday, October 03, 2006

Oink

Gene Sperling examines Republican efforts at budget reform involving pay-as-you-go rules and at the reduction of pork-barrel spending, but finds little of substance in the proposals:

Republican Budget Reform? They Can't Be Serious, by Gene Sperling, Bloomberg: Sometimes it's hard to take seriously what goes on when Congress starts talking about budget reform. Since Republicans took control of Congress in 1995, pork- barrel spending ... tripled. In that light, the anti-pork legislation passed last month is at best a papier-mache tiger.

Rather than create a bill with some teeth, the House decided that when earmarks are inserted into legislation the members have to attach their names to the spending proposals. Scary stuff, huh?

Normally, I would be delighted with even a small step toward greater budget transparency. This bill, however, doesn't even try to address the guts of the pork problem. ... Requiring nametags on earmarks may shame a few legislators from pushing for the sleaziest projects. For others, having their name next to an earmark is the type of stuff they might put in television election-campaign ads to show they were bringing home the bacon.

How the House's bill defines pork on the tax side is enough to make you laugh -- and cry.

For instance, ... in the House legislation, any tax cut benefiting more than one individual or company is not defined as an earmark. For a special-interest tax break to avoid the pork label, all that's needed is for highly-paid lobbyists to work together to ensure that at least two of their clients benefit. Perhaps we could call it the Tax Lobbyist Team Building Act?

The Senate's budget reform bill unveiled in June is more muscular than the House version, but still unbalanced.

The hallmark of budget reform is finding rules that aim to be even-handed, rather than those promoting one specific political or philosophical agenda. Consider the 1985 Gramm-Rudman-Hollings ... pay-as- you-go rules of the 1990s. Gramm-Rudman-Hollings triggered across-the-board spending cuts if deficit targets were missed. While the bill had its flaws, it was at least seen as fair because it exempted many basic programs for the poor and took half of the required cuts from defense and half from domestic spending.

The goal was to make the enforcement mechanism painful to all concerned, creating an incentive for everyone to work together to hit deficit targets. The same principle of neutrality is seen in the former pay- as-you-go rules that were in place for most of the 1990s. ... Voices ranging from former Federal Reserve Chairman Alan Greenspan, to General Accountability Office Comptroller David Walker have all recognized that pay-as-you-go should apply to both tax cuts and new entitlement spending.

The proposed Senate bill applies pay-as-you-go requirements only to entitlement programs while shielding tax cuts. So, if you have a special-interest goodie you don't want to pay for under the Senate bill, or have labeled as pork under the House bill, simply design it as tax cut that benefits two companies. You're home free. ...

No one should believe that attaching a name to earmarks or adopting one-sided budget reform is ever going to be part of the solution. That will take the type of even-handed and bipartisan effort that so far this Republican-controlled Congress has shown no interest in promoting.

Fixing Global Imbalances

In this post from yesterday, Joseph Stiglitz explains how to solve global warming using WTO trade sanctions. Today he explains how to fix domestic and global imbalances without incurring a recession. He also recommends overhauling the global reserve system to cure the underlying structural problems that allow these imbalances to occur:

How to Fix the Global Economy, by Joseph Stiglitz, Commentary, Ny Times: The International Monetary Fund meeting in Singapore last month came at a time of increasing worry about the sustainability of global financial imbalances: For how long can the global economy endure America’s enormous trade deficits — the United States borrows close to $3 billion a day — or China’s growing trade surplus of almost $500 million a day?

These imbalances simply can’t go on forever. The good news is that there is a growing consensus to this effect. The bad news is that no country believes its policies are to blame. The United States points its finger at China’s undervalued currency, while the rest of the world singles out the huge American fiscal and trade deficits. ...

Treating the symptoms could actually make matters worse, at least in the short run. Take, for instance, the question of China’s undervalued exchange rate... Even if China strengthened its yuan relative to the dollar and eliminated its $114 billion a year trade surplus with the United States, and even if that immediately translated into a reduction in the American multilateral trade deficit, the United States would still be borrowing more than $2 billion a day: an improvement, but hardly a solution.

Of course, it is even more likely that there would be no significant change in America’s multilateral trade deficit at all. The United States would simply buy fewer textiles from China and more from Bangladesh, Cambodia and other developing countries.

Meanwhile, because a stronger yuan would make imported American food cheaper in China, the poorest Chinese — the farmers — would see their incomes fall... China might choose to counter the depressing effect of America’s huge agricultural subsidies by diverting money badly needed for industrial development into subsidies for its farmers. China’s growth might accordingly be slowed...

Nothing significant can be done about these global imbalances unless the United States attacks its own problems. No one seriously proposes that businesses save money instead of investing in expanding production simply to correct the problem of the trade deficit; and while there may be sermons aplenty about why Americans should save more — certainly more than the negative amount households saved last year — no one in either political party has devised a fail-proof way of ensuring that they do so. The Bush tax cuts didn’t do it. Expanded incentives for saving didn’t do it.

Indeed, most calculations show that these actually reduce national savings, since the cost to the government in lost revenue is greater than the increased household savings. The common wisdom is that there is but one alternative: reducing the government’s deficit.

Imagine that the Bush administration suddenly got religion (at least, the religion of fiscal responsibility) and cut expenditures. Assume that raising taxes is unlikely for an administration that has been arguing for further tax cuts. The expenditure cuts by themselves would lead to a weakening of the American and global economy. The Federal Reserve might try to offset this by lowering interest rates, and this might protect the American economy — by encouraging debt-ridden American households to try to take even more money out of their home-equity loans to pay for spending. But that would make America’s future even more precarious.

There is one way out of this seeming impasse: expenditure cuts combined with an increase in taxes on upper-income Americans and a reduction in taxes on lower-income Americans. The expenditure cuts would, of course, by themselves reduce spending, but because poor individuals consume a larger fraction of their income than the rich, the “switch” in taxes would, by itself, increase spending. If appropriately designed, such a combination could simultaneously sustain the American economy and reduce the deficit. ...

Underlying the current imbalances are fundamental structural problems with the global reserve system. John Maynard Keynes called attention to these problems three-quarters of a century ago. His ideas on how to reform the global monetary system, including creating a new reserve system based on a new international currency, can, with a little work, be adapted to today’s economy. Until we attack the structural problems, the world is likely to continue to be plagued by imbalances that threaten the financial stability and economic well-being of us all.

Tax policy won't be used to redistribute money from the rich to the poor anytime soon, even as part of an expenditure reduction package. It also appears it would take very large income transfers to offset government spending reductions since the impact of any dollar that is transferred is only the difference in the marginal propensities to consume. As for the connection between the budget and trade deficits which is assumed but not explained, see Menzie Chinn who estimates that a 10% reduction in the budget deficit would reduce the current account deficit by 4%.

Sunday, October 01, 2006

Vintage Varian: Raise Gasoline Taxes

Hal Varian from October, 2000 on the need for higher gasoline taxes:

Tax cutting may be in fashion, but it's a good time to raise gasoline taxes, by Hal R, Varian, New York Times, Oct 19, 2000: With all the talk of tax cuts, this may be an inopportune time to propose a tax increase. But it is easier to put tax reforms in place when times are good than when they are bad, and United States policy on gasoline taxation could be much improved.

Gasoline taxes are an emotional issue... But there are several good reasons that increasing the gasoline tax in the United States makes economic sense.

First, it is a good idea to tax the consumption of goods that impose costs on other people. One person's consumption of gasoline increases emissions of carbon dioxide and other pollutants, and this imposes environmental costs on everyone. And even those who do not care much about the environment have to acknowledge that driving contributes to traffic congestion. Increased taxes on gasoline would reduce consumption, cutting both pollution and congestion.

But, you might argue, we already have taxes on gasoline: federal, state and local taxes average about 41 cents a gallon, or 28 percent of the price of gasoline. Isn't this enough? The problem is that the tax is used mostly to pay for road construction and maintenance. True, the gasoline tax decreases the use of gasoline, but the road subsidy increases its use.

If we subtract the subsidy from the tax, we end up with a net tax rate on gasoline in the United States of about 2 percent, which is much, much lower than net gasoline taxes in the rest of the world.

There is another, quite different reason to tax oil products.

Economists like to tax things that are in fixed supply because the same amount is available whether or not the tax is imposed. ...[I]n the long run, there is only so much oil. Taxing petroleum products will not reduce the total amount of oil in the ground, it will just slow the rate at which it is discovered and extracted.

Taxes on gasoline reduce the demand for oil, thereby reducing the price received by the suppliers of oil. And most of those suppliers are foreign: the United States now imports 56 percent of its oil... Taxing foreigners is popular both economically and politically -- they do not vote. Of course, domestic oil producers not only vote, they contribute to campaigns, and a tax on gasoline would be unpopular with them. But deals can be made -- taxes can be traded for depletion allowances and other accounting goodies to make such a plan politically viable.

A gasoline tax in a small country falls mostly on the residents of that country. The world price of oil is essentially independent of the taxing policies of most countries, since most countries consume only a small fraction of the amount of oil sold.

But the United States consumes a lot of oil -- almost a quarter of the world's production. That means it has considerable market power: its tax policies have a major impact on the world price of oil, and economic analysis suggests that in the long run, a significant part of a gasoline tax increase would end up being paid by the producers of oil, not the consumers.

Nearly 20 years ago, Theodore Bergstrom, an economist who is now at the University of California at Santa Barbara, compared the actual petroleum tax policies of various countries with policies those countries would adopt if they wanted to transfer more OPEC profits to themselves.

He found that if ... the United States, Europe and Japan all coordinated their oil-tax policies, they would collectively want to impose net tax rates of roughly 100 to 200 percent. This is not as scary as it sounds since such a coordinated tax increase would mostly affect oil producers; the price at the pump would increase much less.

Mr. Bergstrom's analysis was focused entirely on transferring profits from oil-producing to oil-consuming nations. If we factor in the pollution and congestion effects mentioned earlier, the optimal petroleum taxes would be even higher.

In the past, Al Gore has advocated increasing gasoline taxes for environmental reasons, though he has been pretty quiet about this proposal lately. George W. Bush does not think much of oil taxes, but he likes the idea of a tax cut.

Let me propose a bipartisan plan: raise the tax on gasoline, but give the revenue back to taxpayers in the form of an income tax credit.

Average consumers would be about as well off as they are now, but the higher price of gasoline would tend to discourage consumption -- giving us environmental, congestion and tax-the-foreigner benefits. It would make sense to phase the tax in over several years, so that the next time drivers trade in their sport utility vehicles, they would have an incentive to buy those fuel-efficient cars that Detroit has promised to produce.

Increasing the net tax on gasoline by, say, 2 percent a year for the next 10 years would be pretty painless for most people. Oil prices would almost certainly drop back down in the next few years, tending to reduce the price of gasoline back toward historical levels. A higher gasoline tax would just mean prices would not drop quite as far as they would otherwise.

If something must be taxed, it makes a lot of sense to tax something that is costly to the environment, costly to the users and mostly controlled by foreigners. The United States is passing up a big opportunity by not taxing gasoline at a higher rate.

I haven't strongly supported these proposals, perhaps because I hate the idea of paying more for gas. But that's the point of raising the tax, I'm supposed to dislike it and reduce my consumption, and I can't deny that an increase in gas taxes is needed. Robert Frank has a similar proposal (analyzed graphically here), while Martin Feldstein has called for tradeable gas rights.

Saturday, September 23, 2006

Inequality "Jumps Sharply"

New data show that inequality continues to increase:

Richest Americans' Income Share Jumps Sharply, by Greg Ip, Wall Street Journal: The richest Americans sharply increased their share of total income in 2004, though it remained below the high-water mark of 2000, new data from their tax returns show.

Internal Revenue Service data, posted on the agency's web site Friday, also show that the average tax rate for Americans as a whole remained near its lowest in 20 years and has fallen most sharply for the best-off.

The share of all income earned by the top 1% of taxpayers rose to 19% in 2004 from 16.8% in 2003, the IRS said. That remains below the 20.8% high hit in 2000, when it was elevated by capital gains related to the stock boom. ... After tax, the share of income of the best-off 1% jumped to 16.5% from 14.4% but remains below the 2000 peak of 17.8%.

The data show that the average tax rate for all taxpayers was 12.1%, up slightly from 11.9% in 2003 but down from 15.3% in 2000, due in part to the Bush tax cuts. Rates fell most for those at the top. The tax rate of the richest 1% fell to 23.5% from 24.3% in 2003 and 27.5% in 2000. For the bottom 50%, the 2004 tax rate was 3%, unchanged from 2003 and down from 4.6% in 2000.

Although dated, the IRS figures are among the best ways to compare the gains of the rich, middle class and poor because they include things that some other reports don't, including capital-gains income and taxes paid. Because capital gains are volatile and mainly reflect swings in the stock market, some experts prefer the Census Bureau data. That showed the richest families' share of total income in 2004 equaled its previous high and rose to a new high in 2005. ...

The people at the top must be getting smarter and more skilled every year, and a record-setting higher income share is their reward. Tax cuts and other policies had nothing to do with it.

Update: Greg Mankiw also comments on Greg Ip's report in a post called "Ip is caught framing":

In today's Wall Street Journal, Greg Ip describes recent changes in tax rates:

The data show that the average tax rate for all taxpayers was 12.1% [in 2004], up slightly from 11.9% in 2003 but down from 15.3% in 2000, due in part to the Bush tax cuts. Rates fell most for those at the top. The tax rate of the richest 1% fell to 23.5% from 24.3% in 2003 and 27.5% in 2000. For the bottom 50%, the 2004 tax rate was 3%, unchanged from 2003 and down from 4.6% in 2000.

The sentence that I have bolded puts a particular spin on the numbers. Here is an alternative way to describe the changes:

From 2000 to 2004, the average tax rate for all taxpayers fell from 15.3% to 12.1%, representing 21% tax cut. The tax rate of the richest 1% fell from 27.5% to 23.5%, a 15% tax cut. For the bottom 50%, the tax rate fell from 4.6% to 3%, a 35% tax cut. As a result of these changes, the top 1% paid a larger share of the tax burden in 2004 than it did four years earlier, and the bottom 50 percent paid a smaller share.

Isn't it amazing how the same set of numbers can be framed in different ways? ... By choosing the particular framing that he did, Ip let his politics seep into his reporting.

I disagree. The statement "Rates fell most for those at the top" is positive, not normative. That is, it's a statement of fact, not an opinion. Greg Mankiw wants more facts to be presented, but I don't think his suggestion improves the framing.

Mankiw wants Greg Ip to say "the top 1% paid a larger share of the tax burden" but that's a more value-laden presentation due to the word "burden." Is it a "burden" for the wealthy to pay taxes out of their higher incomes? Maybe. It depends on how the question is framed. Why not just say a "higher share of taxes?"

I'm sorry the facts Greg Ip presented don't agree with Mankiw's politics, but I don't see that as a reason to attack the messenger. Mankiw could have added facts of his own without accusing the reporter of letting "his politics seep into his reporting."

Friday, September 22, 2006

Will Bush Raise Your Taxes?

I'm confused by this new strategy coming from the Republicans for the fall elections because it implies Bush is too weak to stand up to Democrats if they take control of congress:

Republican Tax Deception, by James Crabtree: And so it begins. We've known for a while that the Republicans have planned to trot out a tax increase message, as a Siamese twin to "cut and run." There have been reports that the GOP would run the national campaign on security, but in local races would try to capitalize on voter concern about the economy by running hard on tax. This makes sense, particularly if you listen to reports like this on NPR this morning, showing discontent over the economy in rural areas (and noting that Dems were doing surprisingly well amongst rural voters.) And, so, no surprise yesterday when President Bush began to roll out the tax message, during a sweep through Florida yesterday...

Here's what Bush said:

Bush Leads New Offensive Featuring Economy and Linking Democrats to High Taxes, by Jim Rutenberg, NY Times: President Bush began a blistering new political offensive on Thursday, asserting that if Democrats won control of Congress from Republicans it would mean higher taxes, less money in the pockets of working families and damage to the economy.

The speech by Mr. Bush here, in which he belittled Democrats as “the party of high taxes,” signaled what Republicans described as a new phase of the White House’s fall campaign, as Republicans begin to combine their emphasis on national security with a tough new emphasis on the issue that unites them more than any other, taxes.

Mr. Bush’s offensive was backed up by a flood of television advertisements on behalf of Republican candidates.

“If they get control of the House of Representatives, they’ll raise your taxes, it will hurt our economy, and that’s why we’re not going to let them get control of the House of Representatives,” the president said...

“The Democrats have made their position clear,” Mr. Bush said. “I want you to remember the last time they had control of the United States Congress back in 1993, they passed a massive tax increase.” ...

It will take two to do the tax Tango. If Democrats win back the house, they can't pass any legislation unless Bush signs it - they won't be able to overturn a veto. Is Bush saying that if tax increase legislation comes to him, he won't veto it?  He must be, because if he vows "Read my lips, no new taxes," then there's no reason to believe taxes will go up. But he's not saying that.

Update: From comments:

...[Y]ou are overthinking this.  If we can be sure Bush believes in one thing, it is that cutting taxes always helps the econony, and raising taxes hurts it.  ...  Bush truly believes it.  So, no, of course he won't allow a Democraticly controlled Congress to raise taxes.  And, yes, of course he would veto such a bill.

So what did he mean? He has just simplified (dumbed down, if you will) his main point so that voters will get it: Democrats will not allow my tax cuts to become permanent.  True, not the same thing as "raising" taxes, but after 5 plus years of lower taxes, having the marginal rates "return" to their pre-cut rates would be the same thing ... as voters (who vote on the issue of lower tax rates) see it.

Wednesday, September 20, 2006

An Interview with Martin Feldstein

This interview with Marty Feldstein covers its share of controversial topics. The interview is fairly long, so if you want to pick and choose the section headers are: The Art of Monetary Policy, Time Consistency in Fiscal Policy, Social Security Reform, European Social Insurance, European Union, The Return of Saving, The Economics of Health and Health Care, Executive Compensation, Supply-Side Economics, Tax Reform Panel, and The NBER:

Interview with Martin S. Feldstein, by Douglas Clement, Interview on July 10, The Region, September 2006: As a Harvard professor for nearly 40 years, Martin Feldstein has taught economics to thousands of young students, many of whom later became quite influential in their own right—as Treasury secretaries, presidential advisers, corporate leaders, even Fed governors.

As a policy adviser, he chaired the Council of Economic Advisers during the Reagan years, and landed on the cover of Time magazine in 1984 for his controversial opposition to a growing budget deficit. He has a lower profile in Washington these days but remains extremely influential, helping the current administration develop its tax cut initiatives, for instance.

And as president of the National Bureau of Economic Research, the nation's preeminent economics think tank, Feldstein has shaped the course of economic scholarship for almost three decades: identifying key issues, encouraging empirical research, creating opportunities for cooperation and disseminating working papers of leading economists long before they appear in academic journals.

But years from now it is likely that Feldstein will be best remembered as a prescient public citizen, a scholar who identified some of the most serious economic predicaments of our time, developed pragmatic solutions to those problems and then pressed policymakers—persistently—to implement them.

Social Security. Health insurance. Distortionary taxes. Unemployment insurance. The current account deficit. These are the issues that Feldstein has pushed to the forefront of popular and policy agendas decade after decade. Through a prolific stream of professional articles, newspaper columns and scholarly books, as well as frequent speeches and media interviews, he maintains a stark spotlight on crises that others try to ignore.

Educated at Harvard and then Oxford, Feldstein returned to Harvard as an assistant professor in 1967 and two years later became one of the youngest economists granted tenure by the university. In 1977, he won the John Bates Clark award as the best American economist under 40.

Numerous achievements and awards have followed, but Feldstein seems most gratified by close collaboration with colleagues. In the following interview, held during a break from the NBER's 2006 Summer Institute, a three-week gathering in Cambridge of about 1,400 economists, Feldstein notes that earlier in the day Paul Samuelson compared the Institute to Niels Bohr drawing atomic physicists to Copenhagen in the 1920s. “I thought that was a nice sentiment,” Feldstein comments quietly. His smile suggests that he could hardly conceive of higher praise.

Continue reading "An Interview with Martin Feldstein" »

Thursday, September 14, 2006

How Progressive is the U.S. Federal Tax System?

There's been a lot of discussion about how progressive taxes are in the U.S. and how the progressivity of the tax code has changed over time. In particular, the Wall Street Journal editorial page, Eddie Lazear, and others have claimed that the Bush tax cuts have made U.S. taxes more progressive mainly because of changes at the top of the income distribution. Thomas Piketty and Emmanuel Saez, the leading experts on long-term trends in inequality, look at this question and conclude the opposite, that progressivity at the top of the income distribution has declined dramatically since 1960:

How Progressive is the U.S. Federal Tax System? A Historical and International Perspective, by Thomas Piketty and Emmanuel Saez, NBER WP 12404 Issued, August 2006: Abstract This paper provides estimates of federal tax rates by income groups in the United States since 1960, with special emphasis on very top income groups. We include individual and corporate income taxes, payroll taxes, and estate and gift taxes. The progressivity of the U.S. federal tax system at the top of the income distribution has declined dramatically since the 1960s. This dramatic drop in progressivity is due primarily to a drop in corporate taxes and in estate and gift taxes combined with a sharp change in the composition of top incomes away from capital income and toward labor income. The sharp drop in statutory top marginal individual income tax rates has contributed only moderately to the decline in tax progressivity. ...

In pictures, here's total federal taxes by income group in 1970 and 2004. Starting in 1960 instead does not change the picture much:

Tax191406

What caused this change between 1970 and 2004? Following Piketty and Saez and focusing on the top income groups (the following graphs collapse the income groups below the 90th percentile into one group), was it income taxes?:

Tax391406

Some, but not so much. How about payroll taxes?:

Tax491406

Nope, that's not it, those go the wrong way, though the overall percentage changes aren't that large. Corporate taxes perhaps?

Tax691406

Bingo. And how have estate taxes changed?:

Tax591406

That reinforces the corporate tax change. Thus, as noted in the abstract, the change in progressivity is due primarily to changes in corporate taxes with an assist from estate taxes, as well as a compositional effect not shown in these graphs.

From the conclusion to the paper, contrary to what others have said:

These large reductions in tax progressivity since the 1960s took place primarily during two periods: the Reagan presidency in the 1980s and the Bush administration in the early 2000s. The only significant increase in tax progressivity since 1960 took place in the early 1990s during the first Clinton administration.

Monday, September 11, 2006

Luck, Skill, and Progressive Taxes

The current debate over income inequality reminded me of this Hal Varian column from 2001 on the relationship between optimal taxation and whether income is derived from luck or skill:

In the debate over tax policy, the power of luck shouldn't be overlooked, by Hal Varian, NY Times, May 3, 2001: President Bush's proposed tax cut has rekindled an age-old debate: how progressive or regressive should the income tax be?

The United States has a generally progressive income tax, which means that at a given level of income, the marginal tax rate (the rate paid on the last dollar earned) is higher than the average tax rate at that level of income.

The result, according to a Heritage Foundation report by Daniel Mitchell, is that the top 1 percent of income earners account for about 35 percent of personal federal income tax collected, and the top 25 percent of the income distribution pays almost 83 percent. Over all, the upper half of the income distribution pays 96 percent of all federal income taxes collected.

Those who argue for a more progressive income tax emphasize equity: a tax dollar paid by a rich person causes less pain than a tax dollar paid by a poor person. Those who argue for a less progressive system emphasize efficiency: the most productive people should face lower tax rates to give them strong incentives to work harder and produce more.

These trade-offs have been examined in the economic literature concerning the ''optimal income tax.'' Economists model the trade-off as a mathematical optimization problem in which the quantity being maximized is some measure of overall welfare, which typically involves a concern for equity, while the constraints have to do with efficiency issues, like creating appropriate incentives for producers.

This formulation of the optimal income tax problem was first examined by the economist James Mirrlees of Cambridge University, who received a Nobel in economic science for his analysis. In the simplest version of the Mirrlees model, taxpayers differ only in their ability: how much they can produce with a given amount of effort. One striking result of this model is that those at the very top of the income scale should face low marginal rates.

This result emerges from a detailed mathematical analysis, but the intuition is not hard to explain. Let us assume, for the sake of argument, that Bill Gates made $1 billion in 2000, an amount larger than any other American taxpayer. Suppose further that despite the best efforts of his accountants, he ended up paying 40 cents of the last dollar he earned to the Internal Revenue Service.

Consider the following thought experiment: drop the marginal tax rate from 40 percent to zero for all incomes above a billion dollars. The I.R.S. won't lose any revenue from this reduction, since no one has an income larger than $1 billion. And who knows -- the lower marginal rate might encourage Mr. Gates to work a little harder in 2001, producing new products that would make him, and the rest of us, better off.

Of course, the fact that it pays to reduce the marginal tax rate for billionaires doesn't say much about what tax rates should be like for mere millionaires, a point that has been emphasized by Professor Mirrlees himself and confirmed by subsequent researchers, like Peter Diamond of the Massachusetts Institute of Technology and Emmanuel Saez of Harvard. But the intuitive argument presented above is pretty compelling: if income depends only on ability, those at the very top of the income-ability distribution should face low marginal tax rates.

But perhaps this model is too simple. One might well argue that Mr. Gates, as productive as he is, doesn't owe his success entirely to ability: there was a lot of luck involved, too. And, if truth be told, that's probably true even for mere millionaires.

So let's consider a different model: one in which differences in income are a result only of luck and have nothing to do with ability. In this case, the optimal income tax may well involve taxing billionaires at very high marginal rates. True, aspiring billionaires won't work quite as hard, since the after-tax reward from hitting $1 billion has been reduced. But the chances of becoming a billionaire are pretty low anyway, so taxing billionaires at a high rate won't really discourage much effort by those hoping to become one.

Thus a model where luck is the driving force tends to yield a more progressive optimal tax than a model where ability is the driving force. This is about as far as theory can take us, but it highlights the critical question: How much income results from ability and how much from luck?

It is safe to say that this question has not yet been completely resolved by the economics profession. Still, everyone seems to have an opinion about it: if you want to determine whether someone is a Republican or a Democrat, just ask that person whether differences in income come mostly from luck or from ability.

The preliminary evidence available from in-depth surveys like the Panel Study for Income Dynamics at the University of Michigan shows that income varies a lot from year to year for many households. Economists have found that random events like episodes of bad health, accidents, marital dissolutions and family emergencies play a large role in short-run year-to-year fluctuations in income.

A Harvard social policy professor, Christopher Jencks, and his collaborators pointed out many years ago that income inequality among brothers, who share similar genetic and environmental characteristics, is almost as great as for the population as a whole. This suggests that luck is an important factor in the long run as well.

If luck plays a substantial role in the determination of income, it makes sense to have a progressive income tax, creating a form of social insurance in which the lucky subsidize the unlucky. Perhaps the folk singer Phil Ochs had the best answer for why the upper half of the income distribution should pay so much more in taxes than the lower half: ''And there but for fortune, may go you or I.''

Friday, September 08, 2006

Promises, Promises

Brad DeLong makes a good point in response to Greg Mankiw's comments on Krugman's latest column.

Department of "Huh?", by Brad DeLong: Greg Mankiw, seeking to score rhetorical points off of Paul Krugman, writes:

Greg Mankiw's Blog: A Kept Promise: In 2000, candidate George W. Bush said: "On principle no one in America should have to pay more than a third of their income to the federal government." Today, in Paul Krugman's NY Times column, I learn: "the effective federal tax rate on the richest 0.01 percent has fallen from about 60 percent in 1980 to about 34 percent today."

Because this is the group with the highest average tax rate, I guess we should conclude that President Bush kept his promise.

Huh? No. 

No. No! No!! No!!! No!!!!

In no meaningful sense has George W. Bush reduced the tax burden. In no meaningful sense has he kept any promise. ... As Milton Friedman puts it, to spend is to tax. Bush's spending increases--defense, Iraq, the Republican porkfest, the Medicare drug benefit--are still there... What George W. Bush has done has been to shift taxes from the present to the future--and also made future taxes uncertain, random, and thus extra-costly from a standard public finance view.

The reality-based right-wing public-finance economists right now are not complimenting George W. Bush for keeping his promises to cut taxes. No, no, no, no, no. The reality-based right-wing public-finance economists are saying something very different than "President Bush kept his promise to cut taxes."

Brad goes on to document the comments of right-wing commentators who are:

All impeccably right wing. All reality-based. All well worth listening to. None would say that President Bush has "kept his promise" in any meaningful sense.

The question is who will bear the burden of future tax increases and spending reductions.

Update: PGL at Angry Bear adds:

But what if the future tax increases are levied on middle class Americans and the working poor? Then it is entirely possibly that the promise that no one “pay more than a third of their income to the federal government” might indeed be kept. Alas, few will pay much less than a third either. Of course, this wasn’t Greg’s point. Or was it?

Sunday, September 03, 2006

Income Inequality Follow-Up

I want to follow up on the most recent inequality post. Recall that the WSJ editorial page says that:

[N]ew data show that the bottom 50% of Americans in income ... paid a smaller share of total income taxes in 2004 (3.3%) than in Bill Clinton's last year in office (3.9%). That 3.3% is the lowest share of total income taxes paid by the bottom half of earners in at least 30 years, and probably ever. ...

By contrast, ... the top 5% and 10% of earners saw an increase in their tax share over that same period, with the top 5%'s share rising to 57.1% in 2004 from 56.5% in 2000. If this isn't the definition of a highly "progressive," aka redistributionist, tax code, we don't know what is.

Though I don't agree with defining progressivity according to share of taxes paid or by percent of income, I'd rather see it defined according to marginal tax rates, here's an example of how taxes can become more progressive according to the progressivity definitions used by the WSJ editors, and by others:

Suppose that the tax rate is 10% on the first 100 in income, and 30% after that.

Let person A have an income of 125. Taxes are 17.50.
Let person B have an income of 225. Taxes are 47.50.

Then the average tax paid as a percentage of income is 17.50/125 = 14% for person A. Similarly, person B's average tax rate is 47.50/225 = 21%. The shares of total taxes paid are 27% and 73% (e.g. 47.50/(17.50+47.50) = 73%)

Now move 50 from A to B, i.e. move 50 up the income ladder. This could be from government policy that redistributes income, productivity changes, or other reasons.

Person A now has an income of 75 and a tax burden of 10%. a smaller amount than before, and person B has an income of 275 and a burden of 23%, a larger amount than before. The shares of taxes paid have increased from 73% to 89% for person B, and have fallen from 27% to 11% for person A. Thus, taxes have become more progressive in the sense that average tax burdens have tilted upward, and in the sense that the share of taxes paid has increased for higher income people and decreased for lower income people.

Nobody should be surprised that the share of taxes paid by a particular group goes up when their share of income goes up. Nor should we be surprised that if a group's share of income falls to historic lows, the share of taxes will fall to historic lows as well. Share of taxes paid is a poor metric for assessing progressivity for this reason.

What is important, and where the debate should be focused, is why the shift in income shares has taken place, i.e. what is causing the more unequal distribution of income. Is it due to productivity or some other factor? If it's due to changing market power relationships, allocative inefficiencies, or government policies that transfer income upward, the fact that the higher income people now pay a larger share of total taxes may be of little consolation. Do conservatives really want to argue that increased progressivity is a good thing if it arises from redistributing income up the income ladder? Obviously not, and neither would liberals. So before we begin pointing to changes in the shares of taxes paid as evidence of increased fairness, we should be certain we know why the changes have occurred.

Currently, we don't know for certain, or even nearly so, and this is the subject of debate. The split is between those who think growing inequality is due to productivity changes, skill-based technological change in particular, and those who believe it arises from other factors such as changes in public policy (e.g. taxes, union busting) and globalization.

I believe that public policy plays a large role, but even if it is skill-based to some notable degree, public policy can still be a factor. For example, are we certain that the opportunity to acquire the skills needed to realize the skill-based premium are fair and equitable, i.e. that everyone has an equal chance to compete in the global economy? If the opportunity to acquire skills is not equal, has public policy (and doing nothing is a policy) played a role? If so, the role of public policy in bringing about inequality may be understated because econometric investigations designed to determine the source of income inequality will have trouble distinguishing the role of public policy in the skill acquisition process.

Friday, September 01, 2006

Opportunity Costs

What has your state given up?:

Oregon will pay $2.6 billion for the cost of war in Iraq. For the same amount of money, the following could have been provided:

  • 732,182 People with Health Care or
  • 46,359 Elementary School Teachers or 
  • 390,635 Head Start Places for Children or 
  • 1,363,209 Children with Health Care or 
  • 13,420 Affordable Housing Units or 
  • 255 New Elementary Schools or
  • 517,220 Scholarships for University Students or 
  • 46,214 Music and Arts Teachers or
  • 54,745 Public Safety Officers or 
  • 3,756,763 Homes with Renewable Electricity or 
  • 48,228 Port Container Inspectors 

$56.5 billion in tax cuts for the wealthiest 1% this year could be spent on the people of Oregon instead. If that money were used to support state and local programs, the residents of Oregon could have $688.3 million, which could provide:

  • 196,485 People with Health Care or
  • 12,441 Elementary School Teachers or
  • 104,829 Head Start Places for Children or
  • 365,825 Children with Health Care or
  • 3,601 Affordable Housing Units or
  • 68 New Elementary Schools or
  • 138,799 Scholarships for University Students or
  • 12,402 Music and Arts Teachers or
  • 14,691 Public Safety Officers or
  • 1,008,147 Homes with Renewable Electricity or
  • 12,942 Port Container Inspectors

Check these and other national budget tradeoffs for your state here [via C&L].

Thursday, August 31, 2006

Are Taxes on Interest Income Unconstitutional?

Bruce Bartlett looks for legal loopholes in the government's ability to levy income taxes:

Tax ruling with portent?, by By Bruce Bartlett, Commentary, Washington Times: Last week, a federal appeals court in Washington handed down an important decision relating to the definition of income for tax purposes. What is important is the decision is the first one in decades saying the Constitution itself limits what the government may tax. If upheld by the Supreme Court, it could significantly alter tax policy and possibly open the door to radical reform.

In the case, a woman named Marrita Murphy was awarded a legal settlement that included compensation for physical injury and emotional distress. The former has always been tax-exempt, just as insurance settlements are. Obviously, it makes no sense to tax as income the payment for a loss that only makes one whole again. One is not made better off, so there is no income. But under current law, compensation for nonphysical injuries are taxed.

Ms. Murphy argued that just as compensation for physical injuries only makes one whole after a loss, the same is true of awards for emotional distress. In short, it is not income within the meaning of the 16th Amendment to the Constitution. The appeals court agreed and ruled her award for emotional distress is not income and therefore not taxable.

Tax experts immediately recognized the far-reaching implications for other areas of the tax law. Tax protesters have long argued that the 16th Amendment did not grant the federal government power to tax every single receipt it deems to be income. Yet in practice, that is what the Internal Revenue Service does.

The very concept of income itself has never been defined in the tax law. It is pretty much whatever the IRS says it is. ...

One area where I would like to see the court go further has to do with whether interest constitutes income. To economists, some portion of the interest we receive on our saving is merely compensation for loss of the immediate enjoyment we would receive if we consumed our income today instead of saving it.

Think of it this way. Would you be satisfied receiving your paycheck a year from now instead of on payday? Of course not. You would suffer a real loss if you had to wait a year to get paid for your work. But if you were offered, say, 10 percent more in a year, you might say that was OK. Collectively, our willingness to put off consumption today for greater consumption in the future is what determines the pure rate of interest.

But in the view of many great economists, such as John Stuart Mill, the future interest is merely compensation for the loss of immediate satisfaction. Therefore, it is not income but more like an insurance settlement that simply makes us whole.

Now, obviously, market interest rates are more than simply a discount between present and future, as my example implies. A lot represents a return to risk and an adjustment for expected inflation. But in principle, some portion of interest is compensation for loss and therefore not income.

Given the logic of the Murphy decision, it is quite possible the risk-free, inflation-adjusted rate of interest could also be excluded from taxation on constitutional grounds. Following through that logic consistently would revolutionize taxation and eventually lead to a pure consumption tax, which most economists today favor.

I'm not predicting the Supreme Court will follow this logic. But it does open an interesting possibility that tax analysts will follow with interest.

Why can't wage income also be viewed as making a person whole for the sacrifice of working all day, or, in the language of the article, as a reward for delaying leisure (you can't go to the beach today if you work)? Being made whole for giving up consumption is not fundamentally different from being made whole for working, i.e. for giving up leisure.

Historically, arguing that interest income was the reward for a sacrifice allowed interest to be viewed as justified and provided a defense against the charge that interest income was unearned or undeserved. That is, the argument that giving up consumption involves a sacrifice in the same way that labor does was an attempt to show interest income was just like labor income - both involved a sacrifice and therefore both required compensation - it was not an attempt to distinguish interest income from labor income.

My guess is that Bruce Bartlett would say no problem, the more income taxes that are unconstitutional because they are compensation for sacrifice, the better. But, like him, I doubt the courts will find, nor do I think they should find, that interest or wages (or rents and profits where similar arguments can be made) cannot be taxed because "it is not income but more like an insurance settlement that simply makes us whole."

Update: PGL at Angry Bear also discusses Bartlett's article and in a similarly titled post notes, as I did only implicitly (his post came before mine), that this would shift the tax burden from capital income to labor income. He also notes this is consistent with an ongoing conservative agenda to eliminate taxes on capital income.

Update: Bernard Yomtov, in comments, adds:

[T]here is an additional flaw in Bartlett's "reasoning." Interest is not "compensation for loss" at all. It is part of a voluntary transaction in which the recipient exchanges cash now for more cash later. This is exactly like selling some physical object. If a car dealer makes, say, $1000 profit on the sale of a car this is not "compensation for the loss of the car," it is income.

Ms. Murphy's transaction was not voluntary. She did not choose to sell her emotional wellbeing. The compensation she received did not include a profit component.

If someone steals your car, and you get it back (or its cash equivalent), that is not income. The court ruling extends this principle to loss of emotional well-being.

Monday, August 21, 2006

Paul Krugman: Tax Farmers, Mercenaries and Viceroys

Back to a bad old future:

Tax Farmers, Mercenaries and Viceroys, by Paul Krugman, A Monarchy Commentary, NY Times: Yesterday The New York Times reported that the Internal Revenue Service would outsource collection of unpaid back taxes to private debt collectors, who would receive a share of the proceeds.

It’s an awful idea. Privatizing tax collection will cost far more than hiring additional I.R.S. agents, raise less revenue and pose obvious risks of abuse. But what’s really amazing is the extent to which this plan is a retreat from modern principles of government. I used to say that conservatives want to take us back to the 1920’s, but the Bush administration seemingly wants to go back to the 16th century.

And privatized tax collection is only part of the great march backward. In the bad old days, ...[t]here was no bureaucracy to collect taxes, so the king subcontracted the job to private “tax farmers,” who often engaged in extortion. There was no regular army, so the king hired mercenaries, who tended to wander off and pillage the nearest village. There was no regular system of administration, so the king assigned the task to favored courtiers, who tended to be corrupt, incompetent or both.

Modern governments solved these problems by creating a professional revenue department to collect taxes, a professional officer corps to enforce military discipline, and a professional civil service. But President Bush apparently doesn’t like these innovations, preferring to govern as if he were King Louis XII.

So the tax farmers are coming back, and the mercenaries already have. There are about 20,000 armed “security contractors” in Iraq, and they have been assigned critical tasks, from guarding top officials to training the Iraqi Army.

Like the mercenaries of old, today’s corporate mercenaries have discipline problems. “They shoot people, and someone else has to deal with the aftermath,” declared a U.S. officer... And armed men operating outside the military chain of command have caused at least one catastrophe. ...

To whom are such contractors accountable? Last week a judge threw out a jury’s $10 million verdict against Custer Battles, ... a symbol of the mix of cronyism, corruption and sheer amateurishness that doomed the Iraq adventure — and the judge didn’t challenge the jury’s finding that the company engaged in blatant fraud.

But he ruled that the civil fraud suit ... lacked a legal basis, because ... the Coalition Provisional Authority  ... wasn’t “an instrumentality of the U.S. government.” It wasn’t created by an act of Congress; it wasn’t a branch of ... any ... established agency.

So what was it? Any premodern monarch would have recognized the arrangement: in effect, the authority was a personal fief run by a viceroy answering only to the ruler. And since the fief operated outside all the usual rules of government, the viceroy was free to hire a staff of political loyalists lacking any relevant qualifications for their jobs, and to hand out duffel bags filled with $100 bills to contractors with the right connections.

Tax farmers, mercenaries and viceroys: why does the Bush administration want to run a modern superpower as if it were a 16th-century monarchy? Maybe people who’ve spent their political careers denouncing government as the root of all evil can’t grasp the idea of governing well. Or maybe it’s cynical politics: privatization provides both an opportunity to evade accountability and a vast source of patronage.

But the price is enormous. This administration has thrown away centuries of lessons about how to make government work. No wonder it has failed at everything except fearmongering.

_________________________
Previous (8/18) column: Paul Krugman: Wages, Wealth and Politics
Next(8/25) column: Paul Krugman: Housing Gets Ugly

Saturday, August 12, 2006

Reviving Estate Tax Reform

The WSJ's Washington Wire reports:

New Life for Death Tax Reduction?, WSJ Washington Wire:  Sen. Grassley of Iowa moves to revive estate tax legislation despite the bill’s second defeat on the Senate floor last week. A spokeswoman says Grassley would like to craft an estate tax compromise in the Finance Committee that can win the support of Democrats. Republicans may also take up a new package of popular but expiring tax incentives that were defeated along with the estate tax bill. Hopes for a big cut faded when the Senate failed to pass legislation before summer recess. But some Republicans are determined to take action this year, in part out of fear that if Democrats pick up seats in November, further estate tax cuts will become impossible in a new Congress.

Give it up.

Tuesday, August 08, 2006

Without Tax Cuts, the Budget Would Be Balanced

Here are the details from the Center on Budget and Policy Priorities based upon a Congressional Budget Office analysis:

New CBO Deficit Estimate Indicates that Without the Tax Cuts, The Budget Would be Balanced, by James Horney, CBPP: The Congressional Budget Office announced on August 4 that it now projects the deficit will be $260 billion for fiscal year 2006... CBO’s projection of the deficit for the current year is $30 billion below the level projected by the Administration when it released its Mid-Session Review of the Budget on July 11. ...

Some may assume that the CBO estimate means that tax revenues are coming in at even higher levels than the Administration assumed just a few weeks ago. Such an assumption, however, would be incorrect... Furthermore, the new CBO estimate indicates that were it not for the tax cuts of recent years, the budget would now be in balance.

  • CBO is not projecting that revenues will be higher in 2006 than the Administration projected last month. ... CBO’s projected deficit for 2006 is $30 billion lower than the Administration’s July estimate because CBO estimates that spending will be $30 billion lower this year than the Administration’s estimates showed.
  • CBO’s projection that spending in 2006 will be lower than the Administration has estimated is not surprising. ... OMB commonly overestimates current-year spending when issuing its Mid-Session Review. Federal agencies generally report to OMB each June that they will expend more of their funding by the end of the fiscal year than they actually end up doing. CBO’s mid-year estimates more accurately take this factor into account...
  • CBO’s deficit estimate of $260 billion in 2006 illustrates one other reality, as well. Based on Joint Committee on Taxation estimates, the tax cuts enacted since January 2001 are costing a total of $258 billion in 2006 (including the increased interest costs of the debt that result from the borrowing that is required to cover the lost revenues). This means that even with the spending for the wars in Iraq and Afghanistan and the response to Hurricane Katrina, the federal budget would essentially be in balance this year if the tax cuts had not been enacted, or if they had been offset by either increases in other taxes or cuts in programs, as would have been required under the Pay-As-You-Go rules that tax-cut proponents first ignored and then allowed to expire.

This might be worth remembering when it is suggested that cuts to essential programs are necessary to bring the budget into balance. They're not. There may be good reasons to cut dividend and capital gains taxes from an economic efficiency standpoint, so I am not suggesting that those particular taxes be reversed. But that does not exhaust the possibilities for increasing revenue and less distortive taxes are available to make up the revenue loss without sacrificing progressivity. What I am suggesting is that we think hard about who pays for the tax cuts - should it be a tax shift to reduce distortions or should it be cuts to programs - because it's very clear tax cuts won't pay for themselves.

Tuesday, August 01, 2006

Gimme Tax Shelter

It's just a sham away:

Tax Cheats Called Out of Control, by David Cay Johnston, NY Times: So many superrich Americans evade taxes using offshore accounts that law enforcement cannot control the growing misconduct, according to a Senate report that provides the most detailed look ever at high-level tax schemes. ... Cheating now equals about 7 cents out of each dollar paid by honest taxpayers, as much as $70 billion a year, the report estimated.

“The universe of offshore tax cheating has become so large that no one, not even the United States government, could go after all of it,” said Senator Carl Levin, the Michigan Democrat whose staff ran the investigation.

Senator Norm Coleman, the Minnesota Republican who is chairman of the subcommittee, adopted the minority report on Sunday as the product of the full committee. ... The investigation, which took 18 months, involved 74 subpoenas, 80 interviews and the collection of more than two million documents...

The 400-page report recommends eight changes, some of them aimed at going after the law and accounting firms, banks and investment advisers that the report says enable tax schemes that rely on complexity, secrecy and compartmentalizing information so that advisers can claim they had no idea that the overall transaction was a fraud.

“We need to significantly strengthen the aiding and abetting statutes to get at the lawyers and accountants and other advisers who enable this cheating,” Senator Levin said, adding that “we need major changes in law to stop the use of tax havens” by tax cheats.

It also recommends new rules that strip away the underlying legal presumptions that make offshore tax havens like the Cayman Islands, Nevis, the Isle of Man and Panama attractive places for Americans to hide assets and income from the Internal Revenue Service. Senator Levin said the law “should assume that any transaction in a tax haven is a sham.”

He said that during the investigation he grew angry as he learned how common cheating had become and how existing government rules aided tax cheats. He said that complex schemes were broken into discrete pieces, allowing professional advisers working on each piece to assert that they had no idea that, taken as a whole, a scheme was improper.

“I get incensed by people who use tax havens to not pay their taxes while the average guy has to pay his taxes because they are taken out of his pay before he gets it,” he said. ...

Saturday, July 29, 2006

How Would You Solve the Deficit Problem?

This is an exercise by a group of "ordinary" people to see what measures they would take to cut the deficit. They are surprisingly open to tax increases. In an attempt to find lessons for both political parties, the result that tax-increases are widely endorsed by the group is mentioned along with the observation that the group was open to change in Social Security and Medicare programs, but I read the support for tax increases as much stronger than the support for big changes in social programs:

Public’s Deficit Fix May Stun Politicians, by Edmund L. Andrews, Economic View, NY Times: ...Could three dozen ordinary American adults who had never met before — a group that included fresh college graduates, retired schoolteachers and a self-employed business owner — reach agreement on how to prevent a fiscal train wreck? Could they do any better than their elected leaders in Washington, and were they willing to make any sacrifices? ...

The effort, conducted two weeks ago, was sponsored by ... the Brookings Institution, home to many centrist Democrats; the Heritage Foundation, a conservative stronghold...; and the Concord Coalition, a bipartisan group that advocates fiscal discipline but is essentially neutral on whether it should come from higher taxes or lower spending...

The researchers are still analyzing the results, to be published later this summer. But the session in Philadelphia left some strong impressions on a reporter permitted to observe it. Among them:

• The participants didn’t hate taxes nearly as much as many Republicans think.

• They seemed to treasure Social Security and Medicare in their current forms, but were more open to change than many Democrats think.

• None of the participants pushed for less defense spending, even if the war in Iraq were to wind down.

• Nobody could agree on a single government program that ought to be cut or eliminated altogether.

The good news was that people here appeared less polarized and more open to sharing burdens than do their elected leaders in Washington. The bad news was that the ... group thought the best solutions were to tax other people (smokers, drinkers, S.U.V. buyers, the rich) or to somehow “spend smarter.”

In that sense, participants were much like their elected representatives. The difference was that people were willing to contemplate higher taxes or other measures considered taboo in one party or the other.

Virtually no one needed to be persuaded that the federal budget is on an unsustainable path. ... Participants were given four strategies for tackling the problem. The first was do nothing, but wait and hope that economic growth eliminated the need for big changes.

The second approach put a priority on “keeping our promises to the elderly” while raising taxes and cutting spending in other areas.

The third was to “increase personal responsibility and choice,” shifting Medicare and Social Security from government financing to individual investment-type accounts.

The last strategy was to “invest in the future,” putting more money into education and economic development, but raising taxes and trimming old-age programs. ...

[N]o one endorsed “wait and hope,” the de facto strategy in Washington. More surprising, virtually all the participants agreed on the need for higher taxes. Many supported a repeal of Mr. Bush’s tax cuts of 2001.

That contrasted sharply with the adamant opposition to tax increases among Republican leaders, especially President Bush. But the openness to at least talking about higher taxes appeared unanimous among those in the Philadelphia group, including those who described themselves as supporters of Mr. Bush.

“I was surprised that so many people were in favor of higher taxes, but I think it’s a good thing,” said Anthony Condo, a construction contractor in his 50’s and a strong Bush supporter. “If taxes went up to lower the deficit, and I knew they were being used for that, I would be in favor of it.”

This isn’t to say that tax increases amount to a winning election issue. “Focus groups and polls create a kind of laboratory with conditions that don’t always exist in the real world,” said Geoffrey D. Garin, president of ... a polling company that does work for many Democratic candidates (and was not involved in the ... exercise). ...

When the subject shifted to reducing government spending, the group seemed less successful. Few if any people thought military spending was too high — even if the United States withdrew from Iraq. Nor was there agreement on other programs to cut. Most wanted more money for education, and many wanted more money for prescription drugs. Budget cuts, such as they were, involved “smarter” spending and a crackdown on waste, fraud and abuse...

Still, people seemed willing to accept change. Despite intense support for Social Security, for example, many said that workers should be encouraged to postpone retirement. And despite support for Medicare, there was approval for reducing “heroic” high-technology measures that might keep very old and very ill people alive for a few weeks or months.

So if there was a message, it was not that people wanted to dodge tough choices. It was that they wanted good ideas from their leaders.

Quick note: I have been resistant to the idea of raising the retirement age, more so than most, because I wanted to be convinced that the health of older workers had increased enough to justify such a change. This gives me reason to reconsider, but only as part of a more comprehensive (and reality-based) reform plan.

Friday, July 28, 2006

Dynamic Scoring Undermines the Arguments of Tax-Cut Advocates

It's getting repetitious repeating the same thing again and again, that tax cuts do not pay for themselves, etc., but Paul Krugman's column today makes me realize that we need to keep rebutting the claims of tax-cut advocates for as long as the "propaganda machine" is up and running, and it doesn't run out of gas easily.

In this article from the Center on Budget and Policy Priorities, Jason Furman makes the same point in the box below that I made here about changes in the level of output versus changes in economic growth (see David Altig also). If anyone tries to tell you that tax cuts change the long-run growth of output per capita, call them on it. They don't.

The CBPP report is followed by an article from American Prospect on inconsistencies in the "starve the beast" and "tax cuts pay for themselves" dogma espoused by tax-cut advocates:

Treasury Department Dynamic Scoring Analysis Refutes Claims by Supporters of Tax Cuts, by Jason Furman: On July 25, the Treasury Department released a study entitled “A Dynamic Analysis of Permanent Extension of the President’s Tax Relief.” This study refutes many of the exaggerated claims about the tax cuts that have been made by the President and other senior Administration officials, the Wall Street Journal editorial page, and various other tax-cut advocates. Contrary to the claim that the tax cuts will have huge impacts on the economy, the Treasury study finds that even under favorable assumptions, making the tax cuts permanent would have a barely perceptible impact on the economy. Under more realistic assumptions, the Treasury study finds that the tax cuts could even hurt the economy.

In addition, the study casts doubt on claims that the tax cuts are responsible for much of the recent growth in investment and jobs. It finds that making the tax cuts permanent would lead initially to lower levels of investment, and would result over the longer term in lower levels of employment (i.e., in fewer jobs).

Misunderstanding of the Treasury Study Mars Some News Accounts

Some of the reporting on the Treasury analysis has made a basic mistake. The Treasury study found that making the tax cuts permanent would increase the size of the economy over the long run — i.e., after many years — by 0.7 percent, if the tax cuts are paid for by unspecified cuts in government programs. This is a very small effect. If it took 20 years for the 0.7 percent increase to fully manifest itself (Treasury officials have indicated it would take significantly more than ten years but have not been more specific than that), this would mean an increase in the average annual growth rate for 20 years of four-one-hundredths of one percent — such as 3.04 percent instead of 3.0 percent — an effect so small as to be barely noticeable. Moreover, after the 20 years or whatever length of time it would take for the 0.7 percent increase to show up, annual growth rates would return to their normal level — that is, they would be no higher than if the tax cuts were allowed to expire.

Several news reports, however, mistakenly said that the Treasury found that making the tax cuts permanent would lead to a 0.7 percentage point increase in the annual growth rate. If true, that would be an enormous economic benefit; it would increase the size of the economy by 40 percent after fifty years. It would be more than fifty times larger than the 0.7 percent increase in the size of the economy over several decades that the Treasury study actually found.

The Treasury also study decisively refutes the President’s claim that “The economic growth fueled by tax relief has helped send our tax revenues soaring,” — in essence, that the tax cuts have more than paid for themselves. Instead, under the study’s more favorable scenario, the modest economic impact of the tax cuts would offset less than 10 percent of the cost of making the tax cuts permanent.

Finally, the conclusions in the Treasury study are based on the assumption that the tax cuts will be paid for by deep and unspecified cuts in government programs starting in 2017. The Treasury study is consistent with other research on dynamic scoring in finding that in the absence of such budget cuts — i.e., if the tax cuts continue to be deficit financed indefinitely — the tax cuts would end up weakening the economy over the long run.

The following are four key findings from the report.

Finding #1: At best, making the tax cuts permanent would have a barely perceptible effect on the economy. ...Moreover, the Treasury study acknowledges that the long-run growth rate would not rise at all... 

Finding #2: The tax cuts would pay for less than 10 percent of themselves in the long run. ...This finding shreds claims that the tax cuts are paying for themselves or even offsetting a sizable fraction of their costs...

Finding #3: Tax cuts will benefit the economy modestly only if they are paid for by large and unspecified cuts in government programs. The featured results in the Treasury study are based on the assumption that government programs are cut sharply starting in 2017 in order to pay for the tax cuts. ... That would be equivalent to cutting domestic discretionary spending in half...

Finding #4: The Treasury study confirms that it is more prudent to raise taxes by a small amount today than to raise them by a larger amount in the future. ... The Treasury study ... finds that cutting taxes today and raising them by even more in the future to make up for the lost revenue and the larger deficits would ultimately reduce the size of the economy (real GNP) by 0.9 percent. ...

Here's another piece along the same lines from The American Prospect. This is Robert S. McIntyre, director of Citizens for Tax Justice:

Report Retort, by Robert S. McIntyre, American Prospect: For decades, most Republican politicians have treated as an article of faith that tax cuts, especially tax cuts for the rich, will “pay for themselves” through improved economic growth and resulting higher revenues. Critics deride this implausible belief as “voodoo economics” or “the free-lunch theory.” Its adherents prefer to call it “supply-side economics.”

Oddly, the same GOP politicians who think tax cuts augment revenues also fervently hold exactly the opposite position, which they call “starve the beast.” They insist that big tax cuts will so sharply reduce revenues that they will force steep cuts in government programs.

The apostle of these conflicting dogmas was President Ronald Reagan, back in the 1980s. On the one hand, Reagan claimed that the way to stop Congress from providing what he saw as excessive public services was to “cut off their allowance.” On the other hand, he also promised that he would pay for his huge increase in defense spending “with the revenues generated by the [even huger] tax cuts” he pushed through Congress in 1981. As it happened, of course, neither theory panned out.

Despite the sorry historical record, our current president, George W. Bush, and most of his fellow Republicans in Congress are ardent disciples of Reagan’s contradictory belief system. In their ongoing and increasingly desperate search for proof of their faith -- at least the part that holds that tax cuts are a blessing for the economy and the federal budget -- Bush and Congress recently asked the Treasury Department to undertake a “dynamic analysis” of the economic and budgetary effects of making the Bush tax cuts permanent...

On July 25, the Treasury Department released its report. Despite the fact that Treasury is managed by Bush appointees who profess a deep affection for Bush’s tax-cutting policies, the results offer no comfort to supply-side true believers.

Instead, Treasury’s study found that extending Bush’s tax cuts would have essentially no beneficial effect on the U.S. economy at all. But, the report casually implies, it could have grave consequences for the ability of our government to deliver the public services that Americans depend on. ...

I think it's also worth recall in Menzie Chinn's excellent point that this is not a welfare analysis. For example, in the analysis no benefit is derived from what the government does with the taxes it collects. If the government builds schools, water systems, roads, keeps the elderly healthy and out of poverty, and so on, the study does not include any benefit from such spending.

Update: David Altig clarifies in comments:

Mark -- I think the statment "If anyone tries to tell you that tax cuts change the long-run growth of output per capita, call them on it. They don't." is too strong.  It is true that they don't in the class of exogenous growth models that the Treasury group seems to employ.  However, such effects are clearly possible in some variants of endogenous growth models. Cheers -- da

Thanks David. I should have made it clear, as I hope it was in the original discussion when I quoted from the report, that I was talking in the context of the model used by Treasury that had generated all the buzz. Better wording would have been, "If anyone tries to tell you ... using the evidence in the report ..."

Wednesday, July 26, 2006

Tax Cuts and Changes in Output

One more time, tax cuts do not pay for themselves:

Tax Cuts May Come At a Price, Study Says Treasury: Financing Must Be Found, by Nell Henderson, Washington Post: The federal government will need to either cut spending or raise taxes down the road to pay for extending President Bush's recent tax cuts, the Treasury Department said in a report released yesterday, dismissing the idea popular with many Republicans that such sacrifices can be avoided.

The ... Treasury's view reflects "a recognition the federal government has to finance the tax relief" to avoid a rise in government debt, Robert Carroll, deputy assistant secretary for tax analysis, said in an interview.

The report stressed that the economic effects of extending the tax cuts "depend crucially on whether they are financed by lower spending or higher taxes in the future." ...

If ... tax cuts are extended and matched by comparable reductions in government spending, under the best scenario, the nation's level of economic activity would be increased by about 0.7 percent per year over time, or by $90 billion a year in current dollars, Carroll said.

If the government instead decides to raise taxes later, effectively making the tax cuts temporary, that could lower economic output over time, the report said. ...

The Treasury report released yesterday relieved "a lot of fears that dynamic scoring would lead to the view that cutting taxes raises revenue," said Jason Furman... Rather, the report "pours a huge bucket of cold water on the exaggerated claims that tax cuts transform the economy and pay for themselves." ...

Here's commentary from the WSJ on the same topic posted on Greg Mankiw's blog:

Dynamic Analysis by Robert Carroll and N. Gregory Mankiw, Commentary, WSJ: Does tax relief mean more economic growth? Many people believe the answer is yes, and now they get strong support from the staff of the U.S. Treasury.

Most press reports on the Mid-Session Review of the federal budget, released by the Bush administration a couple of weeks ago, focused on the good news about expanding tax revenues and the shrinking budget deficit. But for tax-policy geeks, the most intriguing part of the report was an easily overlooked box on page 3: "A Dynamic Analysis of Permanent Extension of the President's Tax Relief." Over the past six months, the Treasury Department staff has been studying the dynamic effects of tax cuts on the economy. The results of this analysis, previewed in this box, were released yesterday in more complete form (available at http://www.treas.gov/offices/tax-policy/).

A bit of background: Most official analysis of tax policy is based on what economists call "static assumptions." While many microeconomic behavioral responses are included, the future path of macroeconomic variables such as the capital stock and GNP are assumed to stay the same, regardless of tax policy. This approach is not realistic, but it has been the tradition in tax analysis mainly because it is simple and convenient.

In his 2007 budget, President Bush directed the Treasury staff to develop a dynamic analysis of tax policy, and we are now reaping the fruits of those efforts. The staff uses a model that does not consider the short-run effects of tax policy on the business cycle, but instead focuses on its longer run effects on economic growth through the incentives to work, save and invest, and to allocate capital among competing uses.

The Treasury report describes what will happen to the economy if the tax relief of the past few years is made permanent, compared to the alternative scenario of reverting back to the tax code as it was in 2000. Specifically, the report analyzes the effects of lower taxes on dividends and capital gains, the effects of lower taxes on ordinary income, and the extension of other tax cuts, including the new 10% bracket, the expanded child credit and marriage-penalty relief. Here are three main lessons.

Lesson No. 1: Lower tax rates lead to a more prosperous economy.

According to the Treasury analysis, a permanent extension of the recent tax cuts leads to a long-run increase in the capital stock of 2.3%, and a long-run increase in GNP of 0.7%. In today's economy, such a GNP expansion would mean an extra $90 billion a year that the nation can spend on consumer goods to raise living standards, or capital goods to maintain prosperity. More than two-thirds of this expansion occurs within 10 years.

Lesson No 2: Not all taxes are created equal for purposes of promoting growth.

Some tax rate reductions have a profound impact on incentives and economic growth, while others have minimal or even adverse effects. The Treasury staff reports particularly large bang-for-the-buck from the reductions in dividends and capital-gains taxes. Even though these tax cuts account for less than 20% of the static revenue loss from permanent tax relief, they produce more than half of the long-run growth.

At the opposite end of the spectrum are the tax reductions from the 10% bracket, child credit and marriage-penalty relief. These tax cuts put money in people's pockets when, during the recent recession, the economy needed a short-run boost to aggregate demand. They also fulfill other objectives, such as making the tax system more progressive. But they illustrate that not all tax cuts promote long-run growth. Treasury estimates that without the tax reductions from the 10% bracket, child credit and marriage-penalty relief, the long-run increase in GNP would be larger -- 1.1% rather than 0.7%.

Lesson No 3: How tax relief is financed is crucial for its economic impact.

Like all of us, the government eventually has to pay its bills. In technical terms, the government faces an intertemporal budget constraint that ties the present value of government spending to the present value of tax revenue. This means that when taxes are cut, other offsetting adjustments are required to make the numbers add up.

The Treasury's main analysis assumes that lower tax revenue will over time be accompanied by reduced spending on government consumption. But the report also shows what happens if spending cuts are not forthcoming. In this alternative scenario, a permanent extension of recent tax relief is assumed to lead to an eventual increase in income taxes.

The results are strikingly different. Instead of increasing by 0.7% in the long run, GNP now falls by 0.9%. Tax relief is good for growth, but only if the tax reductions are financed by spending restraint. One exception: Lower taxes on dividends and capital gains promote growth, even if they require higher income taxes.

These Treasury results are sure to spark debate and further research. While the Treasury report is not the last word on dynamic analysis, it is a big step toward a more realistic view of tax policy.

This says that cutting taxes knowing that you will have to raise them again in the future is unwise because it will result in a lower level of output.

I want to point out that Lesson 1 summarizes the effect of the policy on the level of output, a movement to a new steady state. It is not a change in economic growth. A one-shot increase in the capital stock of 2.3% increases the level of output, in this case by .7% if (infeasible) cuts in spending are used to cover the tax cuts, but there is no change at all in the growth rate of output. Quoting from the report, "In the steady state, per-capita growth in the model is equal to a constant rate of technological change." I've missed something somewhere. The commentary is about changes in economic growth, not changes in the level of output, so it would be helpful to see the connection between tax cuts and the (constant) rate of technological change explained further since an increase in the rate of technological change is needed to increase the growth rate of per capita output.

Finally, the acknowledgement that this is not that last word, and that further research is needed, says not to take the actual numbers the model produces too seriously -- they are subject to a great deal of uncertainty.

Update: Menzie Chinn at econbrowser also comments on the Treasury report.

Update: David Altig at macroblog follows up with "A Teachable Moment."

Tuesday, July 25, 2006

Don't Like the Estate Tax? Don't Enforce It

Maybe the problem with our current leadership is that many of the people in charge, people who grew up with wealth, power, and prestige, are used to getting their own way. They cannot stand or accept being told they can't do what they want to do, so they just find a way to do it anyway. This is from A Taxing Matter:

If you can't cut the estate tax, cut the enforcement team, by Linda M Beale: The New York Times carried an interesting article on a scoop based on internal documents at the IRS. See David Cay Johnston, IRS Will Cut Tax Lawyers Who Audit the Richest: "The IRS plans to cut the jobs of 157 of the agency's 345 estate tax lawyers, plus 17 support personnel, in less than 70 days." The person ordering the cuts, Kevin Brown, said it was done because far fewer people need to pay estate tax under the Bush legislation... But the Times articles notes that "six IRS estate tax lawyers whose jobs are likely to be eliminated said in interviews that the cuts were just the latest moves behind the scenes at the IRS to shield people with political connections and complex tax-avoidance devices from thorough audits." Another called them "a back-door way for the Bush Administration to achieve what it cannot get from Congress, which is repeal of the estate tax."

This decision to cut enforcement personnel makes no sense from ... a collections efficiency standpoint. ... [W]ealthy people are the ones with the most to gain from cheating, and estate tax is one of the ways they can cheat most easily, with fake family partnerships and ridiculously low prefab valuations of their valuable property. As Colleen Kelly states, "If these lawyers are not there to audit the gift and estate tax returns, than a lot of taxes that should be paid will go uncollected..."

The NY Times article also notes that:

Estate tax lawyers are the most productive tax law enforcement personnel at the I.R.S., according to Mr. Brown. For each hour they work, they find an average of $2,200 of taxes that people owe the government.

I assume that, even with benefits thrown in, the I.R.S. tax lawyers make less than $2,200 per hour. If so, why is Mr. Brown eliminating them?

Sunday, July 23, 2006

Florida's "Biblical Use" Exemption

This is from the blog A Taxing Matter written by Linda Beale, a "law professor at the University of Illinois College of law who teaches various courses in the area of federal income tax--statutory construction (tax), introduction to federal income tax, corporate taxation, and introduction to international taxation":

Florida's "Biblical Use" Exemption, by Linda M Beale: A new Florida statute (L. 2006, H 7183 (c. 164)) takes effect on the first of July. It provides an exemption from ad valorem tax for the use of property owned by a 501(c)(3) tax exempt organization to "exhibit, illustrate, and interpret Biblical manuscripts, codices, stone tablets, and other Biblical archives, provide live and recorded demonstrations, explanations, reenactments, and illustrations of Biblical history and worship; and exhibit times, places, and events of Biblical history and significance." Id.

Now, this is clearly not a federal tax issue (the State is merely using the federal tax-exempt organization category as a part of its definition for the tax expenditure). But is it a constitutional one? Is it really cricket for a state to single out events and exhibits related to the Bible for a tax exemption? Yes, parts of the Bible are sacred to both Jews and Christians, but isn't this providing the imprimatur of the state selectively to the Judeo-Christian heritage over all other religious heritages (Muslim, Hindu, Buddhist, etc.)? Maybe the legislators who passed this law, and Jeb Bush who signed it into law on June 9, would argue that it is merely a form of support for a particular type of historical scholarship/experience that just happens to be closely connected to fundamentalist Christian views.

But the facts, as always, are telling. This legislation was passed to aid a specific entity--a Christian theme park in Orlando, Florida called the Holy Land Experience. See this discussion in the St. Petersburg Times. The park is quite profitable, and the local county in which it is located tried to tax it (about $300,000 a year). The park argued that the profits financed its Christian ministry and so it was entitled to a property exemption. The park won the first round in court, but the county appealed. Then the legislature decided to step in and make sure that the institution couldn't be taxed. The county has now conceded defeat on the issue and dropped its suit for back taxes. See Holy Land Experience Wins Final Round. The Republican state senator who sponsored the bill said it was intended to cover only the Christian theme park and that it had been "stiffly worded" to ensure that object. Id. But, of course, there are always loopholes that can be exploited. Apparently a creationist group that runs a dinosaur park is trying to become eligible for the exemption now. Id.

Even conceding arguendo the constitutional concern (i.e., a violation of the First Amendment Establishment Clause because the state is selectively endorsing a particular religion), I wonder about the wisdom of this kind of preferential treatment for activities so closely associated with evangelical Christians today. We are a pluralistic society with people whose roots lie in many different cultural and religious heritages. Where is the state regard for the Koran, the Vedas and the history of religious societies and worship that those documents represent? Our basic notion of respect for individuals depends on respectful treatment of each person's core beliefs and values, even though they may differ from our own. Florida seems to have missed the boat here.

Continue reading "Florida's "Biblical Use" Exemption" »

Thursday, July 20, 2006

Yet Another Robert Samuelson Edition...

Robert Samuelson repeats a familiar refrain on the budget deficit:

No Shame, No Sense and a $296 Billion Bill, by Robert J. Samuelson, Commentary, Washington Post: For those who believe our leading politicians are utterly shameless, there was dreary confirmation last week. President Bush publicly bragged about the federal budget. Here's the objective situation that inspired the president's self-congratulation: With the unemployment rate at 4.6 percent (close to "full employment" by anyone's definition), the White House and Congress still can't balance the budget. For fiscal 2006, which ends in September, the administration projects a $296 billion deficit; for fiscal 2007, the estimate is $339 billion. How could anyone boast about that?

Easy. In February the administration projected a $423 billion deficit for 2006, so the latest figure is a huge drop. A skeptic might say that the first estimate was inept; some cynics argue that it was deliberately exaggerated to magnify any subsequent improvement. Naturally the president had a different story. The shrinking deficits, he said, proved that his tax cuts are working. ... All around Washington, Republicans staged media events to hug themselves for their good work.

The tendency for politicians to claim credit for favorable news is as natural as flatulence in cows. Still, the Republicans' orgy of self-approval amounts to a campaign of public disinformation. It obscures our true budget predicament. Let's go back to basics. Here are two essential points.

First, budget deficits are not automatically an economic calamity. Their effects depend on their timing, their size and other economic conditions. During recessions, deficits may prop up the economy. In a boom, they may drain money from productive investments. Similarly, deficits are only one influence on interest rates; others include inflation, the demand to borrow, the supply of savings and Federal Reserve policy. At present the effect of deficits is modest; otherwise, rates would be higher than they are (about 5 percent on 10-year Treasury bonds).

What truly matters is government spending. If it rises, then future taxes or deficits must follow. There's no escaping that logic. The spending that dominates the budget is for retirees. Social Security, Medicare (health insurance for those 65 and over) and Medicaid (partial insurance for nursing homes) already exceed 40 percent of federal spending. As baby boomers retire, these costs will explode. ...

Second, the budget should be balanced -- or run a surplus -- when the economy is close to "full employment," as it is now. Balancing the budget forces politicians to make uncomfortable choices. Which programs are sufficiently needed or popular to justify unpleasant taxes? Balancing the budget also lightens the debt burden. One figure Bush doesn't praise is the annual interest payment on the growing federal debt. Even by White House estimates, it will rise from $184 billion in 2005 to $302 billion in 2011.

Some conservatives rationalize their indifference to deficits as "starving the beast." If you cut taxes and create deficits, government will spend less because it has less -- much like a teenager whose allowance is cut. But the theory doesn't fit the facts. ...

I have reserved my harshest scorn for Republicans, who are (after all) in power. But Democrats aren't much better. The nub of the matter is spending. When Republicans passed the Medicare drug benefit -- the biggest new program in decades -- Democrats actually advocated a more costly version. Whenever anyone suggests curbing spending, Democrats screech: Spare Social Security and Medicare. But Social Security and Medicare are the problem.

Just as Republicans now say their policies have cut deficits, Democrats contend their policies produced budget surpluses from 1998 to 2001. Nonsense. Those surpluses resulted mainly from the end of the Cold War (which lowered defense spending) and the economic boom (which created an unpredicted surge of taxes). In a $13 trillion economy, much of what happens has little to do with the White House's economic policies. The bipartisan reflex is to claim credit where little is due. ...

Nothing significant will happen because it's in no one's interest for anything significant to happen. Republicans don't want to raise taxes or restrain their spendthrift habits. Democrats love big deficits as rhetorical grenades to lob at the Republicans. The present paralysis is perfectly understandable. But to brag about it is disgraceful.

He contradicts himself in his misguided attempt to try and be 'fair' and make sure to criticize both parties. He says first that Republicans are to blame because with an economy near full employment, we should be running surpluses, not deficits. That we aren't is a policy mistake. But when it comes to Democrats who did just that in 1998 to 2001, ran a surplus during a boom, he says it's nonsense that they had anything to do with it and they deserve no credit, only scorn.

Second, time to roll the tape. Here's Brad DeLong on quite similar claims made by Samuelson in the past:

Why Oh Why Can't We Have a Better Press Corps? (Yet Another Robert Samuelson Edition): Mark Thoma directs us to Robert Samuelson in Newsweek on Washington's apparent lack of concern about the budget deficit:

MSNBC - A Deficit of Seriousness : There's no one in Washington--no one with any power--trying to balance the budget. President George W. Bush's budget did not ever envision reaching a balance. The Republican Congress's new budget resolution purports to halve the budget deficit by 2010 but does so only on the basis of optimistic assumptions. Balancing the budget is simply too much trouble. It requires asking unpopular questions about who deserves help, which government programs actually work--and how to pay for the rest. Plenty of programs could disappear without serious ill effects....

In this debate, there is no high moral ground. To critics, the Republican budget strategy is 'starve the beast'--cut taxes and use the resulting deficits as an excuse to squeeze spending. Agree or disagree, that's principled; it's a means to an end (smaller government). In practice, the real Republican strategy is more cynical--cut taxes and feed the beast. ... In 2003, Bush proposed and Congress approved the biggest new spending program since Lyndon Johnson, the Medicare drug benefit. It was all deficit financing; there was no new tax for any of it. Gone is any sense of shame about overspending and undertaxing. For 2006, the... estimated deficit close to $400 billion. Bridging that gap would require Republicans and Democrats to do what neither want--scrub government of less useful spending and then raise taxes. Democrats prefer to deplore Republican 'irresponsibility.' Republicans prefer to tax less and spend more...

My first reaction was, "Huh?" I thought that the Democrats in the House of Representatives had offered a plan to balance the budget--by 2012, in fact.

But Samuelson explains this away:

In floor debate, the Democrats never offered a realistic balanced budget. The closest they came was in the House, where they promised balance by 2012. But that happens only by assuming that all of Bush's tax cuts expire in 2011--a position that even many Democrats reject...

Ah. Now I see. The Democratic leadership's plan was not "realistic." The only "realistic" plan, in Samuelson's eyes, is one that (a) keeps the Bush tax cuts for the rich, and (b) balances the budget by cutting spending.

But then shouldn't somebody make his lead be different, and accurate? It's not "There's no one in Washington... trying to balance the budget," it's "The Republicans are cynical feckless cowards who aren't trying to balance the budget, and the Democratic leadership is trying to balance the budget in a way that I don't like." Truth in packaging would be a good thing, after all.

Not convinced yet? For more on this point, see Brad DeLong once again. Update: Brad DeLong follows up.

Monday, July 17, 2006

Income Redistribution and Tax Revenue

If Dooh Nibor, the reverse Robin Hood of the Second Gilded Age, uses his political and economic powers to take a dollar from the poor and give it to the rich, what happens to tax revenue in a progressive tax system? Greg Ip and Deborah Solomon look at the recent increase in tax revenues and note that while tax revenues and output both exceeded projections, the amount that output growth exceeded projections was small. This implies the unexpected increase in tax revenue is largely a compositional effect rather than a consequence of higher than expected economic growth:

As Bigger Piece of Economic Pie Shifts To Wealthiest, U.S. Deficit Heads Downward, by Greg Ip and Deborah Solomon: In announcing a big drop in its estimate of this year's federal budget deficit, the Bush administration was quick to credit itself. "Tax cuts worked to generate economic growth, and economic growth is now working to raise revenues," White House budget director Rob Portman said...

But this explanation falls short. While tax revenue is growing far faster than the Bush administration forecast in its budget projections in February, the nation's economy isn't. What has changed isn't the size of the economy, but how the economic pie is divided. The share of national income going to corporations and the wealthiest individuals, already large, has expanded, while the share going to typical wage earners has shrunk. Because corporations and the wealthy generally pay income tax at higher rates than does the typical wage earner, that shift benefits the federal Treasury.

U.S. tax revenue for fiscal 2006 ...  is expected to be 5% -- or $115 billion -- higher, than the administration projected in February. Largely as a result, the budget deficit is expected to be $296 billion this year, instead of $423 billion.

But total economic output is expected to be just 1% larger, before adjusting for inflation, than the White House predicted. After adjusting for inflation, it is projected to be just 0.1% larger. ...

So, the tax windfall is another piece of evidence that income inequality in the U.S. continues to grow, which in turn may explain why the average American still gives President Bush low marks on the economy despite its overall strength. ...

On the other hand, it also may be evidence that Mr. Bush's tax cuts are working as advertised. Lower tax rates were meant to encourage people to work more, and because their taxes were cut the most, ... the wealthiest may have the biggest incentive to work and earn more.

In addition, cuts in taxes on capital gains and dividends were meant to reduce the cost of capital and encourage companies to invest more, which should lead to higher profits. This is called the supply-side effect...

Rudolph Penner, a senior fellow at the Urban Institute, a Washington think tank, and a CBO director picked by Republicans in the 1980s, says a supply-side effect "doesn't come close to explaining the revenue surge." ... He notes the administration itself puts the tax cuts' maximum supply-side boost at just 0.7% of GDP, stretched over many years.

Mr. Penner says the revenue surge reflects not a supply-side effect but a replay of the late 1990s, when the 1% of richest taxpayers prospered most and "paid a huge amount of taxes," eventually driving the budget into surplus. Indeed, the CBO and the White House repeatedly raised revenue forecasts then, much as they have now. But the recession and the stock-market bust in 2001 caused revenue to fall far more rapidly than budgeted.

That experience suggests the current revenue surge could also be transient. ... Even if the wealthy and corporations maintain their larger share of national income, budgeting could become more treacherous. That's because corporate profits and the performance-based pay that makes up so much of the affluent's income are inherently more volatile than wages... Thus, the difficulty of projecting the Treasury's tax take could be long-lasting.

Update: Gene Sperling has more on the lack of evidence for supply-side claims:

Inconvenient Facts and Bush's Supply-Side Boast, by Gene Sperling, Bloomberg: ... Judging from the White House's recent economic bragging, when it comes to their tax cuts, only positive news can be allowed into evidence. They are like the student who wants to throw out all of his bad tests scores and be graded only on occasional shows of improvement. ... [I]t is hard to swallow the Bush White House's assertions of direct causation between their tax cuts and any improvement in economic projection.

You just can't ignore the fact that this recovery shows the worst job creation on record and that when you look at the complete recovery -- as opposed to its best couple of years -- growth and investment have been weak. It is also hard to ignore that since the 2001 tax cuts were passed, median family income declined every single year, and since the 2003 tax cuts were passed, typical hourly and weekly wages fell in real terms.

Finally, there is the 2006 deficit, which the administration initially projected at a $500 billion surplus. It now will be a $300 billion deficit. In other words, the Bush White House is celebrating an $800 billion deterioration. (Even in 2002 -- after factoring in the tax cut, the aftermath of recession and Sept. 11 -- the administration still projected a $127 billion surplus for 2006.)

But we are instructed to ignore all these disappointing facts and focus only on how much revenues have improved over recent projections.

Yet,  ... Revenues over the last several years have been dramatically lower than what the Bush administration projected when it took office in 2001. ... In total, revenues between 2003 and 2006 fell short of the 2001 forecast by $1.8 trillion.

So is this proof-positive that the Bush tax cuts are the sole cause of a nearly $2 trillion revenue loss over just four years? If I drew that conclusion based only on those facts I would be guilty of the same selective causation as the Bush White House. ...

Saturday, July 15, 2006

Bigger Budget Surprises

The federal budget deficit has become increasingly volatile in recent years making it difficult to determine if changes in the deficit in a particular time period represent anything more than random period by period fluctuations:

Those Wild Budget Swings, by Edmund L. Andrews, NY Times: It was enough to make a supply-side, tax-cutting Republican beam with pride. Striding into the East Room on Tuesday morning, President Bush announced that tax revenues had been pouring in so fast this year that the federal deficit was likely to shrink for the second year in a row — even though spending continued to balloon.

Tax revenue hasn’t climbed this quickly since President Bill Clinton was in office. ... But the real news is not that tax revenues are particularly high; they are not. The big change is that tax revenues have become more of a crapshoot — more volatile, more unpredictable and more buffeted by swings in the stock market than they were 10 years ago.

Rev71506

Why? Because tax revenues are increasingly dependent on the fortunes of the very rich. And it turns out that ... more of their income is tied, not to wages and salaries, but to the stock market and to executive bonuses, which can swing widely from year to year.

Relying on these gyrating tax revenues makes it harder to gauge the government’s true fiscal health. ... At first blush, the recent jump in tax revenue would seem to validate Mr. Bush and those who believe that tax cuts ultimately generate higher tax revenues because they prompt people to work harder, invest more and take more entrepreneurial risk. ...

But revenues are only up in comparison with how low they had plunged in recent years. Individual income taxes, the biggest component of federal revenue, are barely back to the level that was reached in 2000, $1 trillion. Adjusting for inflation, income tax revenue is still lower than six years ago.

“The idea that tax cuts have led to higher revenues is pernicious,” said Robert L. Bixby, executive director of the Concord Coalition, a bipartisan research group that lobbies for fiscal discipline. “Tax revenues may be higher, but they are not higher than they would have been if the tax cuts hadn’t occurred.” ...

The unpredictable tax revenues first surfaced almost 10 years ago, as booming economic growth and the dot-com frenzy propelled the stock market to spectacular highs. ...

For the most part, the Congressional forecasts missed the mark by less than 4 percent from 1982 until 1995. But starting in 1996, when the dot-com frenzy erupted in earnest, the agency began undershooting by as much as 9.5 percent. In 1996, tax revenues came in $93 billion higher than expected; in 1997, they were $163 billion higher; in 1999, they were $152 billion higher.

When the dot-com bubble popped in 2001, and the economy slid into a brief recession, tax revenues plunged $308 billion below what the Congressional Budget Office had predicted and remained depressed for the next three years.

Now the pendulum is swinging once again. ... Few budget analysts would say the jump in revenues is bad news. But if the last decade is any indication, it would be foolish to count on more of the same.

The Bush administration has quietly acknowledged the point. Its latest estimate anticipates that tax revenues will be almost flat in 2007 and that the deficit will widen to $339 billion. ...

Thursday, July 13, 2006

A Short Guide to Dynamic Scoring

Jason Furman of the Center on Budget and Policy Priorities discusses the newest supply-side buzz word, dynamic scoring:

A Short Guide to Dynamic Scoring, by Jason Furman, CBPP: In recent years, official scorekeepers and academic researchers have devoted increased attention to the macroeconomic effects of tax cuts. The Administration also included a short “dynamic analysis” in this year’s Mid-Session Review of the budget. The results of much of this work indicate that tax cuts can have positive or negative effects on the economy, with the “sign” of the effects depending on a number of variables, the most important of which is whether and how the tax cuts are paid for.

The Congressional Budget Office, the Joint Committee on Taxation (JCT), and academic researchers have all have found that tax cuts that are not accompanied by offsetting revenue increases or spending reductions — and are financed by borrowing instead — can harm the economy over the long term. The research, including the administration’s own analysis, also indicates that even if tax cuts are paid for, the economic benefits generally are relatively modest, with any increased revenues that result from stronger economic growth offsetting only a small fraction of what conventional cost estimates indicate the tax cuts will cost.

This short guide to dynamic scoring makes six points:

  • JCT and Treasury tax estimates already include “dynamic” scoring components. The official cost estimates that the Treasury and Congress’ Joint Committee on Taxation produce for tax-cut legislation are “dynamic” scores in that they incorporate changes in behavior that are expected to occur as a result of the proposed tax cuts. ... At the same time, the official cost estimates do not assume that major macroeconomic conditions like GDP and employment will be altered by tax changes.
  • Tax cuts do not pay for themselves. Economists of all stripes have consistently found that tax cuts do not generate enough growth to fully pay for themselves. In fact, cost estimates that incorporate macroeconomic feedback from tax cuts are reasonably close to conventional cost estimates that ignore such feedback. ... The Administration’s own estimates published in the Mid-Session Review indicate that, even with favorable assumptions, dynamic feedback would pay for less than 10 percent of the cost of making the tax cuts permanent. (See box on page 5 of pdf.)
  • The long-run macroeconomic effects of tax cuts can be either positive or negative, depending on how and when they are paid for. The most critical assumption in an economic model is how and when tax cuts are paid for. Generally research has found that tax cuts that are not accompanied by other tax increases or spending cuts — such as the tax cuts that have been enacted in recent years — will increase the deficit, reduce national savings, and ultimately reduce economic growth. In contrast, tax cuts that are paid for contemporaneously can contribute to economic growth. In neither case are the economic effects very large.
  • Models generally find that tax cuts are more beneficial — or less harmful — in the short run than the long run. Many economic models show modestly positive effects of tax cuts in a five- or ten-year period, due in part to initial stimulus effects, but then show these gains being dissipated or even reversed in the long run, as the adverse effects of deficit-financing the tax cuts in the years following their enactment gradually take hold.
  • You cannot use actual revenue levels from particular years to estimate macroeconomic feedback effects. Some have argued that positive revenue surprises in one or two years are evidence of major dynamic scoring effects. This claim ignores the fact that federal revenues are highly volatile and can swing from year to year for a variety of reasons unrelated to tax cuts. Over the past 25 years, actual revenues in a given year have averaged $150 billion (in today’s terms) above or below the revenue levels that CBO predicted a year in advance. In contrast, even an optimistic reading of the dynamic effects of the 2003 dividend and capital gains tax cuts would lead to an estimate of less than $5 billion in added revenue, relative to the conventional estimates of the costs of these tax cuts. It thus makes little sense to use data from one or two years to claim extraordinary dynamic scoring effects for tax cuts.

    Moreover, in the 1990s, ... revenues fell well below expectations in the years of this decade that followed large tax cuts. Differences between the revenue forecasts that were made and the subsequent, actual revenue levels could as easily be used to construct a case that tax cuts have dynamic effects that harm the economy and slow revenue growth as to construct the rosy case that tax-cut proponents make.
  • Distributional analysis of tax cuts should incorporate the same financing assumptions as dynamic analysis of tax cuts’ costs. All tax cuts must be paid for eventually, since it is not possible to explode the deficit and debt without limit. Macroeconomic models make a variety of assumptions about how tax cuts will be paid for. These same assumptions should be used in presenting distributional analysis of tax cuts.

For example, some analyses that show positive economic effects from the recent tax cuts use the assumption (without highlighting it) that the tax cuts will be fully paid for with across-the-board reductions in benefits and transfer payments, including Social Security and Medicare. Whatever assumptions are made in assessing economic impacts also should be used in assessing the distributional impact that tax cuts would have. Some tax-cut proponent use models that assume the tax cuts are paid for when claiming positive dynamic effects, but then use distributional estimates that are based on the assumption that the tax cuts are not paid for and are essentially a “free lunch.” [Click here for the full analysis.]

Tuesday, July 11, 2006

Tax Cuts Do Not Pay for Themselves

George Bush, as recently as today, made the claim that tax cuts pay for themselves. No credible analysis suggests that they do, but the administration continues to spin this yarn anyway. When will people finally tire of being deceived? The claim Bush made today is refuted by the White House's own analysis, yet the claims are made anyway. Here's the CBPP's quote of Bush's statement:

A Smoking Gun: President’s Claim That Tax Cuts Pay for Themselves Refuted by Administration’s Own Analysis, by James Horney, CBPP: In remarks on July 11 touting revised deficit projections in the Mid-Session Review of the Budget, President Bush once again claimed that tax cuts pay for themselves:

Some in Washington say we had to choose between cutting taxes and cutting the deficit….Today’s numbers show that that was a false choice. The economic growth fueled by tax relief has helped send our tax revenues soaring. That’s what has happened.

These remarks mirror previous statements by the President, the Vice-President, and key Congressional leaders that the increase in revenues in 2005 and the increase now projected for 2006 prove that tax cuts “pay for themselves”...

Another CBPP piece documents claims made by the administration that tax cuts are self-financing. David Wessel of the Wall Street Journal's Washington Wire summarizes the CBPP findings:

Do Tax Cuts Pay for Themselves?, by David Wessel, Washington Wire: Not if you read the fine print in the new White House midsession review of budget trends. “While difficult to estimate precisely,” Treasury long-run analyses of the effects of President Bush’s tax cuts “may ultimately” raise total national output of goods and services by 0.7%.

So is that enough to pay for the tax cuts, even after allowing them to work their economic magic over the next 10 years? The Center for Budget Policies and Priorities ... says it isn’t. “A 0.7 percent increase in the economic output that the Congressional Budget Office has projected for 2016 would represent an additional $146 billion [in gross domestic product],” it says. “If new revenues equaled as much as 20% of the additional output, the increase in revenues resulting from making the tax cuts permanent (assuming Treasury’s best-case assumptions) would be $29 billion.”

That’s a lot of money. But how does it compare to the size of the president’s tax cuts? The congressional Joint Committee on Taxation ... says making the president’s tax cuts permanent would reduce federal revenues in 2016 by $314 billion. That is more than 10 times what the Treasury analysis suggests tax cuts would generate by prompting more hours of work, more savings and investment and more efficient use of resources.

By the way,  according to the CBPP analysis, "An increase in the level of economic output of 0.7 percent — the Treasury’s best-case scenario — in 20 years would represent an increase of about 4/100ths of one percentage point in the annual growth rate of the economy."  That's 0.04% extra growth per year. For even more problems with the analysis, see Brad DeLong's post of Jason Furman's comments on dynamic scoring, the method used to evaluate the effect of tax cuts over time.

It's hard not to view this as anything but willful deception designed to sell an ideology. That deception is required to sell it tells you a lot about its validity. [Update: Brad DeLong has even more from Jason Furman echoing the CBPP analysis above].

Saturday, July 08, 2006

Looting the Future

As I've said before, I'm not generally a fan of Ben Stein's writing. Not at all. But this, like a column he wrote a few weeks ago, is reasonable:

A City on a Hill, or a Looting Opportunity, by Ben Stein, Commentary, NY Times: ...Life in America in 2006 for an upper middle-class person like me — who, although overweight, still has decent health — is just paradise. ... But still, ... something is seriously wrong. ...

When I was a lad, the chief executive of a major public company was paid about 30 or 40 times what a line worker was paid. Now the multiple is about 180. What did they do in the executive suite to become so great? ... Why, as we are being killed by foreign competition, do we need to pay our executives so much?

We have investigators looking into whether some corporations paid their executives with stock options whose strike price was retroactively determined ... so that the options were "in the money" from Day One. After opening investigations..., several companies restated their financial reports, which makes it straight-up fraud in my book. Not one person has been charged with any crime, while young black men and women who sell a tiny amount of drugs on a street corner do hard time. How can this be right?

We have immense corporations that cry the blues all day long about how their pension costs are ruining them and how they have to freeze pensions or lay off workers or end pensions altogether (can you say "Friendly Skies?") and turn over the pension liabilities to the taxpayers. And the same corporations set aside many millions for the superpensions of the top executives.

Even at my own beloved General Motors, ... spectacularly large executive pensions, coming straight out of profits, keep G.M.'s retired top dogs happily playing golf at the Vintage, while the men who actually made the cars are saying: "Welcome to Wal-Mart. How can I help you?"

As I endlessly point out, taxes for the rich are lower than they have ever been in my lifetime. (To be fair, taxes for the nonrich taxes are very low as well.) And this is occurring as we accumulate government liabilities that will kill us in the long run. (And cutting spending will not work. Most federal and state spending is for items that are untouchable...)

We are mortgaging ourselves to foreigners on a scale that would make George Washington cry. Every day — every single day — we borrow a billion dollars from foreigners to buy petroleum from abroad, often from countries that hate us. We are the beggars of the world, financing our lavish lifestyle by selling our family heirlooms and by enslaving our progeny with the need to service the debt. ...

It's ... the way we live today. Drunken sailors ... Heirs living on their inheritance and spending it fast. The titans of corporate America getting as much as they can get away with and hiring lawyers and public-relations people if there is a problem. It is later than anyone dares to think.

Is this America, where far too many of the rich endlessly loot their stockholders and kick the employees in the teeth, the America that our soldiers in [Iraq]... and Afghanistan are fighting for? Is this America, where we will end up so far behind the financial eight ball we won't be able to see because of mismanagement by both parties, the America that our men and women are losing limbs for, coming home in boxes for?

The Saturday before Memorial Day, I spoke at a gathering of widows and widowers, parents and children of men and women in uniform who have lost their lives in Iraq and Afghanistan. The person who spoke before me was ... named Joanna Wroblewski, whose husband of less than two years ... had been killed in Iraq...

Are we keeping the faith with Joanna Wroblewski? Are we keeping the faith with her husband? Are we maintaining an America that is not just a financial neighborhood, but also a brotherhood and a sisterhood worth losing your young husband for?

Is this still a community..., or a looting opportunity? Will there even be a free America for Mrs. Wroblewski's descendants, or will we be a colony of the people to whom we have sold our soul? Are we keeping the faith with this young widow? That is the question I ask about this beloved and glorious America for which her husband, Lt. John Thomas Wroblewski, died. If we are, we should be proud. If we are not, we'd better change, and soon.

Kind of wishy-washy at the end. He asks the question about whether we are being led in the wrong direction, but doesn't answer it directly and leaves it as an open question. I would have thought his belief that "It is later than anyone dares to think" would justify taking a firm position that "we'd better change, and soon."

Are Business Taxes High in the U.S.?

Do businesses in the U.S. face higher taxes than their foreign counterparts? Not according to this Economic View from the New York Times:

Why U.S. Companies Shouldn't Whine About Taxes, by Edmund L. Andrews, Economic View, NY Times: To hear some people talk, the United States is the scourge of the Fortune 500. Despite all the tax cuts that President Bush and Congress have passed in the last five years, business groups and their supporters in Washington complain that the United States imposes higher tax rates on corporate profits than almost any other industrialized country.

"Foreign-based competitor companies operate under tax rules that are often more favorable than our own," warned R. Glenn Hubbard, a former economic adviser to President Bush and now dean of the Columbia Business School, at a House hearing two weeks ago. ...

Around Washington, the rumblings are growing for "reform" of corporate taxes to improve the global competitiveness of American companies. Henry M. Paulson Jr., the incoming Treasury secretary, declared at his confirmation hearing that he wanted to increase "competitiveness" in the tax code. Can it be true that the United States, where bare-knuckled capitalism is a romantic ideal ..., is harder on big corporations than "old Europe" welfare states like Germany, France and Sweden?

Don't believe it. There are plenty of problems with the corporate tax code — rococo complexity, perverse incentives, antique ideas — but overly high taxes is not one of them. By most measures, the corporate tax burden is lower in the United States than it is in the European Union or in Japan or most other industrialized countries. [graphic showing relative tax rates].

The political danger, at least from a fiscal standpoint, is that arguments for corporate tax reform will be hijacked to justify another round of corporate tax cuts. That was what happened with the corporate tax overhaul of 2004, which became a grab bag of tax breaks to almost every corner of business, at a net cost of $60 billion over 10 years.

Those who see the American corporate tax as oppressive point to a striking fact: the standard corporate tax rate of 35 percent is now higher than that of most other industrialized countries. The average top rate is 25.8 percent in the European Union, where most nations have cut rates to attract investment.

But official tax rates are not the same as actual tax burdens. What American companies lose in high tax rates they more than make up in higher tax breaks.

One indicator of the true tax burden is corporate tax revenue as a share of gross domestic product. According to the Organization for Economic Cooperation and Development, ... corporate taxes in 2003 were 2.1 percent of G.D.P. in the United States, 3.2 percent in the European Union and 4.3 percent in industrialized countries in Asia. ...

To be sure, many experts contend that the American tax code does impose some competitive disadvantages. One big complaint is that the United States is one of the very few countries that taxes corporate profits worldwide. Almost all other nations use "territorial" systems, taxing only profits inside their borders. ...

In practice, the disadvantage is smaller than it appears. For one thing, American companies receive tax credits for taxes paid in other countries. More important, American companies have proved extremely adept at shifting profits into low-tax countries like Ireland and then deferring the American taxes on those profits by keeping them outside the United States. ... By some estimates, American multinationals had accumulated more than $400 billion in profits outside the country.

Last year, Congress rewarded that behavior. First, it widened companies' ability to claim tax credits against their foreign taxes, at a cost to the Treasury of almost $40 billion over 10 years. Second, it gave companies a one-time chance to repatriate their vast hoard of overseas profits at a tax rate of only 5.25 percent — a bonanza for many pharmaceutical and electronics businesses...

Many analysts agree that today's rules are a mess: they do not raise much revenue from foreign profits, they encourage companies to invest outside the United States, they encourage profit-shifting schemes and they probably put some American companies at a competitive disadvantage. The challenge is to change the system without cutting taxes yet again. ...

New Fangled Parking Meters

Smarter parking meters through technology. There's even a graph:

No Time Left on the Meter -- By Design, by Chris Kirkham, Washington Post: In the exasperating quest for street parking, victory comes in tiny increments -- the stray 20 minutes left on the meter by the driver who just pulled away, for example. ...

IntelliPark LLC wants to take that small pleasure away. It is marketing a parking meter called IntelliMeter that uses sonar technology to detect when a space is occupied and resets the meter to zero every time a car moves out. "You take away that free lunch, but on the other hand that's tax revenue," said IntelliPark chief executive Glen A. Hellman.

The company is one of several exploring technologically savvy parking systems as a way for municipalities to control street congestion and bring in extra revenue at the same time. Major cities such as New York and Baltimore have installed "smart parking" systems in some areas that allow for easier payment with credit cards, smart cards or even cellphones. ...

Continue reading "New Fangled Parking Meters" »

Friday, July 07, 2006

Cutting Constitutional Corners

I hear a lot about patriotism, the constitution, that sort of stuff from Republicans. They've shown they can 'talk the talk.' But when it comes to the hard part, abiding by the constitution when it makes things more difficult or prevents you from doing things you want to do, well, then it's a different story:

The Deficit Reduction Act? What Deficit Reduction Act?, by Dorothy Samuels, Editorial, NY Times: ...[R]eading over new legal filings by the Justice Department in an unusual, and unusually important, federal lawsuit challenging the validity of the phony Deficit Reduction Act that President Bush signed in February, it suddenly struck me: ... the Justice Department's reasoning for why the suit should be dismissed sharply conflicts with my understanding — and most Americans' understanding — of what it takes for a bill to become law. If that reasoning prevails, it will be very bad for democracy.

Brought by Public Citizen, and set to be heard on Monday, the case I'm referring to is one of a handful of pending suits seeking to block the law's unfair cuts in student loans, Medicaid and Medicare. It bases its argument on the most elemental constitutional violation imaginable: although the measure was signed by the president and approved by the Senate, it was never approved in the same form by the House.

This travesty began last December with an inadvertent clerical error after the Senate approved the bill by the narrowest of margins, with Vice President Dick Cheney breaking a tie. Owing to that accidental change, the version that passed the House by a mere two votes differed from the Senate measure. A provision on Medicare calls for covering the rental of certain medical equipment, like wheelchairs, for 36 months, instead of the 13 months in the Senate version. Although that may sound like a minor deviation, it adds up to a $2 billion difference.

Made aware of the discrepancy, House Speaker Dennis Hastert and Senate Majority Leader Bill Frist apparently made a command decision not to try to fix it by having their chambers vote again, this time on the same measure. Given the closeness of the first votes, after all, there was no guarantee a rerun would end in passage. ...

Instead, the leaders barged ahead. Mr. Hastert signed a statement with the president pro tempore of the Senate attesting that the act had been approved in identical form by both chambers when everyone knew that hadn't happened. As for President Bush, his hands are hardly clean. He was well aware of the constitutional defect but chose to ignore it and sign the bill anyway — a dismaying reminder that the president's instinct to cut constitutional corners isn't limited to the war on terror.

In briefs filed last week, the Justice Department does not dispute this rendition of what happened, or the constitutional rule against transmitting one-house bills to the president's desk. Instead it contends that a musty 1892 Supreme Court ruling requires courts to accept as fact Mr. Hastert's fictional certification that both chambers passed the same bill. In other words, to enact large budget cuts affecting millions of Americans, the House and Senate needn't bother to go through the tedious and politically fraught exercise of passing the same legislation. It suffices for leaders of each chamber to fudge and say it happened. ...

Wednesday, June 28, 2006

Unpleasant Estate Tax Tradeoffs

Today, the senate delayed the vote on the estate tax because "Senate Republicans are determined to pass the legislation this year, [but] they want to ensure they have the 60 votes needed to withstand a challenge by Democrats."

Most senators in favor of eliminating or reducing the estate tax also favor the Gregg bill changing the budget rules. The CBPP describes the Gregg bill as aiming a "budget knife at domestic programs while shielding tax cuts from fiscal discipline."

This analysis shows the likely outcome if those in favor of the bills prevail. If both bills are put into place at once, the estate tax cuts will trigger automatic across the board reductions in the entitlement programs:

Combined Effect of Bills Moving In The Senate Would be to Finance Near-Repeal of the Estate Tax with Cuts in Medicare, Veterans Benefits, School Lunches, and Other Programs, by by Robert Greenstein and Richard Kogan: At the urging of Senate Republican leader Bill Frist, the House of Representatives ... approved a measure designed by House Ways and Means Committee chairman Bill Thomas to repeal most but not all of the estate tax. The measure contains no “offsets”; its large cost would be financed through higher deficits. The Senate takes up the bill this week.

One day before Rep. Thomas unveiled his proposal, the Senate Budget Committee approved a far-reaching bill to make major changes in federal budget rules. Crafted by committee chairman Judd Gregg and co-sponsored by Senator Frist and 24 other Senate Republicans, the bill includes a provision that would establish binding deficit targets... In any year in which the deficit targets would otherwise be missed, automatic across-the-board cuts would be triggered in every entitlement program except Social Security.

Policymakers who have pushed for repeal of most or all of the estate tax (and for other tax cuts) often act as though tax cuts are a “free lunch,” ...[H]owever, this is not so. Sooner or later, someone has to pick up the bill.

The Gregg bill places a spotlight on how these tax cuts would be paid for. Taken together, the Thomas estate-tax bill and the Gregg budget-enforcement bill would result in multi-million dollar tax cuts for the estates of the wealthiest Americans who die, with these lavish tax cuts being financed by large reductions in health care, retirement, and other benefits on which millions of ordinary Americans rely....

Congressional Budget Office projections show that if the President’s tax cuts are extended ... and relief from the Alternative Minimum Tax is continued, the projected budget deficit in 2012 and every year thereafter will be close to or more than $200 billion above the level needed to hit the Gregg bill’s deficit targets...  Under ... the Gregg bill, every dollar that a tax-cut bill loses in revenue must eventually be made up by cutting a dollar out of entitlement or other mandatory programs (unless discretionary programs are cut more deeply, other tax cuts are terminated or scaled back, or other revenue-raising measures are adopted). ...:

Table 1: Cuts in Various Entitlement Programs
Triggered by Thomas Estate-Tax Plan
(in billions of dollars)


  Cuts 2007-2016
Medicare 121
Medicaid/SCHIP 64
Federal Civilian Retirement 17
EITC/Child Tax Credit 10
Military Retirement 10
Unemployment Insurance 10
SSI for elderly and disabled poor 10
Veterans disability compensation and pensions 8
Food stamps 8
School lunch/child nutrition 3
Farm Programs 3
Total entitlement cuts 283

...Enactment of the Thomas bill would trigger $283 billion in entitlement cuts over the 2007-2016 period, with $262 billion of these cuts coming in the second five years (2012-2016). ..

Table 1 displays the cuts that would have to be made in various entitlement programs to offset the increases in deficits the Thomas bill would cause. The Table is based on the official cost estimate that the Joint Committee on Taxation has issued of the Thomas bill...

A point could be made that few, if any, Members of Congress favor allowing the estate tax to return in 2011 to its parameters under the pre-2001 tax law. Many Senators ... support making permanent the estate-tax rules that will be in effect in 2009, when the first $3.5 million of an estate — $7 million per couple — will be exempt and the top rate will be 45 percent. Were that approach to be adopted, the entitlement cuts that would be triggered under the Gregg bill would be about half the size of the cuts shown in Table 1...

Monday, June 26, 2006

Everything Old is Still Old

This National Review Online commentary urges Republican leaders to reconsider their opposition to tax increases as part of the solution to growing entitlements. The idea is to trade concessions on taxes for the creation of personal Social Security accounts with the hope that, once the door has been opened slightly, salesmanship can open it further and allow conservatives to reach their goal of privatizing Social Security. Beware of compromise in sheep's clothing:

Entitlement-Reform Realities A little conservative compromise will go a long way as we attempt to revamp today’s safety-net system, by Jagadeesh Gokhale, NRO: Some conservatives are apoplectic about the prospect of abandoning the “no-tax-hike” pledge as part of entitlement reforms. ... Unfortunately, the political and economic arithmetic of entitlement shortfalls does not permit them much hope; remaining wedded to high principles and shunning compromise will only worsen their choices. They should learn from past experience and adopt a more strategic approach. ...

As the aphorism goes, “possession is nine-tenths of the law.” Liberals’ programs have been in operation for decades and are now supported by a large bloc of voters, making it especially difficult for conservatives to challenge or modify them. It’s quite telling that liberals are viewed as having no new ideas. But that could be because most of their ideas are already in operation.

Liberals are in a peculiar bind. Entitlement shortfalls are growing larger and threatening to undo their legacy. ... That presents an opportunity for conservatives to revamp today’s safety-net system by introducing their own market-oriented framework, with personal Social Security accounts as the crown jewel. Unfortunately, worsening entitlement shortfalls also make adopting personal accounts more difficult each year. The closer baby boomers come to retirement age, the less likely they are to acquiesce to smaller entitlement benefits than they are currently promised in exchange for adopting personal accounts — as last year’s debate showed. ...

Now the cake of higher future taxes is in the oven, with the temperature rising rapidly. Could conservatives remove the cake and replace future tax hikes with personal accounts? As last year’s stalled Social Security debate showed, that’s unlikely. But conservatism’s high priests continue to answer this question with a “yes.” Perhaps they have a closely guarded strategy for guaranteeing overwhelming electoral success.

Could conservatives do better by agreeing to accept some of the taxes in exchange for removing the cake earlier and replacing a part of future tax increases with personal accounts? The answer of the high priests is “no,” which is puzzling given that their choices would only worsen over time.

What are the strategic tradeoffs? Three items seem relevant: First, resolving the entitlement shortfall by paring scheduled benefit growth is becoming less feasible as time passes. The large baby-boomer voting bloc would increasingly view those benefits as inviolable and would likely possess the political muscle to enforce those claims. Thus, intransigence on compromise will make higher taxes more, not less, likely. ...

Second, the fact that personal Social Security accounts do not yet exist and thus cannot compete with the existing system to demonstrate their superiority is a huge disadvantage. Their absence allows liberal opponents to compare personal accounts with placing one’s retirement on a Las Vegas roulette table.

Third, if personal accounts were introduced and proved successful, they would incorporate property rights much more compelling than existing claims on Social Security benefits. Those rights on income-earning assets would also be bequeathable.... Such rights would not only be irreversible, they would carry strong momentum for expansion as more groups clamored for access to personal accounts.

So any arguments that the advantages of introducing personal accounts are not worthy of a few early concessions on taxes appear far from credible.

First, there is nothing that necessitates linking tax changes to personal accounts - no such linkage was made when taxes were cut. This is nothing more than a strategy for attaining personal accounts, it is not a solution to the entitlement problem. Medicare is the problem, not Social Security. Here's Robert Reich on this point who, while bemoaning turning 60, is compelled by his 60th birthday to think hard about Social Security:

On Turning 60 (Postscript), by Robert Reich: Commentator Rodger doesn't believe we can grow our way out of the pending Social Security crisis, but I think he's (almost) wrong. Look, I was a trustee of the Social Security trust fund. I saw up close how the actuaries made their projections for when the fund will run out of gas. They plugged in (and continue to plug in) very low estimates of average annual economic growth over the next seven decades. But if the U.S. economy grows anywhere close to its average growth over the LAST seven decades -- which is over 3 percent a year -- the trust fund will do just fine. How can we grow that fast when we won't have enough new entries into the labor force to support the vast baby-boom generation? Two ways: First, productivity gains will be substantial, as new technologies work their way through the economy (consider the astounding productivity gains what's over the last five years). Second, America will continue to have lots of legal and illegal immigration, despite whatever Washington does in the meantime. So don't worry too much about Social Security. Fix your worried gaze at Medicare instead. There's the real problem.

And I'm tired of the "we're the party of ideas" claim. The recent Republican agenda includes:

Flag Burning
Line Item Veto
Tax Cuts
Gay Marriage

This is the party of new ideas? Where?

Update: MaxSpeak has more to say about the NRO commentary.

Update: Brad DeLong has even more. And in response, I like pomegranates, always have, and as an add-on to the main course or as a snack they're great (though watch out for the stains). But, like Brad, I wouldn't feature them as the main course.

Sunday, June 25, 2006

Sweet Spots and Doughnut Holes

Paul Krugman is on vacation, so here's a column from October, 2003. The column explains how the 2001 and 2003 tax cuts contain provisions designed to make it politically difficult to call for a rollback of the tax cuts to their original levels:

The Sweet Spot, by Paul Krugman, Commentary, NY Times, October 17, 2003: "What we have here is a form of looting." So says George Akerlof, a Nobel laureate in economics, of the Bush administration's budget policies — and he's right. With startling speed, we've blown right through the usual concerns about budget deficits — about their effects on interest rates and economic growth — and into a range where the very solvency of the federal government is at stake. Almost every expert not on the administration's payroll now sees budget deficits equal to about a quarter of government spending for the next decade, and getting worse after that.

Yet the administration insists that there's no problem, that economic growth will solve everything painlessly. And that puts those who want to stop the looting — which should include anyone who wants this country to avoid a Latin-American-style fiscal crisis, somewhere down the road — in a difficult position. Faced with a what-me-worry president, how do you avoid sounding like a dour party pooper?

One answer is to explain that the administration's tax cuts are, in a fundamental sense, phony, because the government is simply borrowing to make up for the loss of revenue. In 2004, the typical family will pay about $700 less in taxes than it would have without the Bush tax cuts — but meanwhile, the government will run up about $1,500 in debt on that family's behalf.

George W. Bush is like a man who tells you that he's bought you a fancy new TV set for Christmas, but neglects to tell you that he charged it to your credit card, and that while he was at it he also used the card to buy some stuff for himself. Eventually, the bill will come due — and it will be your problem, not his.

Still, those who want to restore fiscal sanity probably need to frame their proposals in a way that neutralizes some of the administration's demagoguery. In particular, they probably shouldn't propose a rollback of all of the Bush tax cuts.

Here's why: while the central thrust of both the 2001 and the 2003 tax cuts was to cut taxes on the wealthy, the bills also included provisions that provided fairly large tax cuts to some — but only some — middle-income families. Chief among these were child tax credits and a "cutout" that reduced the tax rate on some income to 10 percent from 15 percent.

These middle-class tax cuts were designed to create a "sweet spot" that would allow the administration to point to "typical" families that received big tax cuts. If a middle-income family had two or more children 17 or younger, and an income just high enough to take full advantage of the provisions, it did get a significant tax cut. And such families played a big role in selling the overall package.

So if a Democratic candidate proposes a total rollback of the Bush tax cuts, he'll be offering an easy target: administration spokespeople will be able to provide reporters with carefully chosen examples of middle-income families who would lose $1,500 or $2,000 a year from tax-cut repeal. By leaving the child tax credits and the cutout in place while proposing to repeal the rest, contenders will recapture most of the revenue lost because of the tax cuts, while making the job of the administration propagandists that much harder.

Purists will raise two objections. The first is that an incomplete rollback of the Bush tax cuts won't be enough to restore long-run solvency. In fact, even a full rollback wouldn't be enough. According to my rough calculations, keeping the child credits and the cutout while rolling back the rest would close only about half the fiscal gap. But it would be a lot better than current policy.

The other objection is that the tricks used to sell the Bush tax cuts have made an already messy tax system, full of special breaks for particular classes of taxpayers, even messier. Shouldn't we favor a reform that cleans it up?

In principle, the answer is yes. But an ambitious reform plan would be demagogued and portrayed as a tax increase for the middle class. My guess is that we should propose a selective rollback as the first step, with broader reform to follow.

Will someone be able to find the political sweet spot, the combination of fiscal responsibility and electoral smarts that brings the looting to an end? The future of the nation depends on the answer.

Sweet spots seem to have a lot in common with doughnut holes. But on the broader question, two and a half years after the column was written, is it smart politics to call for "selective rollback as the first step, with broader reform to follow" as the elections approach in the fall?  I haven't heard anyone hit the political sweet spot yet.

Saturday, June 24, 2006

"The Fiscal House is in Severe Disorder"

I've had a lot of problems with the things Ben Stein has written in the past (understatement alert), and I cut the parts I didn't like from this commentary, but I suppose I should give credit when it's due: 

Note to the New Treasury Secretary: It's Time to Raise Taxes, by Ben Stein, Commentary, NY Times:

Henry M. Paulson Jr.
The Goldman Sachs Group
New York, N.Y.

Dear Mr. Paulson:

You almost certainly don't remember little me, but I met you many years ago... To become chairman of an empire like Goldman Sachs is a spectacular achievement by any measure. But now you have your work cut out for you as Treasury secretary. You are facing what is, in many ways, the most dangerous economic future since the Depression. Danger is coming on many fronts, only dimly seen by the powers that be in Washington, and your insights ... will be urgently necessary. ...

Right now, inflation is moving out of the Federal Reserve's comfort zone. The Fed chairman, Ben S. Bernanke, is doing the right thing by raising rates and trying to slow the overheated economy, but in a way that does not bring us a recession. To give us a soft landing without recession or stagflation — rising inflation and slow growth, as we had in a good part of the 1970's — is not an easy or assured task. ...

May I respectfully suggest that in this environment, ending the estate tax is not a major sensible priority? May I suggest that having the lowest taxes in 65 years on high-income taxpayers is not really as prudent as it might be if we were not running stupendous deficits, with far worse in the future?

I know you are a Republican, and so am I. Now and then, scornful fellow Republicans ask me what kind of Republican I am, since I'm for higher taxes on the rich. I tell them that I am an Eisenhower Republican, the kind who wants to leave a healthier America to posterity. That includes an economy not headed for the status of a banana republic's economy.

Now, I know that ... Ronald Wilson Reagan, when asked if he were not worried that his tax cuts would burden posterity with a heavy weight, supposedly asked, "What has posterity ever done for me?" Those of us with teenage children certainly know what he meant. But the problem is no longer quite as funny.

The fiscal house is in severe disorder. ... Mr. Bernanke knows what's right and wrong. You will have allies. But someone needs to take a stand, and that person might as well be you. The time is always right to do right... This one will make running Goldman Sachs look easy.

Respectfully submitted,
Ben Stein

Tuesday, June 20, 2006

Problems with the Value-Added Tax in Europe

Conservative columnist Bruce Bartlett and others have pushed hard for the imposition of a Value-Added Tax in the U.S. to replace other federal taxes. My own reaction has been:

VATs are  regressive, but they're an important source of revenue for highly progressive tax-and-transfer systems, so their characteristics depend upon the details of the implementation. However, one thing I do know, making estate tax repeal permanent while introducing a VAT would be a nasty case of bait and switch...

In supporting the VAT, Bartlett argues:

This is the best strategy tax economists have ever devised for raising revenue without investing a lot in enforcement and economic incentives. The V.A.T. is a kind of sales tax embedded in the price of goods. ... [T]he tax is largely self-enforcing. And because the tax is applied only to consumption, its impact on incentives is minimal. ...

But is it self-enforcing? Since VATs continue to enter policy discussions, knowledge of how they've worked in countries that have used them can be helpful. According to this analysis in the Financial Times there are two main problems with the VAT in Europe where it has been widely adopted, fraud and complexity:

Evasion and exemptions erode VAT’s own value added, Financial Times: In half a century, value added tax has taken the world by storm... But despite its reach, some are ready to declare it an idea whose time has gone.

VAT fraud has become pervasive and, at least in Europe, the tax is at a watershed. Can it survive in its current form? ...[I]t is in Europe that the weaknesses are at their most glaring. This month the European Commission launched an “in-depth debate” on whether VAT should be modified. Chas Roy-Chowdhury of the Association of Chartered Certified Accountants says: “I think the writing is on the wall for the VAT system.”

European VAT is in a mess for two main reasons: its vulnerability to fraud and its complexity. Fraud, evasion and avoidance cost at least one in every 10 euros of the tax collected – roughly double that in other industrialised countries... VAT abuse takes many forms – most commonly the reluctance of traders in the black economy to have anything to do with the tax. But the biggest headache is sophisticated fraud. ...

The problem lies largely in the refund process... VAT is normally self-policing: everyone in the supply chain has an incentive to act as tax-collectors as they offset the VAT they pay their suppliers against the VAT they charge their customers. But in some circumstances, notably when exporting goods – which are VAT-free under nearly all national systems – businesses can claim refunds. ... This fraud ... has forced governments to consider drastic remedies. ... Germany and Austria are pressing for a “reverse charge” mechanism that would in effect turn VAT into a hybrid sales tax.

As well as the administrative hassles faced by exporters, businesses are often left paying big VAT bills as a result of governments’ desire to exempt certain types of goods and services, such as education, from the tax. Some critics argue that governments should reduce, if not eliminate, exemptions and reductions. ...

And Germany is pressing hard for action. From a June 8 Financial Times report:

Germany blocks EU deal on e-commerce services, by By George Parker and Vanessa Houlder, Financial Times: Germany yesterday claimed at a monthly Ecofin council of European Union finance ministers that value added tax fraud was costing it €17bn-€18bn a year and demanded that it be allowed to change its tax rules to tackle the problem.

Peer Steinbrück, German finance minister, blocked a separate agreement on the taxation of e-commerce services, indicating he would not budge until Berlin won permission to adopt measures to tackle VAT fraud.

Germany and Austria, the current holder of the EU presidency, want to make wide use of so-called "reverse" charging of VAT, a mechanism for accounting for VAT that denies a fraudulent supplier the opportunity to pocket the tax.

Although Laszlo Kovacs, the EU tax commissioner, is sceptical about whether the system is effective in beating fraud, he was asked to draft legislation that would give the countries the option to use reverse charging. ...

For a tax sold as "largely self-enforcing," the finding that fraud, evasion and avoidance result in lost tax collections that are "roughly double that in other industrialised countries" is notable. And repeating from above, if Germany and Austria prevail in their reform efforts, the ""reverse charge" mechanism ... would in effect turn VAT into a hybrid sales tax."