Category Archive for: Taxes [Return to Main]

Thursday, April 12, 2007

Robert Frank: Trickle-Down Theories Don’t Hold Up

Speaking of supply-side economics and trickle-down, Robert Frank explains that trickle-down theory, which says that higher taxes on the wealthy will reduce incentives causing lower growth and hence lower employment and income generally, "is supported neither by theory nor evidence." Thus, contrary to what its proponents argue, trickle-down theory does not provide a valid objection to a more progressive tax code:

In the Real World of Work and Wages, Trickle-Down Theories Don’t Hold Up, by Robert Frank, Economic Scene, NY Times: When asked why he robbed banks, Willie Sutton famously replied, “Because that’s where the money is.” The same logic explains the call by John Edwards, the Democratic presidential candidate, for higher taxes on top earners to underwrite ... universal health coverage.

Providing universal coverage will be expensive. With the median wage, adjusted for inflation, lower now than in 1980, most middle-class families cannot afford additional taxes. In contrast, the top tenth of 1 percent of earners today make about four times as much as in 1980, while those higher up have enjoyed even larger gains. ... In short, top earners are where the money is. Universal health coverage cannot happen unless they pay higher taxes.

Trickle-down theorists are quick to object that higher taxes would cause top earners to work less and take fewer risks, thereby stifling economic growth. ... On close examination, however, this claim is supported neither by economic theory nor by empirical evidence.

The surface plausibility of trickle-down theory owes much to the fact that it appears to follow from the ... belief that people respond to incentives. Because higher taxes on top earners reduce the reward for effort, it seems reasonable that they would induce people to work less... As every economics textbook makes clear, however, a decline in after-tax wages also exerts a second, opposing effect. By making people feel poorer, it provides them with an incentive to recoup their income loss by working harder than before. Economic theory says nothing about which of these offsetting effects may dominate.

If economic theory is unkind to trickle-down proponents, the lessons of experience are downright brutal. If lower real wages induce people to work shorter hours, then the opposite should be true when real wages increase. According to trickle-down theory, then, the cumulative effect of the last century’s sharp rise in real wages should have been a significant increase in hours worked. In fact, however, the workweek is much shorter now than in 1900.

Trickle-down theory also predicts shorter workweeks in countries with lower real after-tax pay rates. Yet here, too, the numbers tell a different story. ...

Trickle-down theory also predicts a positive correlation between inequality and economic growth, the idea being that income disparities strengthen motivation to get ahead. Yet ... researchers ... find a negative correlation. In the decades immediately after World War II, for example, income inequality was low by historical standards, yet growth rates in most industrial countries were extremely high. In contrast, growth rates have been only about half as large in the years since 1973, a period in which inequality has been steadily rising.

The same pattern has been observed in cross-national data. ... Again and again, the observed pattern is the opposite of the one predicted by trickle-down theory.

The trickle-down theorist’s view of the world ... bears little resemblance to reality. In the 1950s, American executives earned far lower salaries and faced substantially higher marginal tax rates... Yet most of them competed energetically for higher rungs on the corporate ladder. The claim that slightly higher tax rates would cause today’s executives to abandon that quest is simply not credible.

In the United States, trickle-down theory’s insistence that a more progressive tax structure would compromise economic growth has long blocked attempts to provide valued public services. Thus, although every other industrial country provides universal health coverage, trickle-down theorists insist that the wealthiest country on earth cannot afford to do so. Elizabeth Edwards faces her battle with cancer with the full support of the world’s most advanced medical system, yet millions of other Americans face similar battles without even minimal access to that system.

Low- and middle-income families are not the only ones who have been harmed by our inability to provide valued public services. For example, rich and poor alike would benefit from an expansion of the Energy Department’s program to secure stockpiles of nuclear materials that remain poorly guarded in the former Soviet Union. Instead, the Bush administration has cut this program, even as terrorists actively seek to acquire nuclear weaponry.

The rich are where the money is. Many top earners would willingly pay higher taxes for public services that promise high value. Yet trickle-down theory, which is supported neither by theory nor evidence, continues to stand in the way. This theory is ripe for abandonment.

Here's a simple way to show that a an increase in taxes does not necessarily reduce effort. Suppose you have a summer job and you have to earn $2,000 for the summer. You don't need to earn any more than that, and don't plan to, but it is a necessity that you reach this goal. Also suppose that you have a job paying $10 per hour so that you can earn the money in 200 hours, or five 40 hour weeks. Let taxes be zero initially.

Now let the government tax you at 50%, surely enough to reduce effort. But in this case it won't. Instead, you will now work twice as long, 10 weeks or 400 hours at $5 per hour, in order to reach your goal of $2,000. So in this example, a tax of 50% doubles work effort rather than reducing it.

This is, of course, a special case and it is possible in the more general framework for the opposite to happen, i.e. for a reduction in the take-home wage to reduce effort, though as noted above the evidence is against the trickle-down story. But this does show clearly that the claim that higher taxes will reduce effort is not necessarily correct. If there is a strong incentive to recover income losses after an increase in the tax rate, effort will increase in contradiction to the trickle-down claims.

Friday, March 30, 2007

Pro Growth Liberal: Tax “Cuts”: Fill My Mug and Pass the Popcorn

PGL at Angry Bear reminds Greg Mankiw that tax cuts don't pay for themselves:

Tax “Cuts”: Fill My Mug and Pass the Popcorn, by PGL: Greg Mankiw provides this parable about tax policy:

Suppose that every day, ten men go out for beer and the bill for all ten comes to $100. If they paid their bill the way we pay our taxes, it would go something like this:

The first four men (the poorest) would pay nothing. The fifth would pay $1. The sixth would pay $3. The seventh would pay $7. The eighth would pay $12. The ninth would pay $18. The tenth man (the richest) would pay $59. So, that's what they decided to do.

The ten men drank in the bar every day and seemed quite happy with the arrangement, until one day, the owner threw them a curve. "Since you are all such good customers," he said, "I'm going to reduce the cost of your daily beer by $20." Drinks for the ten now cost just $80.

Let me interject something here from Greg's post. The story goes on and after the price cut:

[T]he bar owner ... proceeded to work out the amounts each should pay [after the 20% reduction]. And so:

The fifth man, like the first four, now paid nothing (100% savings).
The sixth now paid $2 instead of $3 (33%savings).
The seventh now pay $5 instead of $7 (28%savings).
The eighth now paid $9 instead of $12 (25% savings).
The ninth now paid $14 instead of $18 (22% savings).
The tenth now paid $49 instead of $59 (16% savings).

Each of the six was better off than before. And the first four continued to drink for free. But once outside the restaurant, the men began to compare their savings. "I only got a dollar out of the $20," declared the sixth man. He pointed to the tenth man," but he got $10!" "Yeah, that's right," exclaimed the fifth man. "I only saved a dollar, too. It's unfair that he got ten times more than I!"

"That's true!" shouted the seventh man. "Why should he get $10 back when I got only two? The wealthy get all the breaks!" "Wait a minute," yelled the first four men in unison. "We didn't get anything at all. The system exploits the poor!"

The nine men surrounded the tenth and beat him up. ... And that, boys and girls, journalists and college professors, is how our tax system works. ...

Back to PGL:

Greg continues with this parable, which can also be found here, commenting on the distribution of this alleged tax cut. I guess this is supposed to be a comment on the 2001 tax cut but there’s something missing here. In the real world, we did not get a tax cut – only a tax shift. Yes, government spending did not decline so somebody will have to pay more in taxes someday.

So let’s finish his parable by assuming that the owner raised the price of the munchies such as popcorn and the beer nuts. One cannot talk about talk about the distribution of the change in tax policy without bringing in the total picture. Yet, we often see our conservative friends implicitly denying that either sales taxes or employment taxes (or both) will have to be increased. Of course, this is one of many myths that get created when one falls for the free lunch fallacy that permeates Republican discussions of fiscal policy.

Hey bartender – pour me another pint and give me some more popcorn. It’s all free – right?

I'll note too that the fact that the owner can cut 20% off the bill and still make a profit ought to raise some eyebrows among the patrons - that's no small amount of monopoly power. In a competitive market, the owner could not do this. In addition, this is not how we analyze the general equilibrium effects of change in the burden of taxes after a tax change. Even with partial equilibrium analysis, when taxes are increased the customers will not face 100% of the burden, the burden is shared between the owner and the customers. In the opposite direction, when taxes are cut, the reduced burden is shared as well. That's missing from this analysis.

As to Greg's the main point, questions about the equity of tax cuts, the other thing missing is what taxes pay for. Making the good in the story beer (i.e. something we could do without) and then allowing the same quantity to be purchased at a lower price is not a parable that relates to government spending. Unlike this made-up story with it's made-up resentments, taxes fund government services - something must be given up when taxes are cut, or taxes must be raised in the future as PGL notes. In the case where programs must be cut, if it's essential social programs, then I hope that people do raise questions of basic equity. Cutting estate taxes when we cannot afford pre-school programs for disadvantaged children would be a much better parable for Greg to tell. We could point fingers at the disadvantaged and call them whiners for asking if paying for estate tax-cuts by not fully funding programs such as these is fair - but I suspect we won't hear that story.

Thursday, March 29, 2007

The "Dramatic" Reduction in the Progressivity of Federal Taxes

The Center on Budget Policy and Priorities reports on changes in the progressivity of federal taxes over time:

New Study Finds "Dramatic" Reduction Since 1960 in the Progressivity of the Federal Tax System, by Aviva Aron-Dine, CBPP: In a new study, Thomas Piketty and Emmanuel Saez ... examine how the progressivity of the federal tax system has changed over time. Unlike previous analyses, theirs examines effective federal tax rates going back to 1960, including income, payroll, corporate, and estate taxes, and provides data for income groups reaching up to the top one-hundredth of one percent (.01 percent) of the population. Several crucial findings emerge from their study.


“The progressivity of the U.S. federal tax system at the top of the income distribution has declined dramatically since the 1960s.” As Figure 1 shows, since 1960, average federal tax rates for middle-income households have increased and then declined modestly. Over the same period, high-income households saw sharp drops in their federal tax rates.

Moreover, the drops were largest for the very highest-income households. The average tax rate declined by a larger amount for households in the top one hundredth of 1 percent of the income scale (where incomes in 2004 averaged about $15 million) than for households in the top tenth of 1 percent (where incomes averaged above $3.7 million) or for households in the top 1 percent (where incomes averaged about $850,000). ...

“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.” ...

As Piketty and Saez point out, economists generally assess whether a tax system is progressive based on whether the distribution of after-tax income is more equal than the distribution of pre-tax income. They assess whether a tax cut is progressive based on whether it makes the distribution of after-tax income more or less equal.

Like others who have examined the effects of the 2001 and 2003 tax cuts, Piketty and Saez find that the tax cuts made the distribution of after-tax income less equal. ... In short, the tax cuts were regressive.

Because it omits the effects of those tax cuts enacted in 2001 that were not fully phased in by 2004 (such as the repeal by 2010 of the estate tax and of the provisions of the tax code that reduce the value of itemized deductions and personal exemptions for households at high income levels), Piketty and Saez’s simulation substantially understates the regressivity of the tax cuts once they are fully in effect. Even so, it offers additional confirmation that the tax cuts were regressive.

In sum, Piketty and Saez’s new study shows that the federal tax system has become much less progressive over the past several decades, and the 2001 and 2003 tax cuts have continued this trend. Over much the same several decades, pre-tax income inequality has grown as well. Thus, during a period in which economic forces have been generating increased pre-tax inequality, changes in the tax system have exacerbated rather than mitigated the widening of the income gap.

The new results showing that income inequality continues to widen have been covered here before, the CBPP details the results here, and today's NY Times summarizes the results as well:

Income Gap Is Widening, Data Shows, by David Cay Johnston, NY Times: Income inequality grew significantly in 2005, with the top 1 percent of Americans — those with incomes that year of more than $348,000 — receiving their largest share of national income since 1928... The top 10 percent, roughly those earning more than $100,000, also reached a level of income share not seen since before the Depression.

Continue reading "The "Dramatic" Reduction in the Progressivity of Federal Taxes" »

Friday, March 23, 2007

Reagan: The Great Taxer (Updated)

Continuing with "Don’t Cry for Reagan," for those still battling this one out, here's more Reagan versus Bush:

The Great Taxer, by Paul Krugman, Commentary, NY Times, June 2004: Over the course of this week we'll be hearing a lot about Ronald Reagan, much of it false. A number of news sources have already proclaimed Mr. Reagan the most popular president of modern times. In fact, though Mr. Reagan was very popular in 1984 and 1985, he spent the latter part of his presidency under the shadow of the Iran-Contra scandal. Bill Clinton had a slightly higher average Gallup approval rating, and a much higher rating during his last two years in office.

We're also sure to hear that Mr. Reagan presided over an unmatched economic boom. Again, not true: the economy grew slightly faster under President Clinton, and, according to Congressional Budget Office estimates, the after-tax income of a typical family, adjusted for inflation, rose more than twice as much from 1992 to 2000 as it did from 1980 to 1988.

But Ronald Reagan does hold a special place in the annals of tax policy, and not just as the patron saint of tax cuts. To his credit, he was more pragmatic and responsible than that; he followed his huge 1981 tax cut with two large tax increases. In fact, no peacetime president has raised taxes so much on so many people. This is not a criticism: the tale of those increases tells you a lot about what was right with President Reagan's leadership, and what's wrong with the leadership of George W. Bush.

The first Reagan tax increase came in 1982. By then it was clear that the budget projections used to justify the 1981 tax cut were wildly optimistic. In response, Mr. Reagan agreed to a sharp rollback of corporate tax cuts, and a smaller rollback of individual income tax cuts. Over all, the 1982 tax increase undid about a third of the 1981 cut; as a share of G.D.P., the increase was substantially larger than Mr. Clinton's 1993 tax increase.

The contrast with President Bush is obvious. President Reagan, confronted with evidence that his tax cuts were fiscally irresponsible, changed course. President Bush, confronted with similar evidence, has pushed for even more tax cuts.

Mr. Reagan's second tax increase was also motivated by a sense of responsibility — or at least that's the way it seemed at the time. I'm referring to the Social Security Reform Act of 1983, which followed the recommendations of a commission led by Alan Greenspan. Its key provision was an increase in the payroll tax that pays for Social Security and Medicare hospital insurance.

For many middle- and low-income families, this tax increase more than undid any gains from Mr. Reagan's income tax cuts. In 1980, according to Congressional Budget Office estimates, middle-income families with children paid 8.2 percent of their income in income taxes, and 9.5 percent in payroll taxes. By 1988 the income tax share was down to 6.6 percent — but the payroll tax share was up to 11.8 percent, and the combined burden was up, not down.

Nonetheless, there was broad bipartisan support for the payroll tax increase because it was part of a deal. The public was told that the extra revenue would be used to build up a trust fund dedicated to the preservation of Social Security benefits, securing the system's future. Thanks to the 1983 act, current projections show that under current rules, Social Security is good for at least 38 more years.

But George W. Bush has made it clear that he intends to renege on the deal. His officials insist that the trust fund is meaningless — which means that they don't feel bound to honor the implied contract that dedicated the revenue generated by President Reagan's payroll tax increase to paying for future Social Security benefits. Indeed, it's clear from the arithmetic that the only way to sustain President Bush's tax cuts in the long run will be with sharp cuts in both Social Security and Medicare benefits.

I did not and do not approve of President Reagan's economic policies, which saddled the nation with trillions of dollars in debt. And as others will surely point out, some of the foreign policy shenanigans that took place on his watch, notably the Iran-contra scandal, foreshadowed the current debacle in Iraq (which, not coincidentally, involves some of the same actors).

Still, on both foreign and domestic policy Mr. Reagan showed both some pragmatism and some sense of responsibility. These are attributes sorely lacking in the man who claims to be his political successor.

Update: Email brings approval ratings for Bush, Nixon, Clinton, and Reagan (click on figure for larger version):


Thursday, March 22, 2007

Want Tax Cuts? Then Pay for Them

Jared Bernstein looks at the differences between the president's budget proposal and the House Budget Committee's proposal for spending and revenue:

Show us the money, by Jared Bernstein, Comment is Free: Well, with both the Democratic House and Senate having weighed in on President Bush's 2008 federal budget, the battle lines are taking clear shape.

Today, the House Budget Committee released its mark-up of the budget resolution, a document that sets broad budgetary outlines and preferences - on spending and revenue targets... In this case, there are some clear lines of demarcation from the president's budget that are worth noticing.

First, on the so-called sunset clause under which the president's tax cuts are due to expire in 2011: they say, if you want to cut taxes, you've got to find the money. (This idea is called pay-as-you-go, or paygo). And second, in some key areas of domestic programmes, most notably healthcare for poor kids, where Bush cuts, the House and Senate Democrats spend.

The part of all this that is sure to get the most attention is the expiration of the Bush tax cuts enacted in 2001 and 2003. Though it's fair to say conservatives never intended for the sun to set, to sell the cuts they had to build in their demise by the end of the decade. Now they go around saying that allowing the cuts to expire would amount to a massive tax increase.

But since it would take new legislation to extend the cuts, Democrats legitimately make the case that to do so would be to enact yet another round of tax cuts. Which brings us to the second point: paygo. ... [P]ay-as-you-go ... mean[s] that any tax cut must be offset with either a tax increase or a cut in entitlement spending. ... But beyond that, it means the tax-cut zombies have a new, big problem.

For years, they have been able to ignore the fiscal implications of their massive tax cuts. They could wave hands and argue that the cuts would pay for themselves ... (even when their own agencies were submitting reports saying that wouldn't happen). Or they could simply ignore the fact that both current (the wars in Iraq and Afghanistan) and looming (healthcare) expenses were going to lead to large and damaging deficits.

In other words, as long as the grown-ups are away, you can have all the guns and butter you want. Well, paygo means the grown-ups are back in the room.

Bush and the Republican minority are starting to get really fired up about all this and are accusing the Democrats of massive tax increases. But ..., if Bush and the Republicans want to extend the cuts, they are going to need to find the money.

Which bring us to a final point. The president does go after entitlements, cutting them by $52bn over five years, and the Democrats are already taking flak for not joining him there. But here's why that is not fair: before this budget discussion even started, the White House ruled out any tax increases to pay for spending priorities.

Under these conditions, the Democrats have to fight their way out of a tight box. Even with the sunsets, vital public healthcare spending will ultimately have to fall. In fact, the president's budget threatens health coverage to more than 1 million children by 2012.

With this resolution, they are essentially saying they are going to take the revenue from the expiring cuts and spend it on their priorities, which include expanding the very child healthcare programme the president is cutting... You want to cut more taxes? Show us the money...

And, from the Center on Budget and Policy Priorities today, "Key Argument Against Applying Pay-As-You-Go To Tax Cuts Does Not Withstand Scrutiny" which will make it even harder for Republicans to argue against the need to pay for any further tax cuts.

I worry that deficit hawkishness will cause the deficit numbers themselves will take precedence over the programs they represent, i.e. that the desire to show progress on the budget deficit will lead to unwise cuts in necessary programs. The current deficit isn't a problem, it's the long-term outlook that we need to worry about, and focus on current deficit numbers is more for show than for real budgetary dough.

There are political gains to be made from deficit reduction in the short-run, and certainly a return of discipline is needed after the excesses of the last few years, but we need to be careful how we go about resolving projected budgetary imbalances and keep in mind that the long-run is the focus. I have much more confidence that Democrats will exercise sound judgment than I do for Republicans, e.g. not cutting taxes on the wealthy if it means giving up health care for children. On this point, Jared Bernstein notes:

True, [Democrats] are keeping mum on big forthcoming budgetary constraints. But when the powers that be are ready to entertain the possibility that there are other ways to deal with the challenge of entitlements - specifically healthcare - than cutting them, the Democrats will come back to the table.

Tuesday, March 20, 2007

IRS Agents Say There's Pressure to Close Corporate Tax Cases

David Cay Johnston reports on pressure IRS agents are feeling to end corporate cases prematurely so that managers can meet case load goals and receive bonuses:

I.R.S. Agents Feel Pressed to End Cases By, David Cay Johnston, NY Times: The head of the Internal Revenue Service faces questions in Congress today about auditors’ complaints that they are being forced to close corporate cases prematurely, allowing billions in tax dollars to go unpaid. ...

The agency countered that it had increased the number of companies whose tax returns it examined by a fourth since 2001, even though the number of auditors was virtually the same. ... [T]he officials say they have shortened the average time to complete an audit from almost two years in 2001 to less than 18 months last year.

I.R.S. officials say the auditors who are complaining are mostly older agents unwilling to adopt new approaches. ... Deborah M. Nolan, the I.R.S. official in charge of auditing businesses with more than $10 million of assets, said that her auditors recommended payment of almost $27 billion in additional taxes last year, more than double the amount in 2001, but down 15 percent from 2005 when added taxes totaled almost $32 billion...

Asked about data showing that additional taxes recommended for each audit are up, the agents who were interviewed all said that this showed only how pervasive tax cheating had become. ...

One veteran agent of the largest corporate audits compared the I.R.S. to a crew that walks through an orchard instead of working from ladders. “You can grab all the low-hanging fruit in a few highly productive hours, while leaving most of the harvest untouched,” he said.

In an interview last week, Ms. Nolan ... reiterated her position that the agency would “do the right thing” by keeping cases open past preset deadlines when evidence points to large amounts of tax due.

All 21 agents interviewed over the last two months said that the I.R.S. paid lip service to its “do the right thing” policy. They provided e-mail messages and memos in which managers and executives made little or no mention of anything but closing files quickly.

In one widely circulated directive, Cheryl P. Claybough, who oversees half the audits of communications, technology and media companies, alternately encouraged and chastised subordinates for not closing cases quickly enough, while making only passing references to the “right thing” policy. ...

A Feb. 1 e-mail message from Kenneth L. Kates of the audit quality assurance operation orders nine subordinates to complete their reviews of audits without mentioning quality.

“We must have ten case apiece closed by 3-7-2007,” Mr. Kates wrote. “You must keep me informed and make me aware immediately if you will have any problems meeting this goal. The goal translates into two cases per week.”

All of the agents interviewed said they believed that the controlling factor in determining whether their superiors qualified for cash bonuses and promotions was their success at closing cases. “How the managers get paid; that’s the real policy,” one auditor in Texas said.

Only in cases of blatant fraud, agents said, are deadlines ignored. A few agents supplied e-mail messages and memos to support their statements.

Two auditors described separate training sessions that began with a few words about the “right thing” policy, then focused entirely on closing cases by the preset deadlines.

“What message do you think employees get when almost an hour is spent on cycle time and overage, and doing the right thing gets a brief mention?” one auditor said.

One agent, who said he had worked on some of the largest I.R.S. cases, said he was admonished for resisting management pressure to close a case in which his team believed that vast sums were due.

The agent said his team was forced to sign off on a closing agreement allowing the company to permanently underpay its taxes by hundreds of millions of dollars a year. When a taxpayer receives a formal closing agreement from the I.R.S. .., the taxpayer may forever follow that practice, even if it violates the tax law. ...

[O]ne of the agents ... said, “in most cases management is making these decisions in order to drive case closure goals.”

Over and above whatever politics might be behind this policy, this is an example of an agency problem, i.e. the problem of having the incentives of those making the decisions (cases processed) differ from the incentives needed to produce optimal public policy (tax equity and efficiency). Performance goals can work, but they have to be constructed carefully so that the incentives of decision makers are consistent with overall policy goals. Basing bonuses of managers on closed cases within a particular time frame does not appear to produce optimal corporate tax compliance policy.

Monday, March 19, 2007

The 2001 and 2003 Tax Cuts Made the Tax Code More Regressive

This analysis of the 2001 and 2003 tax cuts from Aviva Aron-Dine of the Center on Budget and Policy Priorities concludes that the tax cuts made the tax code became more regressive:

Have the 2001 and 2003 Tax Cuts Made the Tax Code More Progressive?, By Aviva Aron-Dine, CBPP: With debate beginning on the Senate budget resolution, congressional supporters of the 2001 and 2003 tax cuts have begun recycling old arguments for extending all of these tax cuts.  Among these is the claim that the tax cuts have made the tax code more progressive.

The reality is that the tax cuts have made the tax code more regressive.  A progressive tax code is one that makes the distribution of after-tax income more equal than the distribution of pre-tax income, and one tax code is “more progressive” than another if it has a larger effect in reducing income inequality.  So, in order for the 2001 and 2003 tax cuts to have made the tax code more progressive, after-tax incomes would have to be less unequal today than if the tax cuts had not occurred.  In fact, however, the reverse is true:  the tax cuts made the distribution of after-tax income more unequal.

When fully in effect, the 2001 and 2003 tax cuts will increase the incomes of high-income households by a much larger percentage than the incomes of low- or middle-income households, according to estimates by the nonpartisan Urban-Brookings Tax Policy Center.  As Figure 1 shows, the tax cuts will increase the after-tax incomes of households with annual incomes above $1 million by an average of 7.5 percent, compared to a 2.3 percent increase for households in the middle of the income spectrum and a 0.5 percent increase for the lowest-income 20 percent of households.  This means that high-income households will hold a larger share of the nation’s after-tax income as a result of the tax cuts.

Claims That the Tax Cuts Were Progressive Rely on a Flawed Measure Supporters of the tax cuts generally do not attempt to refute these facts.  Instead, they frequently point to CBO data showing that high-income households paid a larger percentage of federal taxes in 2004 (after the tax cuts) than in 2000 (before the tax cuts).  They claim that this shows that the tax cuts made the tax system more progressive, and they imply that it means that high-income households received disproportionately small tax cuts, or even that these households are paying more in taxes now than in earlier years.  Such claims and inferences are incorrect.  The same CBO data cited by tax-cut supporters also show that high-income households are paying considerably less of their income in taxes now than before the tax cuts.  In 2000, households in the top 1 percent of the income scale paid an average of 24.2 percent of their income in federal individual income taxes.  By 2004 (the latest year for which data are available), that figure had fallen to 19.6 percent, the lowest level since 1986.  That decline works out to a reduction in these households’ tax burden of about $58,000 per household (in 2004 terms).

The CBO data also show that income tax burdens fell by considerably more for high-income households than for other households (see Table 1).  While effective federal income tax rates dropped by 4.6 percentage points for those in the top 1 percent of the income scale, they fell by only 2.1 percentage points for those in the middle of the income scale, and by 1.6 percentage points for those at the bottom.[1]

As these facts suggest, the change in the “percentage of taxes paid” is not a useful metric for assessing which income groups benefited the most from the tax cuts or whether the tax cuts made the tax code more or less progressive.  This measure is fundamentally flawed in three respects.

  • It is distorted by growing inequality in pre-tax incomes.  When high-income households’ share of the pre-tax income in the nation increases — as it did in 2003, 2004, and (new data show) 2005 — the share of the total taxes that high-income households pay naturally rises as well, for reasons having nothing to do with legislated changes in tax policy.
  • The “percentage of taxes paid” measure also fails to take into the account the fact that when a tax cut reduces the total amount of revenue collected, high-income households can get a large reduction in their tax bills even if the percentage of taxes they pay is increasing.  For example, between 2000 and 2004, the share of individual income taxes paid by the top 1 percent of households edged up marginally, from 36.5 percent to 36.7 percent.  But total revenues from the individual income tax fell by more than $250 billion between 2000 and 2004 (in 2004 dollars).  The slightly larger percentage of taxes that high-income households paid worked out to a considerably smaller amount of taxes paid about $100 billion less, adjusted for inflation — as well as a considerably smaller average per-household tax burden (see Figure 3 and Table 1).
  • Finally, the “percentage of taxes paid” measure fails to take into account the fact that tax cuts that are financed by government borrowing — as the 2001 and 2003 tax cuts were — must eventually be paid for.   As former Federal Reserve Chairman Alan Greenspan warned, “If you’re going to lower taxes, you shouldn’t be borrowing essentially the tax cut.  And that over the long run is not a stable fiscal situation.”  Simply stated, funds that are borrowed must eventually be paid back.

    Tax Policy Center data show that even if the costs of the tax cuts eventually are paid for through measures that reduce income by the same percentage for households at every income level (which is roughly what could occur under a balanced package of program reductions and progressive tax increases), the bottom four-fifths of households will end up worse off, on average, than if the tax cuts had not been enacted (see Table 2).[2] In other words, the large majority of American households are likely to lose more from the measures eventually needed to pay for the tax cuts than they gain from the tax cuts themselves.

The analysis has another section noting that "Other Measures Also Cast Doubt on the Tax Cuts’ Fairness."

Friday, March 16, 2007

Krugman vs. Barro

From the archives, a debate between Paul Krugman and Robert Barro:

The Charlie Rose Show, November 1, 2004:  CHARLIE ROSE: ... With only days until the election, domestic policy remains as much a concern for Americans as Iraq or national security. Joining me now two leading economists, Paul Krugman and Robert Barro. ... I'm pleased to have both of them at this table. Are tax cuts for the rich good for economic growth, for those people who make in this -- using the political numbers of our time, people who make more than $200,000 a year?

PAUL KRUGMAN: Not if they add to a budget deficit. Not if whatever arguments you can make for them are outweighed by the fact that it is adding to the amount of money the government is borrowing.

CHARLIE ROSE: I'm trying to get at this question. So, what is the basic difference between the two of you with respect to where this economy is and what it needs?

PAUL KRUGMAN: We have differences about what's effective for the economy as well, but the biggest difference is value. I want to maintain the social insurance institutions. I want to maintain Social Security, Medicare and Medicaid. And I want some from further expansion of health insurance. So I say look, you know, we don't have enough revenue as is. I don't want more tax cuts that will further undermine the revenue base that makes it possible to have these programs that sand off some of the rough edges of capitalism. And Robert will have to talk for himself on how he wants to go. But let me put it this way. If you are going to ask me about the Bush tax cuts, is the criterion, is the economy in better shape now currently than it would be if nothing had been done? Probably. I think we got some stimulus out of these tax cuts.

ROBERT BARRO: No, I disagree with a lot of this. Because I think where we are now, which is actually quite a good economy -- owes quite a bit to the 2003 tax cut plan. And I should distinguish a lot between the 2003 and 2001 tax cut plans. They are really quite different. The big thing about the 2003 plan is that it didn't just heap money to people. It didn't just particularly give money to people at increased incentives to do things. It did that particularly by accelerating the marginal income tax rate cuts. It did it by cutting some of the tax rates that pertain to saving. It motivated people to work more, to enhance productivity, to increase investment. It worked great. I mean, since early 2003, the economy has done extremely well. And I can't prove it for sure, but I think it is a very convincing case that that tax cut in 2003 was a lot responsible for it.

CHARLIE ROSE: But what about his basic argument that there is a difference in terms of value judgment here, in understanding distinctions between the two of you?

Continue reading "Krugman vs. Barro" »

Saturday, March 10, 2007

I Can Do That Voodoo That You Do Too

Jonathan Chait watches John McCain adopt the party line and faithfully assert that tax cuts increase government revenues even though there's no evidence to support that contention:

John McCain goes over to the dark side, by Jonathan Chait, Commentary, LA Times: 'This is not Luke Skywalker here," said Sen. Lindsey Graham (R-S.C.), discussing his friend and Senate colleague John McCain's second run for the presidency. "This is a totally different campaign." ...

Seven years ago, of course, McCain was likening himself in public to Luke Skywalker, waving light sabers on stage at rallies and comparing his party's establishment to the Death Star. He would say such things as, "My party has become captive to special interests." He would cite a bumper sticker that read "The Christian Right Is Neither."

And now? Well, let's just say that if John McCain circa 2007 was campaigning against John McCain circa 2000, he would call him a communist. The old McCain called President Bush's tax cuts fiscally and socially irresponsible, a giveaway to the rich in a time of rising inequality. The new McCain was recently interviewed by National Review's Ramesh Ponnuru and asked if there were any circumstances, including the guarantee of spending cuts, under which he'd consider repealing the tax cuts he denounced and voted against. He replied: "No. None. None. Tax cuts, starting with Kennedy, as we all know, increase revenues."

We all know that? In fact, economists know that this is not true. Conservative economists know this isn't true. Even conservative economists who work in the Bush administration have admitted this isn't true. ... There's really no dispute among economists about that."

How does McCain explain his conversion to voodoo economics? He doesn't. He says things like: "I haven't changed. My record is the same on all issues, which is that of a conservative Republican." Which is funny, because a few years ago one of his close advisors — someone who is now furiously insisting that McCain has always been a staunch conservative — told me, "Ideologically, we all changed."

What makes McCain's conversion all the more tragic is that it's plainly not working. ... His career ... has indeed resembled a certain famous Jedi. He began as a crusader for justice. Soon he realized that he needed to acquire more power in order to accomplish his noble goals. But over time, his pursuit of power became the goal itself, and by the end he lost his capacity to differentiate between right and wrong.

This is not Luke Skywalker here. This is Luke Skywalker's father. But at least Darth Vader attained his position before the Death Star exploded.

Given the vast amount that's been written concerning tax cuts and government revenue and the broad consensus on the topic, it's difficult to believe that any major candidate could be ignorant of the work showing that tax cuts do not increase revenue. If they are ignorant of this broad consensus, or if they choose to simply ignore the evidence and adopt the party line that tax cuts pay for themselves, then questions should be raised about their ability to lead the nation in economic policy. Will they understand enough economics to implement effective policy? If they do understand, will ideology or party loyalty get in the way?

Update: Vox Baby says:

More Laffer Curve Laughers: Via Greg Mankiw, we find this National Review interview of Senator McCain by Ramesh Ponnuru. Greg refers us to this part of the Q&A (by far the worst on economic issues):

...Sen. McCain: ...Tax cuts, starting with Kennedy, as we all know, increase revenues. So what’s the argument for increasing taxes? If you get the opposite effect out of tax cuts?

Greg suggests two appropriate follow-up questions for McCain:

1. If you think the 2001 and 2003 tax cuts increased revenue, why did you vote against them?

2. If you think tax cuts increase revenue, why advocate spending restraint? Can't we pay for new spending programs with more tax cuts?

As Greg has announced that he's an economic advisor to Governor Romney, I'll be very curious to hear Romney's response to a direct question about the circumstances under which he would be willing to increase taxes if he's elected President.

The question that I would like to have answered by any policy maker who voted for the tax cuts and believes that they have increased revenues is:

Why did you make them so small?

Sunday, February 25, 2007

Republicans Could Have Diffused the "AMT Bomb," But Didn't

Linda Beale of ataxingmanner takes on a recent Wall Street Journal editorial on "Bill Clinton's AMT Bomb":

Wall Street Journal AMT Editorial, by Linda Beale: The Wall Street Journal is an important source of financial news, but people should not expect to read its editorial page without their spin antennae turned on. Today's editorial on the AMT is a good example of the way the Journal does partisan (and misleading) spin. It's titled "Bill Clinton's AMT Bomb," Wall Street Journal, Feb. 23, 2007...

What's wrong with it?

Continue reading "Republicans Could Have Diffused the "AMT Bomb," But Didn't" »

Friday, February 09, 2007

Does Tony Snow's Dissembling Pay for Itself?

Brad DeLong with some dynamic scoring of Tony Snow:

Why Oh Why Are We Ruled by These Fools? (Tony Snow Destroys His Brain Department), by Brad DeLong: Bush Press Secretary Tony Snow has a problem, which he resolves by being as stupid as he can. He is asked a question. How does he answer?

Tony Snow doesn't dare answer: "The President has said that the tax cuts grow the economy and help balance the budget. Next question?" That would kill his remaining credibility with the press corps.

Tony Snow doesn't dare answer: "Because of the tax cuts the deficit is larger than it would have been with higher taxes, but the economy is stronger, and the tradeoff is worth it." That would get him fired by Bush within the week. And

Tony Snow doesn't dare answer: "The administration economists have tried to get Bush to drop the 'tax cuts help balance the budget' line because it is misleading and wrong and it harms the administration each time Bush or Cheney uses it. But they have had no success." That would have the advantage of being the truth, but it would get him fired by Bush within the hour.

So what does he do? He acts as stupid as possible: Q Can I ask you about an argument the President made today and has made repeatedly in terms of the tax cuts? He speaks of the economic output that is raised by the tax cuts. But he specifically is crediting his tax cuts for the increased revenues to the U.S. Treasury. Does the President believe that the tax cuts have paid for themselves, or will pay for themselves anytime in the foreseeable future?

MR. SNOW: What you're doing is you're getting yourself into abstruse ground. There are any number of ways of calculating it. By some calculations they have paid for themselves and then some. But what I'd ask to do before getting into that thicket is to find out what you want to use as your base, know what your baselines are, because whenever one gets into games like this, it's all about assumptions. And I don't know what assumptions are embedded in the question.

Q I'm not sure I'd look at it as a game, but when the President says low taxes means economic vitality, which means more tax revenues --

MR. SNOW: Yes.

Q -- does the Treasury tell him that more money is coming in than was lost to the tax cuts?

MR. SNOW: Well, I'm not sure -- the whole point is that the tax cuts generate extra economic activity. All you have to do is -- I would, if you want to --

Q That's a separate issue.

MR. SNOW: Well, no, it's not. It's not a separate issue at all. What it says is when you have greater economic --

Q If the economy is growing more, that's one thing; but whether tax revenues are growing is a separate issue.

MR. SNOW: Well, but tax revenues tend to grow in tandem with economic activity. When you've got a growing economy -- let's take a look at what we have. We have an economy where we've had economic growth for 42 consecutive months. You also have an economy that now has more people working than ever before. You've got higher levels of employment, home ownership, economic activity. Wages, especially in recent months, have shown real significant growth. Real disposable income up 5.4 percent in the fourth quarter of last year. You put all that together, you're going to have more revenue. And the fact is, a good, growing economy is always good for revenues.

Q I'm asking specifically about the budget, which is what the President was arguing about today. And when he says low taxes means more tax revenues --

MR. SNOW: Yes, that's right.

Q -- he is, in a sense, saying that it makes it easier to balance the budget, is he not?

MR. SNOW: Yes. A growing economy always makes it easier to balance the budget.

Q No, that cutting taxes in the way he's done makes it easier to balance the budget.

MR. SNOW: But cutting the taxes -- you're not connecting the dots. Cutting the taxes, in fact, is something that encourages economic growth. And it is that economic growth that ends up generating the revenue, that allows you to balance the budget ahead of time.

Q But has the Treasury told him that the tax cuts enacted on his watch make it easier to balance the budget?

MR. SNOW: I'm not sure that anybody has framed it that way. Call over to Treasury, ask them.

Q I've looked at their analyses; I don't see it, is why I'm asking.

MR. SNOW: Like I said, that's why -- when you talk about pay-for, that really does get into how are you cutting it, and what are you using as your baseline, what's your projection, what are the assumptions. That is not as simple a question as you might think it is. It just isn't. Whenever you get into --

Q I know this debate is to how big the effect is, but I've not seen it --

MR. SNOW: But I've also heard people say, yes, we can say it's paid for. But you're asking me to play the role of economist, and as any first-year economic student will tell you, it's all about assumptions. So if you want to get into that argument, I really would suggest you talk to trained economists at the Department of Treasury or within our economic shop, and they'll be able to give you a more precise readout on it.

Tony Snow talks about what an economist will tell you. Let's find an economist--Dartmouth's Andrew Samwick, who was Chief Economist on Bush's Council of Economic Advisers in 2003-2004. Here's what he says:

Andrew Samwick: To anyone [currently] in the Administration who may read this.... Please stop your boss from writing or saying the following:

It is also a fact that our tax cuts have fueled robust economic growth and record revenues.

You are smart people. You know that the tax cuts have not fueled record revenues. You know what it takes to establish causality. You know that the first order effect of cutting taxes is to lower tax revenues. We all agree that the ultimate reduction in tax revenues can be less than this first order effect, because lower tax rates encourage greater economic activity and thus expand the tax base. No thoughtful person believes that this possible offset more than compensated for the first effect for these tax cuts. Not a single one.

The only bright spot is that Tony Snow doesn't dare back George Bush up. Tony Snow doesn't dare say: "The President has said that the tax cuts grow the economy and help balance the budget. Next question?" That's something--not very much, but something.

Does the president continue to repeat this because (a) people are afraid to tell him the truth about tax cuts, (b) he's been told the truth, but chooses to repeat the tax cuts pay for themselves mantra anyway, (c) it's been explained to him, but he doesn't get it, (d) he's decided, as with other issues, that everyone else is wrong and only he sees the truth about tax cuts - they do pay for themselves despite evidence to the contrary, (e) someone he trusts, perhaps someone who has influence on who can access the president, is telling him that tax cuts pay for themselves and he believes it, (f) there's an obscure model somewhere built with the intent of proving this that might, and only might, under the right assumptions, show this effect. That's all that's needed - some evidence somewhere no matter how flimsy - to sell the policy, a lesson learned in the run-up to the Iraq war, or (g) none of the above.

Tuesday, February 06, 2007

An Argument Against the Privatization of Lotteries

This is an argument against privatization of lotteries and other government activities. However, I'm not sure how generally applicable the argument is since it is based on the premise that the activity - gambling in this case - is socially controversial. As such, future governments may want to make the activity illegal but as explained below, if it has been is privatized, that can be more difficult:

Don't privatize future by selling state lottery, by Saul Levmore, U Chicago News: As Indiana and Illinois prepare to sell their lotteries, it is worth thinking about privatization and the selling of a long-term activity. Illinois Gov. Rod Blagojevich says the state might take an estimated $10 billion... Some politicians and voters want the money now, rather than over time, and some voters simply believe the private sector is more efficient and less inclined to corruption.

Who is opposed to these sales? Not future citizens who can't complain about their "missing" revenue stream. The most popular objections will come from those who dislike lotteries or governments. There is, after all, something amusing about a state's ability to give itself a monopoly in a type of gambling--and then to sell it off to the private sector.

There are some good arguments for a state-sponsored lottery... Even a good libertarian could say that inasmuch as the government is not coercing people to play..., a state lottery is not the worst of all evils. Some people might actually like playing it, and that must count for something.

Another objection to the sale of state lotteries carries over to other privatizations. The sale almost certainly locks in public policy in a way that binds future electorates and leaders. ... We know that lotteries are controversial and that it is plausible that our successors may wish they could do away with them. A government that sells the future income stream from a lottery will likely maximize the current sales price or revenue by promising not to devalue the asset it sells after the privatization takes place. It's likely Illinois will look for more upfront cash, and therefore it will promise not to make the lottery illegal (or to compensate the buyers if it does so). It can be counted on to keep these promises for reputation or legal reasons. In this way, a sale of the lottery limits the ability of future governments to do away with the lottery. The objection, then, is that revenue-maximizing privatization locks in policies more than necessary.

The lock-in would be modest if Illinois ... leav[es] the appropriate share of the sale proceeds for future governments. This is not because of intergenerational equity... It is because the saving of proceeds leaves money to compensate the private buyer in the event that future electorates decide they would prefer to do away with the lottery, or at least its monopoly position.

Even if we have no single rule to go by in order to know when the government should own something, create a monopoly or compete in an industry, it seems unlikely that we want a government to lock in future governments. Strange as it may sound, privatization should probably be reversible, especially when there is grave doubt as to whether the government should have been in the business in the first place.

I've never liked lotteries as a government revenue source, but that view doesn't seem to be widely shared. Lotteries are highly regressive, some people are "voluntarily" addicted and because of that lotteries have the potential to do harm far greater than carefully considered taxes yielding identical revenues, and it represents the outcome of a political process where legislators are afraid to make hard decisions. With a lottery, legislators don't have to name the person or business being taxed and they can always claim the tax is purely voluntary. But, you might wonder, who pays taxes voluntarily?

Friday, January 19, 2007

Bartlett: Time for Tax Reform?

Bruce Bartlett wonders if there is sufficient dissatisfaction with the tax code and enough concern over potential future budget shortfalls to bring the political parties together for fundamental reform of the tax system:

Is It Finally Time for Tax Reform?, by Bruce Bartlett, Commentary, NY Times: The idea of tax reform has been off the table for a long time. Republicans used it effectively as a political issue when they were out of power, but once they got control of Congress they lost interest in the subject. It was too easy to enact every tax cut they wanted without worrying about how it was messing up the tax code.

Nevertheless, tax reform remains a popular issue... Of course, one can easily imagine ... tax reform that would either tear the whole system out by its roots and replace it with something else entirely, or just make the current system work better. Any number of such plans have been put forward by various tax commissions, think tanks and such.

There have been two reasons why they never get any traction. The first is that Democrats long ago withdrew from the tax reform debate. After passage of the Tax Reform Act of 1986, which had broad bipartisan support, Democrats pretty much lost interest in tax reform. Perhaps they came to the conclusion that ... anything they put forward would simply play into Republican hands.

Continue reading "Bartlett: Time for Tax Reform?" »

Friday, January 12, 2007

"Catch and Release" at the IRS

Do you remember this change in the leadership at the IRS in January, 2003?:

Budget Official Is Bush's Choice to Lead an Embattled I.R.S., by Richard Stevenson, NY Times, January 14, 2003: President Bush today named Mark W. Everson, deputy director of the White House budget office, to run the Internal Revenue Service... Mr. Everson is an accountant and former corporate executive, but most of his government experience has been in managing large bureaucracies and applying technology to improving performance and cutting costs. The administration ... said that Mr. Everson's main task ... would be to make it operate more effectively...

Mr. Everson ... is little known among tax lawyers, accountants and lobbyists in Washington. His nomination left them unsure what changes he might bring to the I.R.S., which has been buffeted in recent years by criticisms that it has cracked down too hard on taxpayers...

Mr. Everson ... served for six years in a variety of positions in the Reagan administration ... [and] ... has been involved in the administration's efforts to contract out more government functions to the private sector. ...

So what has changed in the four years since Everson, who is often described as having "close ties to the White House," took the helm (his wife was the White House Ethics Officer for three years)? One change is to outsource tax collection to the private sector, a practice that has already come under fire (e.g. see I.R.S. Use of Private Debt Collectors Is Criticized or Tax Farmers, Mercenaries and Viceroys). Here's more on the agency's "cost cutting" efforts:

Agents Say Fast Audits Hurt I.R.S., by David Cay Johnston, NY Times: Top officials at the Internal Revenue Service are pushing agents to prematurely close audits of big companies with agreements to have them pay only a fraction of the additional taxes that could be collected, according to dozens of I.R.S. employees who say that the policy is costing the government billions of dollars a year.

“It’s catch and release,” said Douglas R. Johnson, an I.R.S. auditor in Colorado for three decades who said he grew so frustrated at how large corporations were allowed to pay far less than what he thought they owed that he transferred to the agency’s small-business division. ...

They said a policy intended to avoid delays in auditing corporations was being pushed so rigidly that it prevented them from pursuing numerous examples of questionable corporate tax deductions. ...

[A]uditors said they were told to limit questioning only to those specific issues that the I.R.S. and the companies had agreed in advance to examine. When other questionable deductions emerged in the course of the audit, they said, additional taxes were ignored. ...

One longtime auditor in New York said that when ordered not to pursue an issue “you just write ‘closed per case manager’ to cover yourself.” The auditor was asked why she did not file an official memo indicating that she disagreed and that she believed it was premature or improper to close the audit. “Why would I do that?” the auditor replied. “So my manager will give me a bad performance review?” Others gave similar explanations. ...

Ron McGinley said it was clear when the new policies went into effect in 2003 ... that tax law enforcement was being weakened. Mr. McGinley drew an analogy contrasting the I.R.S. approach to the way the government investigated John Gotti, the organized crime boss known as the Teflon Don. “The way they limit audits,” he said, “is like the FBI going to the Teflon Don and saying, ‘We’d like to look around, so what are you willing to let us see?’”...

Kay Rogers, the union president in Orange County, Calif., said ... supervisors receive cash bonuses, promotions and other benefits based on closing cases within the time allowed, not on the quality of audits or the dollars collected. “When a person is rewarded monetarily for keeping to the cycle time,” she said, they are going to close audits to get their reward.

Individual auditors ... told of case managers and higher supervisors ordering them to drop issues because it would prevent closing the audit by a predetermined date. ... “They are giving away the store,” one agent in New Jersey said.

Agents told of being refused access to specialists, including economists, engineers and historians, because if these specialists developed an issue the audit would have to continue past the deadline. ...

Mr. Lynch, the auditor who retired in California, and many others complained that the effect of the policy was to allow the Bush administration to achieve administratively a further easing of the corporate income tax burden far beyond what Congress has approved legislatively.

According to Melanie Fox, the only current auditor besides Mr. Johnson who agreed to be quoted by name, a large number of the most experienced corporate auditors plan to retire as quickly as they can because they feel their efforts are not respected. “A lot of audit experience is about to walk out the door,” Ms. Fox said. “And then what will happen?”

What will happen? We'll have yet another government agency that has been rendered less effective by the administration in its seemingly never ending attempt to confirm its anti-government ideology.

Tuesday, January 09, 2007

Untruth and Consequences

Recently, the editorial page of the Wall Street Journal was complaining about the reimplementation of paygo by Democrats because it means there can be no more unfunded tax cuts:

Tax As You Go, Editorial, WSJ: Congressional Democrats are dashing out of the gates to establish their fiscal conservative credentials. And as early as today House Speaker Nancy Pelosi will push through so-called "pay-as-you-go" budget rules for Congress. ... "Paygo" ... sounds like a fiscally prudent budget practice... But ... This version of paygo is ... designed ... to make it easier to raise taxes while blocking future tax cuts. ...

It might be useful to remind the editors why these rules were reinstated. Had Republicans not deceived the public about tax cuts paying for themselves, had prominent editorial pages and other media outlets not participated in the deception, and had Republicans not run up the deficit as a consequence of those false promises, there would be no need to reinstate Paygo. If Republicans have a need to blame someone, they ought to blame themselves.

For example, this is an editorial that appeared in the Wall Street Journal last July:

Soaking the Rich Guess who is paying more in taxes now?, Editorial, WSJ, July 2006: Yesterday's political flurry over the falling budget deficit shows that even Washington can't avoid the obvious forever: to wit, the gusher of revenues flowing into the Treasury in the wake of the 2003 tax cuts. ... They've succeeded even beyond Art Laffer's dreams, if that's possible. ... In the 12 quarters ... since the tax cut passed, growth has averaged a remarkable 4%. ... This growth in turn has produced a record flood of tax revenues, just as the most ebullient supply-siders predicted. ...

Remember the folks who said the tax cuts would "blow a hole in the deficit?" ... [T]ax cuts ... are reducing the short-term deficit...

Or, a commentary from Donald Lambro, the chief political correspondent of The Washington Times, the July before that:

Deficit tide ebbing, By Donald Lambro, Commentary, Washington Times, July 2005: The good news this week is the unexpected surge in federal tax revenues that is slashing the federal budget deficit... This is especially welcome news to supply-side tax-cutters who argued all along that lower tax rates spur stronger economic growth, which, in turn, ... increases tax revenues. That is happening now.

It's embarrassing news for President Bush's diehard Democratic critics, who predicted his tax cuts would worsen the budget deficits and drive the government deeper into debt. ... Surely, it has become quite clear they were wrong on all counts.

Surely not. Republicans, with the help of editorials such as these and many, many others, led the public to believe that the tax cuts would be self-financing, or at least largely so. Now that the deception is coming to light, Republicans should quit complaining about having to face the consequences of their false promises.

Wednesday, January 03, 2007

Vox Baby's New Year's Plea

Andrew Samwick asks someone, anyone, in the administration to stop George Bush from claiming tax cuts increase revenue and help with the deficit, because it's not true:

A New Year's Plea, by Andrew Samwick: To anyone in the Administration who may read this blog, I have one small wish for the new year. Please stop your boss from writing or saying the following:

It is also a fact that our tax cuts have fueled robust economic growth and record revenues.

You are smart people. You know that the tax cuts have not fueled record revenues. You know what it takes to establish causality. You know that the first order effect of cutting taxes is to lower tax revenues. We all agree that the ultimate reduction in tax revenues can be less than this first order effect, because lower tax rates encourage greater economic activity and thus expand the tax base. No thoughtful person believes that this possible offset more than compensated for the first effect for these tax cuts. Not a single one.

If I'm wrong, show me the evidence ... and tell me why the tax cuts were so small given their effects on revenues.

Tuesday, January 02, 2007

The Deficit Hawk Faction

In a message on his sidebar, Brad DeLong says:

Deficit Hawks with Our Wings Clipped, Brad DeLong: One thing that happened over the past six years--a thing that I had not recognized--was how much the policies of the Bush administration have destroyed the power of my own faction, the deficit hawk faction, within the Democratic Party. The failure of the Republican deficit hawks to put up even the most feeble of struggles against George W. Bush has led every other faction in the Democratic Party to conclude that we Democratic deficit hawks are saps: deluded enablers of the Republican leadership's right-wing class war.

Brad explains the deficit hawk view further in his review of a book by Robert Rubin from 2004. The deficit hawk, or Eisenhower Republican view as it's termed below is at odds with Paul Krugman's recent column Democrats and the Deficit (but see here too). Here's Brad in the American Prospect:

Bradford Delong, "Robert Rubin's Contested Legacy," The American Prospect vol. 15 no. 2, February 1, 2004: In an Uncertain World: Tough Choices From Wall Street to Washington By Robert Rubin and Jacob Weisberg, Random House, 448 pages...

In 1992 the incoming Clinton administration had, broadly speaking, two strategic options for domestic policy. The first was a double-or-nothing "social democracy" strategy. Federal spending at the time was running at 22 percent of gross domestic product, hardly changed from 1980. Contrary to conservative mythology, the Reagan revolution hadn't shrunk the government, but it had changed its shape: As a share of federal spending, domestic expenditures outside of the entitlement programs were down by one-third, while debt interest and military spending were up. Forecasts showed deficits continuing -- indeed, rising -- as far as the eye could see. If policy had stayed unchanged, the federal debt -- which had already risen from 26 percent of GDP in 1980 to 48 percent in 1992 -- would have continued climbing to 72 percent in 2000.

Bill Clinton could have said: Let the deficit problem be the responsibility of some future Republican administration. We'll pursue Democratic priorities while keeping the deficit constant, or maybe even allowing it to grow a bit in relation to the economy. Spend more to give every American good medical care (instead of using health-care reform for cost containment). Raise public investment in roads, bridges and other crumbling infrastructure. Expand social insurance to provide better benefits and retraining for workers who lose their jobs. Provide incentives -- such as a carbon tax -- for industry to rest lightly on the environment.

Some liberals will not forgive Clinton for failing to pursue this approach, but it was politically infeasible. In Congress, the Democrats had an organizational but not an ideological majority. Many centrist Democrats would not support a social-democratic program, as was evident in the spring of 1993, when Clinton's short-term economic stimulus program (which included money for infrastructure) went down to defeat.

The double-or-nothing strategy also carried serious economic risks. The long-term growth trend had slowed markedly in the late 1970s and stayed low throughout the 1980s. ... Governments that run large and persistent deficits find that their appetite for cash diverts spending that would otherwise flow into productive investment, and that investors get nervous and capital starts to flee the country. Low investment means stagnant productivity and wages, not just in a recession but over the entire business cycle. Would it have been good for the country if Clinton's inauguration had been followed by year after year of slow growth? And what would have been the chances of passing any Democratic legislative priorities if the macroeconomic news was never very good?

Faced with those considerations, Clinton rejected the social-democracy strategy in favor of the second possibility -- call it the "Eisenhower Republican" strategy. Make economic growth the first priority. Attempt to get the Federal Reserve to be dovish on interest rates in exchange for seriously reducing the deficit. Take other steps such as trade liberalization to try to boost growth. Reform rather than expand social insurance so that you can argue that taxpayers are getting good value for what they are buying. Hope that these policies will boost investment. And make the Clinton legacy a high-investment, high-productivity growth expansion. If all goes well, a decade of rapid growth and a resolution of the deficit will open up new possibilities for progressive policy.

This was the strategy that Bob Rubin executed, first as head of the National Economic Council and then as treasury secretary under Clinton. ...[A]nother critical factor in his success was the president himself. Clinton took policy seriously and was usually willing to be convinced that what was good policy would turn out to be good politics (or, at least, that this was a reasonable bet)...

But there is a bigger question. The Clinton-Rubin economic policies certainly contributed substantially to the economic boom of the 1990s, though economists will debate whether they deserve 20 percent, 40 percent or 60 percent of the credit. In the end, however, the resolution of the deficit did not widen the politically realizable possibilities -- at least not in the way we hoped. Rubin's success helped George W. Bush to return us to the budgetary ground zero of 1992 through enormous tax cuts for the $200,000-plus-a-year crowd, higher military spending, and pork for Republican legislators and favored companies such as Dick Cheney's Halliburton.

Might the social-democracy laissez-deficit strategy have been better for the country after all? Of course, neither Clinton nor Rubin could have foreseen the outcome of the 2000 election. And if they had bequeathed deficits rather than surpluses, would the current crew in power have been any less inclined to the reckless fiscal policies it is now pursuing? It's George W. Bush who has gone for a double-or-nothing strategy, and the country will someday pay the price.

I'd like to hear more from Brad on his perception of the costs and benefits of the "double-or-nothing or social democracy" strategy versus the "Eisenhower Republican" strategy given our present budget situation. What will we gain from abandoning the social democracy strategy and how do we preserve those gains into the future? Is the social democracy approach as politically infeasible today as it was then?

As Brad notes, restoring Paygo is supported by those in the social democracy camp, and by itself this would shave around $300 billion off the deficit. The question is whether to go even further and move into Eisenhower Republican territory. Though the choice depends upon how the deficit would be closed, I am not convinced that the benefits of doing so outweigh the costs.

Wednesday, December 27, 2006

Avoiding the Budgetary Bait and Switch

Bruce Bartlett is critical of the Bush administration's cut taxes, spend, and claim it pays for itself policy:

Debts and deficits, by By Bruce Bartlett, Commentary, Washington Times: On Oct. 11, George W. Bush went before the television cameras to proudly announce the budget deficit for fiscal 2006 ... was only $248 billion. This was a great success, he said, because in February the Office of Management and Budget had estimated the deficit would be $423 billion.

If this is the standard for success, one wonders why we didn't do even better. All Mr. Bush had to do was order OMB to make an even bigger mistake... If it had wrongly projected the deficit to be $500 billion or $600 billion in 2006, then Mr. Bush could have announced an even bigger improvement...

In the real world, of course, people measure progress not against some incorrect forecast but against actual results. By this standard, the numbers don't look as good. Mr. Bush inherited a budget surplus of $128 billion in fiscal 2001.. By the following year, fiscal 2002, the surplus was gone and the government had a deficit of $158 billion, which rose to $378 billion in 2003 and $413 billion in 2004, before falling to $318 billion in 2005 and $248 billion last year.

But these figures greatly understate the budgetary turnaround. In January 2001, the Congressional Budget Office (CBO) estimated budget surpluses as far as the eye could see. It projected an aggregate surplus of more than $2 trillion between 2002 and 2006. Instead, we had an aggregate deficit of $1.5 trillion -- a deterioration of $3.5 trillion.

Yet these figures still understate the budgetary damage caused by the Bush administration because it leaves out changes in the budgetary status of entitlement programs such as Social Security and Medicare. ...

Over the next 75 years, these two programs have an unfunded liability of $44 trillion -- $15 trillion for Social Security and another $29 trillion for Medicare.

What is really frightening is that Mr. Bush apparently has no clue the problems of Medicare are twice as bad as Social Security's and are worsening much faster. At the end of fiscal 2002, Social Security's unfunded liability was $11 trillion and Medicare's was just $13 trillion. Today, Social Security is a little worse, but Medicare is much, much worse.

Yet over and over again, Mr. Bush has said we must fix Social Security -- even if we have to raise taxes -- while saying nothing about the way Medicare is hemorrhaging money. He can't because his massive, unfunded program for prescription drugs in 2003 is the principal reason Medicare's financial problems have gotten so much worse since 2002.

Medicare is the biggest worry, no disagreement there. But before we begin using the deficit as a reason to begin slashing valuable social programs, remember that we've had higher debt to GDP ratios in the past and survived. The worry is the future and very specifically, as noted above, Medicare payments are the biggest concern. Thus, getting our health care costs under control is an essential step in bringing the budget into balance.

In light of that, we should be careful to avoid a bait (reducing the deficit) and switch (from solving the health care problem to cutting other social programs) on this issue, particularly since the deficit was enhanced by ill-advised tax cuts.

[Health care has been a topic of much recent discussion, e.g. from yesterday see Ezra Klein, Going universal, Commentary, Los Angeles Times and Raging Lefty Watch, by Daniel Gross. On taxes, I don't oppose revenue neutral changes designed to minimize economic distortions and promote fairness. But that's not what we got.]

Sunday, December 24, 2006

Republicans and the Deficit

After so much lately about Democrats, politics, and the budget deficit, let's move to the other side of the political spectrum and look at Republicans, politics, and the budget deficit. This is Jonathan Chait:

Neocons and Bush deserve each other, by Jonathan Chait, Commentary, LA Times: News reports are suggesting that Bush plans to send more troops to Iraq. Neoconservatives have been urging ... more troops in general for years — even before the war started. And that's not surprising. ... If you read old issues of the Weekly Standard, which is the bulletin board of neoconservatism, you can find calls for a bigger military going back to the Clinton administration. ...

Bush may have come to believe in the neoconservative mission for the nation's military. But he never accepted the corollary about increasing the military. So he ended up pursuing Dick Cheney's foreign policy with Bill Clinton's army.

In hindsight, we can see that the neocons made two huge blunders. The first was to go along with Bush's enormous tax cuts. When Bush took office in 2001, any halfway honest budget analyst would tell you that he was making a lot of promises that didn't add up. The neocons calculated that, if they supported the tax cuts like good party soldiers, Bush would grant them their defense budget increases later on.

So the Standard enthusiastically boosted the tax cuts. Neoconservative defense hawk Frank Gaffney concurred... "Those of us who look forward to helping you succeed in your efforts to rebuild our defense posture appreciate that your success in reducing taxes is a first and highly synergistic step toward that goal," he wrote. "Consequently, you can count on us in the national security community to support you in both of these important endeavors."

Whoops. It turned out there wasn't any money left over for a big troop increase... Enraged at the lack of a defense hike, the Standard published an editorial calling on then-Defense Secretary Donald H. Rumsfeld, and his deputy, Paul Wolfowitz, to resign in protest of "the impending evisceration of the military."

The Standard lamented its own gullibility. "Those of us who expressed concern about the Bush administration's shorting of the military were told not to worry," the editors wrote. "Bush had to pass his tax cut first. Then the damage would be repaired in the [fiscal year] 2002 and FY 2003 budgets. But that's not the way things have turned out."

Let me translate this passage: We thought Bush was just lying to the American public, but now we discover he was lying to us also!

Let me quote one more passage from that editorial, because it's really incredible. The Standard warned that Bush's budget would make an invasion of Iraq all but impossible: "In practice, assembling a heavy armored force of even four divisions to defeat Saddam's army and then occupy Iraq would require every heavy unit based in Korea, Europe and the United States." Yet, just a few months later, the neocons demanded the very war that they said would be impossible, to be waged by that same eviscerated military.

But if they had only withdrawn their support earlier, before the big tax cut and before Bush invaded with too small of an army to win, the United States would be in much better shape today — and so would the neocons.

There has been a lot of discussion about the budget deficit lately, but the deficit itself is the wrong place to focus. We need to ask a straightforward question. What size government do we want and how do we fund it in the long-run?

We can't just pick whatever size government we want irrespective of our ability to pay for it. Nor can we pick whatever tax rates we want without consideration of our needs. How the party in power should react to a surplus or deficit depends upon an evaluation of our ability and willingness to pay for government relative to how well the existing level of government services is doing at meeting our goals.  What do we need, what can we reasonably afford, and who should pay for it?

The answers aren't easy and they differ by party so this requires a political resolution, but it's still better to focus on these questions instead of on whether the deficit taken in isolation is too large or too small.

One way to characterize the discussion from Paul Krugman (with as assist from Brad DeLong) that has generated so much discussion recently is to first recognize that Krugman is starting with the premise of fiscal responsibility. Suppose we are able to generate a surplus relative to the existing budget through fiscally responsible policies. What should we do with that surplus?

We have needs now that are not being met, and we have needs in the future as well. Thus, given the two sets of needs, there is a choice to make. Do we spend the money now, as Krugman has advocated, or do we save it (reduce the deficit) to spend in the future?

Krugman's point is that political realities have lowered the probability that we will be able to meet future needs, and because of this the tradeoff has shifted from future needs toward present needs. It's hard to disagree with that point of view given recent experience, and thus it's hard to disagree with the recommendation to shift priorities to the present until a better commitment mechanism can be enacted. It's really a question of how strongly we can commit to the future and how important our future needs are relative to our present needs.

Saturday, December 23, 2006

More on Democrats and the Deficit

The Economist blog, Free Exchange, weighs in on the Paul Krugman article:

Beating around the Bush Budget, FreeExchange, The Economst: For a certain stripe of Democrat, one of the shining defenses of their lot is that they are the "party of fiscal responsibility". A number of left-leaning economists, notably Paul Krugman, have been leaning hard on this theme.

Perhaps too hard; it seems to have collapsed beneath them.  On Friday, as Mark Thoma points out, Mr Krugman wrote ...[that] cutting the budget deficit is a very fine idea, but unfortunately, it makes it difficult to hold onto power. Mr Krugman, along with his supporters, seems to believe that this is somehow different from the Republican position. It must be a very subtle difference, then.

The genial Tyler Cowen is ... uncharacteristically cutting:

Suppose the Democrats can free up some money...Should they use the reclaimed revenue to reduce the deficit, or spend it on other things?

That is Paul Krugman, and the answer is that Rubinomics is dead and they should spend the money. Deficit reduction is for "the long run." Even from Krugman's point of view, the use of "they" seems premature with a Republican President and a hard-to-elect Democratic frontrunner candidate in the wings. More economically, I am pleased that the forthcoming fiscal destruction of the United States has been averted, or at least held at bay for some time. It took a mere mid-term election; cuts in spending or tax hikes were not necessary, quite the contrary.

Brad DeLong argues that no, really, they're the party of fiscal responsibility:

Most commentators--whether by accident or by design--have missed the significance of this passage in Krugman's op-ed: "Nancy Pelosi, the incoming House speaker, has promised to restore the "pay-as-you-go" rule that the Republicans tossed aside in the Bush years. This rule would basically prevent Congress from passing budgets that increase the deficit. I'm for pay-as-you-go. The question, however, is whether to go further..." ...

The embrace of pay-as-you-go orders up a $300 billion rise in taxes at the end of this decade. That's a significant amount of deficit reduction all by itself, and a very significant change from Bush administration idiocy.

Actually, I make it about $250 billion by the CBO figures, but this assumes that there is no bipartisan coalition for keeping the bits that don't benefit "the rich". This seems like a big assumption; who doesn't want to keep taxes low on the majority of voters? The problem is that while the wealthy got more benefit, as individuals, from the Bush tax cut, they didn't do nearly so well collectively against the poor and middle class, because there are just so damn many of the latter.

According to the widely respected William Gale of Brookings, Mr Kerry's plan to reinstate the top marginal income rate of 39%, and roll back the capital gains and dividend taxes, would have gleaned about $50 billion a year for the treasury. Going back to 1998 (so as to miss the effects of the stock market bubble), we find that bringing back the estate tax in full force would raise about $28 billion in today's dollars. $78 billion is, to be sure, nothing to sneeze at.  But it is about 1/4 of the current budget deficit...  Closing the budget deficit will involve much more; either raising taxes on the middle class, or dangerously stiff increases in marginal tax rates on the wealthy. I will be interested to see whether the Democratic increase in PAYGO survives this political reality.

I'm short on time - will try to weigh in later. But very quickly, let's be clear. Nobody, not Krugman, not DeLong, mot me, not anyone I'm aware of is talking about increasing the deficit. The question Krugman and DeLong are asking is how much to cut. Is 300 billion enough? Should it be even more? How that turns them into the party of big spenders or makes them fiscally irresponsible as implied, especially after recent experience with Republicans, is puzzling.

Democrats and the Deficit

I am not employed by anyone as a political strategist, for good reason, and at times I am hopelessly naive about the politics surrounding many policy actions. I know most of you see economists as fairly political, but that's not my experience. Most academic economists have a very specific area of specialization and they devote their lives to answering questions that are very tightly focused within that narrow area. Politics just doesn't come into play. All they care about is finding the right answers to these questions, whatever they might be. For example, I'd estimate that I have no idea where at least a third of our faculty stand ideologically, and we are a small group (approximately fifteen) who know each other fairly well. I could guess their political orientations, probably somewhat accurately, but I really don't know for sure. It never comes up.

So, in the year and a half or so since I started doing this, I've had to try and catch up on the political side of things quite a bit. It's something I knew very little about, and there's still lots I don't know - it's an ongoing process, but hopefully I'll learn.

With that said, I'd like to follow up on Krugman's recent column. First, let's review the part of Krugman's position I want to talk about:

Now the Democrats are back in control of Congress. ... Nancy Pelosi, the incoming House speaker, has promised to restore the "pay-as-you-go" rule that ... would basically prevent Congress from passing budgets that increase the deficit.

I'm for pay-as-you-go. The question, however, is whether to go further. Suppose the Democrats can free up some money by fixing the Medicare drug program, by ending the Iraq war and/or clamping down on war profiteering, or by rolling back some of the Bush tax cuts. Should they use the reclaimed revenue to reduce the deficit, or spend it on other things?

The answer, I now think, is to spend the money - while taking great care to ensure that it is spent well, not squandered - and let the deficit be. By spending money well, Democrats can both improve Americans' lives and, more broadly, offer a demonstration of the benefits of good government. Deficit reduction, on the other hand, might just end up playing into the hands of the next irresponsible president.

In the long run, something will have to be done about the deficit. But given the state of our politics, now is not the time.

The argument is that the surplus the Democrats accumulated under Clinton set the stage for the Republicans to enact tax cuts:

And you can even argue that Mr. Rubin's surplus was a bad thing, because it greased the rails for Mr. Bush's irresponsibility.

As Brad DeLong ... recently wrote ...: "Rubin and us spearcarriers moved heaven and earth to restore fiscal balance to the American government in order to raise the rate of economic growth. But what we turned out to have done, in the end, was to enable George W. Bush's right-wing class war: his push for greater after-tax income inequality."

This may be the naive part, but I want to have more faith in voters than this. I'd like to believe that if Democrats do what is best and follow a very specific, well communicated strategy, voters will reward them. I don't think Democrats should condition their policies on what the Republicans might do should they seize power again. Democrats need to do what is best according to their core principles and according to what they believe best serves the interests of voters generally. If that means beginning to re-accumulate the surplus to start getting ready for a demographic surge in the future, so be it. That's what we do. If it means taking any surplus that is recovered and spending it wisely as Krugman suggests, that's fine too so long as that is what is best.

Thus, to me the optimal way to proceed is to pick a best strategy irrespective of what might happen if you lose to Republicans in the future, communicate it to people clearly so they know you see the problems and are moving toward a workable solution, and propose and implement the policies with single-minded, stay the course determination that does not blink in the face of political harping from the other side.

I believe voters would respond positively to the Democrat party if it vigorously defended a well-articulated plan to bring Social Security, Medicare, and other programs into balance in coming decades and made it clear that it was leaving politics by the wayside in the process. The deficit is not a big concern at the moment, we can survive this, but projections into the future do need to be considered and they raise concerns and risks that need attention now.

Paul Krugman has been doing this a lot longer than I have, and he has proven time and again to be right when he has given advice. But I prefer not to worry about how Republicans might take advantage of Democrats who do their best to serve the interests of voters while they are in power. If Democrats do their jobs right and get these problems under control, they shouldn't have to worry about Republicans regaining control anyway. In any case, I would prefer to turn over a government with a smaller deficit to Republicans (if that is in the voter's long-run interests) than a government further in debt. Handing Republicans a government that requires fiscal adjustment and is deep in debt is an invitation to cut valuable social programs.

Finally, along those lines, to Brad DeLong: Don't feel it was all for nothing. The Republicans were going to cut taxes one way or the other, surplus or not, come hell or high water (both came -Iraq and Katrina - and taxes were still cut). While the surplus you and others worked so hard to create may have facilitated the tax cuts to some extent, it may have also protected valuable social programs from being axed in order to pay for the tax cuts. There very well may be many children who, without your efforts to move "heaven and earth to restore fiscal balance to the American government," would be having a much worse Christmas this year. For every child, every person, every family your efforts helped, we are all thankful.

: Please see this follow-up with more on Krugman's recommendation.

Wednesday, December 20, 2006

Are All Charities Created Equal?

More from Robert Reich. He asks, should charitable giving that doesn't directly benefit the poor be tax deductible?:

Cost of Giving, by Robert B. Reich, American Prospect: 'Tis the season to be jolly and also to make donations to your favorite charity. This year's charitable donations are expected to total more than $200 billion, a new record. Some 80 percent of them are made now, in the final weeks of the year.

But lots of charitable dollars -- especially from the wealthy... -- are going to culture palaces: to the operas, art museums, symphonies, and theaters where they spend much of their leisure time. They're also going to the universities they once attended and expect their children to attend, perhaps with the help of ... "legacies."

These aren't really charitable contributions. They're more like investments in the lifestyles the wealthy already enjoy and want their children to have, too. They’re also investments in prestige -- especially if they result in the family name engraved on the new wing of the art museum or symphony hall. ...

This year, the U.S. Treasury will be receiving about $40 billion less than it would if the tax code didn't allow charitable deductions. ... I can see why a contribution to, say, the Salvation Army should be eligible for a charitable tax deduction. It helps the poor. But why, exactly, should a contribution to the Guggenheim Museum or Harvard University? Not long ago, New York City's Lincoln Center had a gala dinner supported by the charitable contributions of the leaders of the hedge fund industry... I may be missing something here, but this doesn't strike me as charity. I mean, poor New Yorkers don't often attend concerts at Lincoln Center.

It turns out, in fact, that only an estimated 10 percent of all charitable deductions this year will be directed at the poor. ...  At a time in our nation's history when the number of needy continue to rise, when government doesn't have the money to do what’s necessary, and when America's very rich are richer than ever, we should revise the tax code and limit the charitable deduction to real charities.

Update: Thinking a bit more about this, what if the arts, etc. are public goods? E.g., what if the tax deductions are not intended to help the poor, but instead to help to rectify market failures in the provision of the arts? If that's the case, then a deduction to support the arts (and perhaps poor artists) can be justified on the basis of overcoming these market failures. Also, as noted in comments, there are other charities that cannot be classified on a rich-poor basis, e.g. the humane society. The public good argument comes into play here as well.

Monday, December 11, 2006

Who Feeds the Iraq War Beast?

Republicans like to talk about "starving the beast," cutting government revenues through tax cuts as a means of forcing cuts in government programs. But there's another way to force cuts in programs, create another beast that demands to be fed. Kevin Hassett says there is a new "beast" in Washington, and feeding it will have enormous costs over the next few years, so much so that other, non-beastly parts of government must be cut, or the food supply - taxes - must be increased:

Time to Face Facts About Surging Iraq War Costs, by Kevin Hassett, Bloomberg: The report by the Iraq Study Group added fuel to the fiery foreign and defense-policy debate last week. But it also focused the attention of budget experts on the past and future costs of the war.

As one pores through the spending numbers, one thing is clear: The costs will be steep no matter what. The open question is, will Congress continue to act as if that doesn't matter? ...

Continue reading "Who Feeds the Iraq War Beast?" »

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:


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


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:


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?:


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


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


Bingo. And how have estate taxes changed?:


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.