Category Archive for: Taxes [Return to Main]

Wednesday, July 04, 2007

Taking a Higher Toll

When E-ZPass electronic toll systems are installed, tolls tend to rise:

Technology Eases the Ride to Higher Tolls, by David Leonhardt, NY Times: ...I spent a good part of my childhood summers at the Jersey Shore, and the tollbooths on the parkway always seemed to be a cruel final obstacle between me and the beach. Every 15 minutes or so, our car would have to stop yet again to drop a measly quarter in a bucket.

The ride is very different today, thanks mostly to the electronic toll system known as E-ZPass. At four of the tolls along the Garden State, the system is so sophisticated that cars barely have to slow down. A little box attached to the car’s windshield sends a message to a computer reader looming over the road, and money is then deducted from an electronic account. ...

As a result of E-ZPass and its ilk, ... many [drivers] don’t notice the cost of a toll. Which raises an interesting question: If you don’t know how much you’re paying for something, will you notice when the price goes up? Or has E-ZPass, for all its benefits, also made it easier for toll collectors to take your money?

A young economist named Amy Finkelstein started thinking about these issues a few years ago... So she collected decades of toll records from around the country and found a clear pattern.

After an electronic system is put in place, tolls start rising sharply. Take two tollbooths that charge the same fee and are in a similar setting... A decade after one of them gets electronic tolls, it will be about 30 percent more expensive on average than a similar tollbooth without it. ...

“You may be less aware you’re paying the toll,” said Ms. Finkelstein, now an associate professor at M.I.T., “but you’re paying a higher toll than you used to.”

The implications of this go well beyond highways. We increasingly live in an E-ZPass economy, in which bills are paid online, corporate cafeterias are going cashless and people take along their debit card, instead of cash, when they leave the house. Last year, 55 percent of consumer spending was done electronically..., while checks accounted for less than 25 percent and cash only 20 percent...

The E-ZPass economy is indisputably more convenient. It saves time and frustration. But the old frustrations that came with cash also brought a hidden benefit: they forced you to notice that you were spending money. With electronic money, it’s much easier to be carefree.

Marketers understand this dynamic well, which is a big reason they promote refillable gift cards and other forms of money that don’t feel like money. Part of what’s so intriguing about Ms. Finkelstein’s work is that it suggests that government officials may be coming to understand the dynamic, too. ...

Ms. Finkelstein obviously can’t prove that electronic tolls cause prices to rise by making drivers less aware of them. ... But she makes a spirited case for her conclusion. She has considered a number of alternate explanations for the increases and says the evidence doesn’t support them. At the very least, electronic systems do seem to make it easier for toll collectors to increase prices. ... Ms. Finkelstein discovered that tolls don’t usually rise as soon as an electronic system arrives. The increases tend to come a number of years later, once electronic payment becomes old hat. ...

Let me try an alternative to the agents don't notice price increases when the payments are electronic story (i.e. that agents are irrational). One thing to note is that after the E-ZPass system is installed, waiting times fall, frustration falls, and the inconvenience of not having correct (or any) change also falls. Thus, the economic cost is lower even if the dollar cost of the toll stays the same, and this would cause the quantity of trips demanded to increase. Over time, with inflation, the real cost of the toll falls further, the number of trips increases further, and eventually the increased congestion could require a return of the toll to its original value (in terms of the full economic cost, and assuming congestion is the reason for the toll), or even a higher value if demand for road trips grows due to economic or population growth.

[Another possibility, though I don't think it quite fits here, is that under the old system changing the price of a toll is costly in terms of transaction and collection costs. That is, a $1.00 toll is much more convenient than a $1.05 toll (more currency and coins are involved in the payment, and making change for, say, two dollars also involves more coins and hence more time), but with an electronic system it doesn't matter. Thus, under the old system, instead of changing tolls in small increments between, say, one dollar and two dollars as would occur with E-ZPass, changes will be larger and more infrequent (perhaps in quarter, fifty cent, or even dollar increments rather than nickel increments). The result will be that E-ZPass tolls that are more flexible and rise sooner than under the old system though with this story, in the long-run, the average toll would be the same (net of differences in transactions and collection costs).]

Thursday, June 28, 2007

Robert Reich: Fiscal Balance is a False Economy

Talk of rebuilding is a positive way to send a negative message. It says that things are not okay the way they are - they need to be rebuilt - but the message is one of hope rather than negativity. I think that was one of the keys to Bill Clinton's success. He didn't just tell us "It's the economy, stupid" and things aren't so good, people knew that. What made the difference is that he articulated a plan and a vision, efforts such as rebuilding infrastructure (which were, unfortunately in my opinion, largely abandoned later) that said things don't have to stay this way if you vote for me. As I hear the discussion of the economy, of Iraq, and of other things developing among Democratic presidential candidates, I wonder if there's a lesson here. Yes, we know things are bad, but can you give us any reason for hope? What will you do to change things?

Discussions within the Democratic party over the deficit are related. Economically, how important is deficit reduction now? While there are looming problems on the horizon, my view is: not very. By historical standards, the burden is not large and if we are making good investments that will pay dividends in the future, the benefits exceed the costs.

Politically, how important is deficit reduction right now? Again, I'd say not very. I think selling a positive message about how to improve infrastructure, health care - the usual list of worries - gains more votes than deficit reduction. If there were great economic gains from deficit reduction, I would want to try to let voters know why they should be more concerned. But as I said, I don't think there are big gains from deficit reduction and we can address more pressing needs by not insisting on giving up potentially valuable projects just to show an improvement in the deficit numbers.

Suppose, for example, that the war in Iraq were to end before the next president takes office (and how I wish this wasn't a supposition), or tax cuts are rolled back, or other measures are taken to make additional revenue available. Is our most pressing need to reduce the deficit? I'm not talking about increasing the deficit substantially, just what to do if additional funds becomes available. I think there is a discussion we need to have about whether our tax burden is equitably distributed, what are spending priorities are, and the level and progressivity of taxes needed to meet those priorities, but for now I think the politics keep us near existing revenue and spending boundaries.

Here's Robert Reich who not only thinks that we should maintain the 2% of GDP deficit we have now, he believes the deficit should be increased to 3% of GDP:

Fiscal balance is a false economy, by Robert Reich, Commentary, Financial Times: A quiet but important debate is breaking out inside the Democratic party. It will largely determine whether the Democrats, should they win ... in 2008 ..., will have enough revenue to do the things that need to be done in the nation. The debate is over the importance of reducing the budget deficit and the goal of a balanced budget.

In many ways it is a continuation of a debate that began at the start of the Clinton administration. The difference is that then the budget deficit hovered at about 5 per cent of US gross domestic product and there was broad consensus it had to be reduced. Now, the budget deficit represents only around 2 per cent of GDP, close to its historical norm. Yet it has become an article of faith among some Democrats that fiscal prudence is a necessary precondition for economic health. Indeed, ... Democrats’ proposed federal budget for the next fiscal year avows a commitment to reduce the budget deficit still further.

The Democrats’ presidential candidates are in a fiscal straitjacket. They are promising to address America’s sluggish wage growth and widening inequality by fixing the schools, providing affordable healthcare to all, repairing the nation’s infrastructure and leading the US towards new energy technologies, while also protecting Social Security..., being tough on national defence and homeland security. But they do not want to raise taxes, apart from rolling back President George W. Bush’s temporary tax cuts... How can they accomplish all this while still guaranteeing fiscal austerity?

When Bill Clinton was elected he promised to reduce America’s two deficits – the budget deficit and the growing deficit of public investment in schools, healthcare, infrastructure and environment. But the budget deficit was much larger than expected. Hence, he put the investment deficit on hold. It remained on hold for the next...well, it has now been 14 years.

In the late 1990s, when the budget deficit turned into a fat budget surplus, President Clinton again ignored his original investment agenda. ... [W]orried that Republicans would try to turn the surplus into tax cuts, Mr Clinton used the scare tactic of telling the nation to “save Social Security first”. By 2000, as budget surpluses mounted, candidate Al Gore proposed they be reserved for baby boomers’ Social Security. When the surpluses still overflowed, Mr Gore said they should be used to cut national debt.

The investment agenda had disappeared. Thus did Mr Clinton and Mr Gore tee up a $5,000bn 10-year surplus for Mr Bush to give away mostly to America’s very wealthy without the nation ever considering it might be used to finance what Mr Clinton and Mr Gore were elected to do in 1992.

Democrats had become the official party of fiscal austerity. Fast forward to now. The nation’s investment deficit is now much larger than it was in 1992. ...

Mr Bush has put rich people and big corporations first. Yet as a percentage of GDP the budget deficit is now far less than in the early 1990s. If we cut corporate welfare, raised taxes on the richest Americans, and allowed the deficit to move up to 3 per cent of GDP then there would be plenty of money to invest in the nation’s future.

Yet congressional Democrats have learnt the wrong lesson from the 1990s. They have concluded that cutting budget deficits and balancing budgets is a sure-fire formula for widespread prosperity. ... Their “pay-go” rules make it impossible for them to do much of anything without raising taxes, yet they have been unwilling to commit themselves to raising taxes on the rich. ...

Mr Clinton had it right in 1992. Inadequate public investment in the nation’s future will condemn us to slower growth and shrinking prosperity. It is already happening.

Wednesday, June 27, 2007

Our Progressive Tax System

Warren Buffet is only taxed at 17.7%?:

Buffett Slams Tax System Disparities, by Tomoeh Murakami Tse, Washington Post: Warren E. Buffett ... slammed a system that allows the very rich to pay taxes at a lower rate than the middle class.

Buffett cited himself, the third-richest person in the world, as an example. Last year, Buffett said, he was taxed at 17.7 percent on his taxable income of more than $46 million. His receptionist was taxed at about 30 percent.

Buffett said that was despite the fact that he was not trying to avoid paying higher taxes. "I don't have a tax shelter," he said. And he challenged Congress and his audience to see what the people who "clean our offices" are taxed...

Wednesday, June 20, 2007

Bruce Bartlett: Tax Cuts and the Not So Great Economy

Bruce Bartlett says if conservatives want to argue for lower taxes, fine, do so. But do it honestly and leave the exaggerated claims about tax cuts and tax increases out of the debate:

Greatest Economy?, by Bruce Bartlett: For an interview with a reporter about the state of the economy, I looked up a few numbers that are interesting. I compared the state of the economy today to where it was at the exact same point during the previous business cycle. Thus, according to the National Bureau of Economic Research, the most recent recession ended in November, 2001. If you count forward 21 quarters to the first quarter of 2001 [2007], we see the following:

Real gross domestic product: Up 16.4 percent Real gross private domestic investment: Up 10.2 percent Payroll employment: Up 5.3 percent Standard & Poor's 500 stock index: Up 34.2 percent

Viewed in isolation, these numbers don't seem too bad. For example, real GDP has risen at a 3.1 percent annual rate since the end of the recession. But in areas such as this, there are no objective criteria for saying what is a good performance from a bad one; only experience can guide us. Thus it is interesting to look at the same numbers above counted forward the same number of months from the end of the previous recession, which the NBER tells us ended in March, 1991:

Real GDP: Up 17.9 percent Real investment: Up 51.2 percent Payroll employment: Up 10.8 percent S&P 500: Up 82.2 percent

It is obvious that by every standard, the recovery and expansion after the 1990-91 recession was significantly better than that after the 2001-01 recession. Recognizing this fact is important for several reasons.

Continue reading "Bruce Bartlett: Tax Cuts and the Not So Great Economy" »

Thursday, June 14, 2007

"Paying Taxes Can Make Citizens Happy"

Colleagues find that paying taxes can make people happy:

Paying taxes, according to the brain, can bring satisfaction, EurekAlert: Want to light up the pleasure center in your brain? Just pay your taxes, and then give a little extra voluntarily to your local food bank. University of Oregon scientists have found that doing those deeds can give you the same sort of satisfaction you derive from feeding your own hunger pangs.

A three-member team – a cognitive psychologist and two economists – published its results in the June 15 issue of the journal Science. The scientists gave 19 women participants $100 and then scanned their brains with functional magnetic resonance imaging (fMRI) as they watched their money go to the food bank through mandatory taxation, and as they made choices about whether to give more money voluntarily or keep it for themselves.

The participants lay on their backs in the fMRI scanner for an hour-long session and viewed the financial transfers on a computer screen. The scanner used a super-cooled magnet, carefully tuned radio waves and powerful computers to calculate what parts of the brain were active as subjects saw their money go to the food bank and made yes or no decisions on additional giving.

Researchers found that two evolutionarily ancient regions deep in the brain – the caudate nucleus and the nucleus accumbens – fired when subjects saw the charity get the money. The activation was even larger when people gave the money voluntarily, instead of just paying it as taxes. These brain regions are the same ones that fire when basic needs such as food and pleasures (sweets or social contact) are satisfied.

“The surprising element for us was that in a situation in which your money is simply given to others – where you do not have a free choice – you still get reward-center activity,” said Ulrich Mayr, a professor of psychology. “I don’t think that most economists would have suspected that. It reinforces the idea that there is true altruism – where it’s all about how well the common good is doing. I’ve heard people claim that they don’t mind paying taxes, if it’s for a good cause – and here we showed that you can actually see this going on inside the brain, and even measure it.

The study gives economists a novel look inside the brain during taxation, said co-author William T. Harbaugh, a UO professor of economics and member of the National Bureau of Economic Research in Cambridge, Mass. “To economists, the surprising thing about this paper is that we actually see people getting rewards as they give up money,” he said. “Neural firing in this fundamental, primitive part of the brain is larger when your money goes to a non-profit charity to help other people.” “On top of that,” Harbaugh added, “people experience more brain activation when they give voluntarily – even though everything here is anonymous. That’s a very surprising result – and, to me, an optimistic one.”

However, this latter finding, which offers confirmation to the economic theory of “warm-glow” giving, doesn’t necessarily mean that taxes should be lowered and charity relied on more heavily, Harbaugh said. In a voluntary environment, he added, lots of people free-ride and donations fall.

The study, Mayr said, reflects the balancing act that every society must face. “What this shows to someone who designs tax policy is that taxes aren’t all bad,” he said. “Paying taxes can make citizens happy. People are, to varying degrees, pure altruists. On top of that they like that warm glow they get from charitable giving. Until now we couldn’t trace that in the brain.”

Neural activation from mandatory taxation, the researchers said, helps predict who will give. “We could call the people whose brains light up more when money goes to charity than to themselves altruists,” Mayr said. “The others are egoists. Based on what we saw in the experiments, we can use this classification to predict how much people are willing to give when the choice is theirs.”

There remain a lot of unanswered questions, Harbaugh said. “We show that people liked paying a tax that went to a food bank. But suppose the tax had been unfair. What then" Or suppose that people voted to make other people pay the tax, too" That would help other people even more, so would the voter get a bigger neural reward"”

Harbaugh, Mayr and co-author Dan Burghart, an economics graduate student, say they are not worried about the possibility that governments could use their method to monitor tax evasion, or charities could use it to figure out whom to ask for money. “To do this, we needed a $3 million scanner, some liquid helium and a few weeks of computer time,” Harbaugh said.

“If a participant moved her head,” Burghart added, “we had to start all over. It will be a while before this is built into cell phones.”

Progressive Taxation as a Political Shield for Globalization

David Wessel of the Wall Street Journal says there is increasing support for income redistribution policies to compensate the losers from globalization and prevent a backlash against trade liberalization:

The Case for Taxing Globalization's Big Winners, by David Wessel, Commentary, WSJ (free): A new argument is emerging among the pro-globalization crowd in the U.S...: Tax the rich more heavily to thwart an economically crippling political backlash against trade prompted by workers who see themselves -- with some justification -- as losers from globalization.

The sharpest articulation of this view comes not from one of the Democratic presidential campaigns, but from economist Matthew Slaughter, who recently left President Bush's Council of Economic Advisers to return to Dartmouth's Tuck School of Business.

"Policy has become more protectionist because the public is becoming more protectionist," Mr. Slaughter and ... Yale political scientist Kenneth Scheve, write in the new issue of Foreign Affairs magazine. "And the public is becoming more protectionist because incomes are stagnating or falling."

Globalization, the two academics argue with unswerving conviction, is good for the U.S. ... But the benefits ... have been distributed unevenly. ...

The conventional response from fans of globalization, including the Bush administration, is rhetorical support for more aid for workers hurt by imports ... and better education to equip the next generation of Americans with skills needed to command high wages in a global economy. Both are crucial. Progress on both is painfully inadequate.

But trade-adjustment assistance is traditionally targeted narrowly at workers hurt by imports. Today's angst about globalization is far more pervasive. ... And education takes generations to pay off.

What to do? ... "It is best not to address increasingly salient concerns about inequality by interfering with trade," Mr. Summers argued [recently]... His solution: use progressive taxation to offset some, but not all, of the increase in inequality. For starters, return tax rates for couples with incomes above $200,000 to the levels they were under President Clinton.

"Truly expanding the political support for open borders requires making a radical change in fiscal policy," Messrs. Slaughter and Scheve argue. Their particular proposal: eliminate the Social Security-Medicare payroll tax on the bottom half of workers -- roughly those earning less than $33,000 a year -- and make up the lost revenue by raising the payroll tax on others.

This, obviously, would be a sea change in fiscal policy. ... But all this talk is likely to influence any Democrat who takes the White House in 2008. He or she will almost surely move to raise taxes on the best-off Americans -- both to raise revenue to pay the bills and to resist the three-decade-old inequality trend.

There's a lot of argument about the extent and cause of widening inequality, and a lot about the damage higher tax rates can do to economic growth. That will go on. But the ... palpable resentment of the losers is producing growing resistance among politicians ... to further lowering barriers to trade and promoting globalization...

Expecting market forces to reverse the recent trend toward ever-bigger winnings for those at the top is unwise; the forces are too strong. Taxing winners isn't without risk; as Mr. Summers says, globalization makes it easier for them to "pick up their marbles and go somewhere else."

But using the tax code to slice the apple more evenly is far more palatable than trying to hold back globalization with policies that risk shrinking the economic apple.

Personally, I'm not much on redistribution simply to make outcomes more equal. But there are (at least) three reasons to depart from this. First, when there is change such that makes one group better off at the expense of another as has happened recently with globalization, and when redistribution can leave everyone better off, then redistribution is justified.

Second, I think everyone should have equal opportunity to be a CEO or a hedge fund manager, or whatever they want to be. However, the playing field is far from level and there is a lot more we could do on this side of the equation. Not everyone will be a CEO of course, or achieve their dream job whatever it might be, but everyone should have an equal chance to be one of the winners. In the meantime, until more has been done to level the playing field, progressive taxation is a means of making up for inequality in opportunity.

Third, for me at least, progressive taxation is justified by the equal marginal sacrifice principle (the last dollar paid should cause the same amount of disutility for everyone). Thus, even if opportunity is equal, and even if there were no winners and losers to worry about, justification for progressive taxation would remain. I think a more progressive tax structure than we currently have is needed to equalize the disutility of paying taxes.

We could list "preventing a political backlash" as a fourth reason for redistribution. But I'm not sure we need to invoke the political economy argument. If we use progressive taxation in accordance with the three principles above, then income will be more equally distributed and a backlash against globalization is less likely to occur.

Are the fears of a downward spiral of protectionism real? From China Daily, some evidence that congress has China's attention:

Continue reading "Progressive Taxation as a Political Shield for Globalization" »

Tuesday, June 12, 2007

The Hamilton Project: Reforms to The U.S. Tax System In Today’s Global Economy

Larry Summers, Robert Rubin, and others are proposing reforms to the U.S. tax system in an event today sponsored by the Brookings Institution, see Reforming Taxation in the Global Age [video] Here's part of the press release that came via email:

The Hamilton Project ... hosted a forum today entitled “Reforming Taxation in the Global Age”... During the forum, the Hamilton Project released a new strategy paper and three new discussion papers examining the need to modernize and reform the U.S. tax code to reduce inequality, expand opportunity and respond to the realities of a global economy. ...

Summers opened the forum by highlighting a new strategy paper he co-authored, along with Jason Furman and Hamilton Project Policy Director Jason Bordoff, on “Achieving Progressive Tax Reform in an Increasingly Global Economy.” The paper highlights the enormity of the increase in inequality: in total $664 billion has been shifted from the bottom 80 percent of households to the top one percent of households. At the same time, the tax system has become less progressive—since 1960 the average tax rate for the top 0.1 percent of households has been cut nearly in half while rising slightly for middle-income families

Summers noted that the erosion of progressivity in the tax code is the result of a combination of deliberate policy choices (like the 2001 and 2003 tax cuts) and the failure to reform the tax code to keep up with rapid changes associated with globalization and the increasingly sophisticated financial system. In particular, Summers highlighted the growing ease with which corporations have leveraged these factors to avoid paying taxes, thus contributing to the income gains for the wealthiest Americans.

“The increase in inequality has shifted $664 billion from middle-class families to the most fortunate – the equivalent of taking away $7,000 from each household in the bottom 80 percent. Rather than trying to offset part of this income shift, the tax code has become less progressive thus exacerbating these challenges,” noted Summers. “This inequality, in turn, undermines political support for a competitive market economy, which contributes to economic growth. By making our tax system more progressive, we can help everyone share in the tremendous benefits generated by the economy while creating the political and economic conditions for sustained growth.”

Continue reading "The Hamilton Project: Reforms to The U.S. Tax System In Today’s Global Economy" »

Friday, May 18, 2007

Robert Reich: Democrats and the Deficit

Robert Reich is not happy with the Democrat's commitment to deficit reduction. He has a point:

Democrats and the Deficit, by Robert Reich: House Dems have just unveiled their budget. It’s a gangly, wordy, and ambitious document that – no surprise – contains lots of things all Democrats can agree on, and whose numbers don’t quite add up. The most distressing aspect is its avowed commitment to reduce the budget deficit.

Here we go again.

Shortly after Bill Clinton was elected president he asked me to head up his economic transition team. He had promised during his campaign to “put people first” by reducing America’s two deficits – the yawning budget deficit, and the growing deficit of public investment in the nation’s schools, health care, infrastructure, and environment. ... But the ... budget deficit was so much larger than expected ..., Clinton ...[had] to put the investment deficit on hold. It remained on hold for the next ... well, it’s now been fourteen years.

In the late 1990s, when the budget deficit turned into a fat budget surplus, Clinton ignored his original investment agenda. ... Clinton was worried Republicans would try to turn the surplus into tax cuts, so he used the ever-reliable scare tactic of telling the nation to “save Social Security first.” By 2000, as budget surpluses continued to mount, candidate Al Gore demanded they be put in a “lock box.” When the surpluses overflowed even the lock box, Gore said they should be used to reduce America’s national debt.

Thus did Clinton and Gore tee up a $5 trillion surplus for George Bush to give away mostly to America’s very wealthy – without the nation ever considering it might be used to finance what Clinton and Gore were elected to do in 1992. While Republicans continued to spout the nonsense of supply-side economics, Democrats became the official party of fiscal austerity. The choice became either trickle-down economics or Calvin Coolidge economics.

Fast forward. The nation’s investment deficit is now much larger than it was in 1992. ... There’s less money for job training, and it’s harder for families of modest means to afford college for their kids. Millions more Americans lack health insurance than in the early 1990s. And according to a recent report from the American Society of Civil Engineers, America’s roads, bridges, transit and drinking water systems, and power grids are in worse shape than they were fifteen years ago. On top of all this, the nation will need to invest tens of billions to cope with global warming.

George Bush has put rich people and big corporations first – spending like mad on fat contracts for military contractors, price supports for big agriculture, bloated subsidies for oil companies, and subsidized research pharmaceutical companies. Yet measured as a percent of the gross domestic product the current budget deficit is still less than it was in the early 1990s. Cut the corporate welfare, raise taxes on the top, allow the deficit to move up to 3 percent of GNP, and there would be plenty of money to invest in the nation’s future.

Yet the Democrats don’t seem to know how to let go of Calvin Coolidge economics. Somehow, they got it in their heads that cutting budget deficits and balancing budgets ... is a sure-fire formula for prosperity. Flush from their mid-term victory, congressional Democrats have flung themselves headlong into the guillotine of fiscal austerity. They’ve promised to shrink the deficit, and enacted “pay-go” rules that make it impossible for them to do much of anything without raising taxes, yet they’ve been unwilling to commit themselves to raising taxes on the rich. Democratic presidential candidates, meanwhile, have been assiduously vague about how to finance their plans for affordable health care or anything else. ... All are careful to sound as if they believe that fiscal privation is the road to salvation.

Bill Clinton had it right in 1992. Inadequate public investment in the nation’s future will condemn us to slower growth and shrinking prosperity. It’s already happening.

The Sources and Underlying Causes of the Growth in Tax Revenues Since 2003

An email points me to this CBO report on the sources and causes of changes in tax revenue since 2003. The bottom line: the main source of the growth is corporate tax revenues, the bulk of which are from increased corporate profits. For personal income taxes, the report notes that the tax base for the personal income tax fell because "wages and salaries ... fell relative to GDP." Tax increases came from "higher realizations of capital gains (including any effects associated with legislated reductions in tax rates)," and "bracket creep":

Congressional Budget Office, Peter R. Orszag, , Director U.S. Congress, Washington, DC 20515: Dear Mr. Chairman [The Honorable Kent Conrad, Chairman of the Committee on the Budget]:

Continue reading "The Sources and Underlying Causes of the Growth in Tax Revenues Since 2003" »

Wednesday, May 16, 2007

"A Heavy Load: The Combined Housing and Transportation Burdens of Working Families"

As I was looking around the Richmond Fed website, I came across this research on the amount working families spend on housing and transportation. This is the the introduction to the study and a summary of the findings.

The main point is this. As we think about imposing tolls to drive into cities in order to control congestion, and with many people claiming that working families rely upon public transportation so the toll will have little impact on them, we need to keep this research in mind. It suggests that housing and congestion problems are related, and that there are others measures we can take besides or in addition to the imposition of tolls to help with congestion problems. But most of all it suggests that in areas where housing prices are high, families often locate far from their workplaces to reduce housing costs, and then rely upon private transportation to get to and from work:

A Heavy Load: The Combined Housing and Transportation Burdens of Working Families, by Housing Policy Chairman Kent W. Colton, Center for Housing Policy, October 2006:  Nationally, for every dollar a working family saves on housing, it spends 77 cents more on transportation. This was one of the dramatic findings from the Center’s earlier study, Something’s Gotta Give, which reflects the basic tradeoff many working families face between paying a greater share of their income for housing or enduring long commutes and high transportation costs. But how does this tradeoff play out at the local level? Are there metropolitan areas in which this tradeoff is more or less pronounced? Where do working families end up living within each area, and how does the availability of housing affect their choices? And how does the varying cost of housing and transportation within a region affect families’ combined  housing and transportation burdens?

Continue reading ""A Heavy Load: The Combined Housing and Transportation Burdens of Working Families"" »

John Stossel Should Do a Fraud Investigation on Himself

John Stossel makes a false claim about tax cuts. As we know, tax cuts do not pay for themselves. No credible analyst claims that. But John Stossel does:

The Tax-Cut Myth, by John Stossel, RCP: ...[T]ax cuts stimulated the economy and increased tax revenues. It happens because, as the Laffer Curve illustrates, lower rates mean higher rewards for productive activities. ...

Any decent reporter would know that isn't true. He can't even keep his story straight. After saying it was tax cuts that increased revenues, he then says:

President Bush brags that the deficit is coming down -- and it is. ... But that's largely because your FICA taxes currently exceed Social Security and Medicare payments. ...

He then goes back to the tax cuts increase revenues propaganda and quotes the president pushing the same myth:

Bush boasted last year, "This economy is growing, federal taxes are rising, and we're cutting the federal deficit... Some in Washington say we had to choose between cutting taxes and cutting the deficit. Today's numbers show that that was a false choice. The economic growth fueled by tax relief has helped send our tax revenues soaring."

Remember what Andrew Samwick, who was chief economist of the Council of Economic Advisers from 2003 to 2004, said about statements like this?

Next, Stossel gets himself all tied up in knots. Tax cuts are good. But if tax cuts increase government revenue, then tax cuts are bad because it means government takes more of our money. So tax cuts aren't good after all:

But I don't want tax revenues to soar. That's money you and I could be spending for things we want. I want revenue and spending and government overall to shrink. So I'm not celebrating with the president.

So a higher tax rate is bad, a lower tax rate is bad, and the tax rate we have is unacceptable. It's all the government's fault anyway. Because of politicians, we'll never, ever get to the promised land on the other side of the Laffer curve:

If revenues are pouring in, why don't the politicians return it to the taxpayers instead of spending it? Because politicians love to spend money. They get reelected not by how much they save but by how much they shower on interest groups.

He has a book called Myths, Lies, and Downright Stupidity. I haven't read it and don't plan to, but from the above, I assume it's autobiographical.

Sunday, May 13, 2007

Uncle Sam Needs You

Have you noticed how skinny and weak Uncle Sam looks lately? Ezra Klein says it's time to feed the poor guy so he can do his job:

Give bigger government a chance, by Ezra Klein, Commentary, LA Times: On April 2, this newspaper reported that the Los Angeles Police Department had asked Philip Morris USA for a $50,000 donation to help fund its investigation into counterfeit cigarettes...

[W]hy shouldn't ... police ... have corporate sponsors ... (you know, aside from the obvious reasons of favoritism, bias and perverse incentives)? For that matter, what's wrong with ... families ... holding constant fundraisers to pay for the unfunded needs of their local public schools — drama societies and marching bands and that sort of thing? Or with parents having to go out and purchase body armor ... so that their sons are protected in Iraq? What's so odd about the crown jewel of the University of California graduate system, Boalt Hall Law School, having to move toward "privatization" so that it can raise more money and better compete with its private counterparts in an era when state funding has dried up?

What's so wrong, in other words, with hollowing out the public sector and replacing it with a pay-as-you-go society? It is the natural endpoint, after all, of the privatization craze, of the gospel of tax cuts and of the smaller-government-is-better- government mentality that has been on the ascendancy in the U.S. for nearly 25 years. ...

How has this come to pass? ... Conservatives talk a lot about government failure, but over the last few years, it's really we who have failed government, depriving it of the revenue, the conscientious management and the attention needed for it to succeed. Undercapitalize a pizza joint and your customers will taste the poor ingredients, become frustrated by the long waits and grow repulsed by the grimy environs. Staff it with your unmotivated drinking buddies and the service will falter, as will the quality of the product. It's no way to run a pizza place, and it's certainly no way to run a government.

But that's exactly what we've done. With ... the ... tax revolt, and with presidents whose entire domestic programs amounted to mindless tax-cutting, and with Congresses that have been happy to pass cuts and stack deficits, we have systematically deprived the government of the revenues it needs to provide basic services, even as we've come to need it to do so much more. ...

All that money has to come from somewhere. And the "where" isn't the high-profile initiatives that the media is watching — the Medicares and Social Securities (although they may suffer too) — but from the smaller, less-noticed, but critically important programs and departments that millions rely on.

If ... states cannot pick up the slack, there will have to be cuts in funding for police and schools and jails and Pell Grants and the Food and Drug Administration and the National Institutes of Health and the Department of Veterans Affairs and the nation's infrastructure and all the rest. ... And that it's all happening even as the globalizing economy demands ever higher skills, as ill and traumatized Iraq war veterans are going without care, as roads and schools are crumbling and myriad other minor catastrophes are underway beneath the notice of the national media but well within the range where they harm ordinary Americans.

Such unhappy outcomes are not merely morally unsettling, they're often economically inefficient. Government spending can be ... necessary... It can step in, for instance, when the market fails to deliver public goods that society desires but private entities haven't figured out how to fund. (It's useful having a national military, right?) And it can use its regulatory power to ensure that competition works to increase well-being rather than to simply amp up industry profits.

UC Berkeley economist Brad DeLong once wrote that "sometimes government failures are greater than the market failures for which they purport to compensate. Sometimes they are not." The trick is knowing which is which. But if, like the Bush administration, you are blithely unconcerned with running an efficient, effective government, ..., you never need make those judgments as you have neither the resources nor the personnel to effectively deploy the central organizing structure of modern societies. And that's a shame.

Libertarian humorist P.J. O'Rourke likes to say that "Republicans are the party that says government doesn't work, and then they get elected and prove it." Over the last few years, that's been true. But government can work, and increasingly, Americans appear to be anticipating its return. A new Pew Research Center poll finds that public support for a societal safety net and for government protections is at its highest levels in more than a decade — which suggests that Americans don't think bake sales are the way to fund their schools or that Philip Morris is really who they want subsidizing law enforcement. ...

When asked what type of political system Americans would have, Ben Franklin famously responded, "A republic, if you can keep it." Well, he also bequeathed us a government, if we can run it. And somehow, I don't think the Philip Morris police department is quite what he had in mind.

Saturday, May 12, 2007

Did Tax Cuts Fuel Economic Growth?

Did the tax cuts in 2001 and 2003 stimulate economic growth?

Pop Quiz: Did the Tax Cuts Bolster Growth?, by Daniel Altman, NY Times: Politicians from the president on down have lately been saying that the tax cuts passed in 2001 and 2003 were responsible for the quick growth of the economy starting in mid-2003. That growth has since tapered, but ... it’s worth asking — are they right?

I decided to pose that question to a large group of mainstream economists through an informal survey. The answer, in a nutshell, was no.... But there was a lot more to the story. ...

Last week, I sent e-mail messages to the 177 members of the National Bureau of Economic Research’s program on economic fluctuations and growth. ... The e-mail message had just one question:

“Which factor was most important for the economy’s growth from mid-2003 through the end of 2006?” It offered the economists five possible responses:

a. The tax cuts signed by President George W. Bush.
b. Pent-up demand following the recession, the corporate scandals and the invasion of Iraq.
c. Both (a) and (b) were important.
d. Neither (a) nor (b) was important; it was the regular business cycle.
e. There’s no way to tell now.

...Forty-nine economists responded to my message, including many of the best-known names in the field. Of these, only five, about 10 percent, said that the tax cuts were the most important factor in the economy’s growth.

Two were Nobel laureates known for their conservative views — Robert E. Lucas Jr. of the University of Chicago and Edward C. Prescott of Arizona State University. Two other professors, Martin S. Feldstein of Harvard and Gary D. Hansen of the University of California, Los Angeles, qualified their answers by mentioning other factors. ...

But the majority, 30 economists, answered neither or supplied an answer not listed. Robert E. Hall of Stanford wrote that “the U.S. economy recovered from every single recession it ever had, so the growth in 2003-2006 was generally part of the normal cyclical recovery.”

Several economists volunteered other factors, among which monetary policy was the most popular. “I can’t believe you left off the list: superlow interest rates caused by the Federal Reserve,” wrote Alan S. Blinder, a Princeton professor... Paul M. Romer of Stanford echoed Professor Blinder’s sentiments.

Robert J. Gordon of Northwestern University added: “I hope others tell you that your question is absurd, because it leaves out ... an unprecedented period of negative short-run interest rates...”

Some professors were just as adamant in ... arguing that changes in productivity had been responsible for the economy’s growth. “Productivity growth and financial innovation are the big stories of the 2000s,” said Kenneth S. Rogoff of Harvard. ... Erik Hurst of the University of Chicago said that “aside from the inventory correction in 2001, the growth in 2003-2006 was not that different than 1996-2000 (which had nothing to do with tax cuts or pent-up demand).”

And one economist said that most of the factors named, with the exception of the tax cuts, were part of the usual behavior that followed recessions. “Pent-up demand following a recession sounds like the regular business cycle,” wrote Robert J. Shiller of Yale. “Also, part of the regular business cycle is the Fed and the behavior of speculative markets.” ...

[M]ost of the respondents were unconvinced by the politicians’ claims about the benefits of tax cuts. In fact, one actually argued that the tax cuts hurt the economy. “The tax cuts, by increasing uncertainty about how impending fiscal imbalances will be resolved, probably hurt growth, if anything,” said Christopher A. Sims of Princeton. ...

A similarly contrary argument was suggested by Lee E. Ohanian of U.C.L.A. concerning the war in Iraq. “Large increases in military expenditures are almost always associated with rapid growth ..., but the size of the Iraqi conflict spending is quite small as a fraction of total income.”

Economics is not an exact science, even in hindsight. Indeed, economists rarely say that they’ve proved an empirical hypothesis. Rather, they say that a hypothesis can’t be ruled out. In that spirit, several answered that there was no way to say for sure which factors had caused the economy to grow. ...

I'm not sure whether those who believe the evidence supports the tax cut story are more or less inclined to answer an email survey, so I don't know in what direction the proportions might be tilted. But this seems to me to be a fair representation of the opinion among macroeconomists about the causes of economic growth in recent years, and the quotes are from economists well worth listening to.

Friday, May 11, 2007

Market Failure in Everything: The Carbon Emissions Edition

What's the best approach to limiting carbon emissions, cap and trade or a carbon tax? Many economists will tell you a carbon tax is best. Political consultants, for the most part, will tell you something else:

Getting on a low-carbon diet, by Ronald Brownstein, Commentary, LA Times: ...Scientists, economists and political leaders who support action against global warming all construct their proposals on a simple foundation: attaching a cost to carbon emissions. Since the U.S. ... does not regulate greenhouse gas emissions, factories and power plants and cars can pump carbon into the atmosphere for free; to the polluter, carbon today has no cost. ...

Since none of those costs are internalized..., the effect is to artificially lower their price. That distortion encourages overuse of fossil fuels and discourages investment in clean energy alternatives... "The biggest market failure we have in the world is the fact that [carbon emissions], which are potentially threatening our ability even to survive on this planet, has no price," says environmental consultant Roger Ballentine, the chairman of the White House climate change task force under President Clinton. ...

To the extent American politicians in recent years have talked about controlling carbon emissions, they have almost entirely focused on a system known as "cap and trade"... But now a group of skeptics is questioning whether that approach by itself will achieve the reductions in emissions necessary... Their alternative has a sharper edge: a tax directly on the carbon emissions of fossil fuels. ...

Sen. Christopher Dodd (D-Conn.) is promoting a carbon tax in his campaign for the 2008 Democratic presidential race. ... But Dodd is the only prominent presidential candidate talking about a carbon tax. And he's not surprised to be ... alone. "Why I suspect the other candidates are not talking about this, is all their pollsters and handlers have said 'you are looking for trouble here,'" Dodd says. "I think…there is a larger constituency for [this] than people believe today."

Both a carbon tax and a cap-and-trade system are designed to place a cost on carbon emissions. A carbon tax does so directly: It would tax each fossil fuel based on the amount of carbon it emits when burned. Under that system, coal would be taxed the most, oil less and natural gas least. ...

A cap-and-trade system operates very differently. The cap part works like this: The government would set an overall limit on the amount of carbon the country will emit each year, and then allocate "credits" that establish emission limits for individual companies. At that point, the trade component would kick in. ...[F]irms that can reduce their emissions more efficiently could sell some of their credits to other companies ... that find it more expensive to control carbon. A trading system would develop that establishes a market price for carbon pollution.

There are some other fine points under debate, particularly whether the credits should be provided free to polluters or auctioned off (by all indications, a better option.) ... The cap-and-trade system Congress approved in 1990 to fight acid rain has produced greater reductions in sulfur dioxide pollution at less cost than initially expected and minimal economic disruption...

Skeptics, though, point to the troubles of the cap-and-trade system the European Union has used since 2005... Under pressure from industry, European governments gave away too many credits to polluters; the result was that the price of the credits collapsed, undermining the incentive to cut emissions or use cleaner fuels. ... A second round ... scheduled for next year could ameliorate the problem, but at the least, the European experience suggests that designing a successful cap and trade is an enormously complex undertaking which may require some trial and error before it works.

That prospect is at the heart of Dodd's argument for a carbon tax. A cap-and-trade system, he says, "is confusing, it's complicated and it takes forever." Enforcement could also be a challenge... By contrast, he argues, a carbon tax sends an instant, unambiguous signal discouraging the use of the fuels that contribute the most to global warming. ...

[T]he two policies have complementary strengths. ... Al Gore, in his Congressional testimony, ... testif[ied] that he believed "the most effective approach is to do both."

This discussion may seem wildly premature. ... At the moment there's no sign Congress is ready to approve even a cap-and-trade system... And a carbon tax proposal—because it includes that three letter word—is a much more incendiary proposition than a cap-and-trade proposal (which would also raise electricity and gasoline prices, though in a more muffled and indirect way).

But the political climate on these issues could change as abruptly... More leaders from different segments of American society—from utility and auto executives to the retired military officials who testified before the Senate this week—are endorsing meaningful, mandatory action...

When Washington is ready to act, the real lesson ... from this ... debate ... is that there is no best way. Progress against a challenge as vast as global warming will require us to use all the tools available to us: direct regulation (tougher fuel economy standards for cars, requirements on utilities to generate more of their electricity from renewable sources); economic carrots and sticks (a carbon tax that helps fund tax breaks for investment in greater energy efficiency and alternative energy sources); a cap-and-trade system that sets a hard limit on emissions; federal procurement that nurtures clean new technologies; and steps beyond all of these that we can't yet imagine. ...

Does anyone know any more about this? Is it generally accepted that "Australia's farmers have been responsible for virtually the entire share of the nation's greenhouse gas emissions reductions" due to "government laws banning land clearing"?:

There's little gold in them climate-saving trees, by Michael Duffy, Commentary, Sydney Morning Herald: This week's copy of The Land newspaper contains one of the more unusual items the state's august rural newspaper has published. It's a two-page ad presenting an invoice for $10.5 billion from some farmers to the governments of Australia. The farmers want to be paid for carbon dioxide their farms have absorbed because of state government laws banning land clearing. After all, the more trees left standing, the more carbon gets sucked out of the air.

The farmers argue that laws to protect native vegetation have enabled the Federal Government to claim it is meeting its Kyoto emissions target without penalising other industries. Therefore those industries, via the government, owe the farmers a lot of money. ...

The farmers say they will launch court action if their invoice is not paid. Their chances of success are probably zero, but the ad ... is also a useful reminder of how farmers have been shamelessly used by the Federal Government in relation to the Kyoto Protocol.

Not only have they suffered harshly from state native vegetation laws, which have effectively nationalised large parts of many farms without compensation, their suffering has been used as an excuse to allow other businesses to continue to belch out carbon and profit from it.

Australia managed to get a special clause inserted in the Kyoto deal allowing reductions in land clearing after 1990 to be part of the calculation of its net carbon emissions. Fortuitously, an unusually large amount of land had been cleared in 1990. As a result, the Federal Government has been able to claim that Australia was meeting its targets without any economic activity being penalised.

Apart, that is, from farming. Last October a think tank called The Climate Institute published a report claiming that, thanks to bans on land clearing, "Australia's farmers have been responsible for virtually the entire share of the nation's greenhouse gas emissions reductions … Over the same period, emissions from energy and transport have and continue to skyrocket..."

The climate institute also claimed that, because Australia refused to ratify the Kyoto Protocol, farmers have been unable to access those international emissions trading schemes that do exist. Our farmers "are unable to convert the emissions reductions they have achieved into financial value and benefit from the growing global carbon market". ...

Some farmers have seized on this with joy... My prediction is there will be lots of talk and no meaningful action.

The farmers' problem is that they are acting as though our leaders mean what they say on global warming. In truth they don't. Almost all government action on climate change is driven by the need to pretend to be doing something significant, while actually doing as little as possible. This is because any meaningful action would harm the economy. This is the situation in most countries, not just Australia. Most apparent action on climate change falls into four categories.

1. The commissioning of more research, including the setting up of high-profile study centres and inquiries. This allows leaders to say they're taking the problem seriously while postponing the need to do anything significant. ...

2. Commitments to action that would harm the economies of other nations while affecting one's own hardly at all. The Europeans are masters at this.

3. The portrayal of action that would have occurred anyway as part of a government's brave fight against climate change. Examples include steps to fight air pollution in developing nations, and land clearing bans in Australia.

4. Commitments to action that sound wonderful but never occur, or do occur but with little effect on carbon emissions. Perhaps the best example of this is the European Union's Emission Trading Scheme, whereby nations set caps on carbon emissions. Sounds splendid. But for 2005 the caps set by most nations were higher than actual emissions.

In light of the above, one might propose the following. To the extent that anyone will actually suffer from action to reduce carbon emissions, it will be the weak rather than the strong. ...

Tuesday, May 08, 2007

Robert Reich: Private-Equity Baloney

How should the income of private equity partners be taxed, as capital gains or as compensation? Robert Reich has a definite answer:

Private-Equity Baloney, by Robert Reich: This week, Senators Max Maucus and Charles Grassley, the chairman and ranking minority member of the Senate Finance Committee, are holding "informal meetings" to consider whether the stratospheric incomes of private-equity partners ought to be treated as compensation rather than as capital gains, for tax purposes. ...

[T]he average big-company CEO has to do with a measly $7 million a year, taxed at 35 percent. But private equity partners are raking in hundreds of millions a year, taxed at 15 percent – less than the tax rate paid by middle-class Americans.

What exactly do private-equity partners do? They use the investment money of pension funds and college endowments and wealthy investors to buy up publicly-held companies and turn them briefly into privately-held companies. Then they do what you might do when you want to resell your home – redecorate, refurbish, knock out some walls, apply fresh paint, sell the furniture. ...

Then a few years later the private-equity partners resell the company to the public, usually at a big profit. And they take 20 percent of the profits for themselves.

We’re talking billions of dollars here, folks. And it’s only taxed at 15 percent because even though it’s most of their compensation it’s treated as a capital gain. And courtesy of the Bush tax cuts, capital gains are taxed at 15 percent. Of course, those billions are what these guys pay themselves for their work. It's their compensation.

When capital gains are taxed at less than half the tax rate the rich pay on their incomes, you can expect this sort of gamesmanship.

Now that the tax-writing committees of congress are taking a look at this giant loophole, they’re besieged by private-equity partners who are, of course, screaming: No! You can’t do this to us! If you treat the money we’re making as compensation, you’ll reduce our incentives! We won’t work as hard if we’re taking home only 60 million dollars a year instead of 80 million! And that will cripple the American economy.


Friday, May 04, 2007

Is the Tax Tide Turning?

Christopher Hayes sees signs that the knee-jerk opposition to tax increases of recent years is abating, particularly when the taxes are tied directly to government services the public supports:

Look Who's Taxing, by Christopher Hayes, The Nation: Texas State Senator John Carona is the very image of a Republican lawmaker... He represents north Dallas and the adjacent suburbs, a bastion of country club Republicanism, whose residents are not typically enthusiastic about either taxing or spending. So it was more than a little surprising to hear him say that it was high time ... Texas raised taxes. "No one likes to pay higher taxes," he told me ... "But the people ... send us to the capital to do what is best for the state. The vast majority didn't send us so that we would never raise new revenue. Somehow along the way, the conservative movement ... has taken the definition of conservatism to mean the unwillingness to ever raise taxes for any purpose no matter what the need. And that is just foolish and wrongheaded."

Carona's not alone. Over the past few years, momentum has begun to build, bit by bit, against the antitax movement, and it has largely flown under the radar of the national media. A number of governors, from Democrats Jon Corzine of New Jersey and Mark Warner of Virginia to Republicans like Mitch Daniels of Indiana, have pushed through significant tax increases and been rewarded with high approval ratings. Daniels's apostasy was particularly meaningful, since he was once Bush's budget director and had been a lifelong fellow traveler of antitax warrior Grover Norquist. This year, other states ... facing budgetary shortfalls are proposing significant tax hikes, in stark contrast to just a few years ago, when "legislatures...bent over backwards to avoid major tax hikes, instead raiding rainy day funds, borrowing money or expanding gambling to raise more revenue."

This is big news, because for much of the past two decades states have been the sites of Norquist's greatest victories. ... Unlike the federal government, ... many states are legally required to balance their budgets, so they've resorted to ... tricks and gimmicks to keep the government funded. Gambling has exploded, pension funds have been raided and many states are now reduced to selling off public assets. But eventually the bill comes due. ...

[T]he ground is clearly shifting. In 1994, when the tax revolt was arguably at its zenith, 66 percent of Americans said that the amount of federal income taxes they paid was too high. By 2006 that figure had dropped to 48 percent. ...

Driven by a desire for the approval of the Beltway mandarins, Democratic candidates are going to be tempted to package potential tax increases (for instance, repeal of the Bush tax cuts) as a means of restoring fiscal discipline and reducing the deficit. But telling people you're going to raise taxes to reduce the deficit is like telling them you're going to garnish their wages to pay off the gambling debts of their crazy vagabond uncle. It's no fun.

People seem ready to accept higher taxes, but only if those taxes are sold to them as paying for services they want the government to provide. "The notion that [social programs] are what Democrats want and what Republicans abhor may have been true thirty years ago," Carona told me. "But I feel like there's been a shift. Now everybody wants the programs, but one group is unwilling to pay for them and the other group is unable to pay for them."

Over the past six years, Republicans have succeeded in de-linking taxes from the public services and social programs they pay for. It is the job of Democrats, particularly the presidential candidates who will have the largest platform, to re-establish that connection in voters' minds. ...

Friday, April 27, 2007

Republicans and the Expiration of Tax Cuts

John Berry says if the tax cuts Republicans passed into law expire, they "have only themselves to blame, because the expiration dates were set originally to mislead the public":

Congress Wrangles Over Bush's Expiring Tax Cuts, by John M. Berry, Commentary, Bloomberg: The high-stakes revenue wars have begun again, with some Republicans complaining that the Democrats controlling Congress are planning the biggest tax increase in U.S. history. ...

[T]he potential tax increases worrying the Republicans will occur ... because many of the tax cuts enacted since President George W. Bush took office six years ago will expire in the next two or three years unless legislation extending them is passed.

If that happens, Republicans have only themselves to blame, because the expiration dates were set originally to mislead the public about the amount of revenue loss involved. Of course, from the beginning the plan was to argue that letting the cuts expire would impose tax increases that would harm the economy and cost jobs.

Long-term demands on the government -- such as paying Social Security and Medicare benefits to retiring baby boomers -- mean some increases probably are in store. Nevertheless, it's highly likely that many of the tax cuts benefiting low- and moderate- income taxpayers ... will be extended.

In the tax debates, the link between tax cuts or tax increases and growth is frequently exaggerated. The impact of either depends on the economic circumstances of the time.

Do you recall Rush Limbaugh's offer to bet $1 million that President Bill Clinton's 1994 tax increases would plunge the country into a recession? Didn't happen. ...

In 2001, when the bill was being debated, Bush and Republican congressional leaders -- with the help of some Democrats -- played all sorts of games to make the cuts appear smaller when calculating the impact over the next 10 years.

Some of the cuts were to be phased in and then eliminated in the 10th year. Perhaps the most egregious give and take was played with the estate tax. Its bite was to be reduced gradually through 2009, then repealed altogether in 2010 and then re- imposed fully in 2011. ...

Democrats should challenge Republicans to identify what cuts they would make to social programs in return for making these tax cuts permanent -- not some game this time to hide the full impact of the tax cuts -- but the cuts required to make the tax cuts permanent like they desire. The programs that will need to be sacrificed, not output growth and employment which are not substantially impacted by tax changes of the type and magnitude we are talking about, is what's on the table.

Tuesday, April 24, 2007

George McGovern Says Dick Cheney "Twisted My Views and Those of My Party Beyond Recognition"

Brad DeLong and PGL have both highlighted George McGovern's sharp response to vice president Cheney's recent speech in which he said, among other things:

Thirty-five years ago, the standard-bearer for the Democrats, of course, was Senator George McGovern, who campaigned on a far-left platform of heavy taxation, a greatly expanded role for government in the daily lives of Americans, and a major retreat from America's commitments in the Cold War.

I'm not sure that quote fully conveys Cheney's attack on McGovern and Democrats, but, in any case, George McGovern responded with:

Vice President Dick Cheney recently attacked my 1972 presidential platform and contended that today's Democratic Party has reverted to the views I advocated in 1972. In a sense, this is a compliment, both to me and the Democratic Party. Cheney intended no such compliment. Instead, he twisted my views and those of my party beyond recognition. ...

Cheney said that today's Democrats have adopted my platform from the 1972 presidential race and that, in doing so, they will raise taxes. But my platform offered a balanced budget. I proposed nothing new without a carefully defined way of paying for it. By contrast, Cheney and his team have run the national debt to an all-time high.

He also said that the McGovern way is to surrender in Iraq and leave the U.S. exposed to new dangers. The truth is that I oppose the Iraq war, just as I opposed the Vietnam War, because these two conflicts have weakened the U.S. and diminished our standing in the world and our national security.

In the war of my youth, World War II, I volunteered for military service at the age of 19 and flew 35 combat missions, winning the Distinguished Flying Cross as the pilot of a B-24 bomber. By contrast, in the war of his youth, the Vietnam War, Cheney got five deferments and has never seen a day of combat — a record matched by President Bush.

Cheney charged that today's Democrats don't appreciate the terrorist danger when they move to end U.S. involvement in the Iraq war. The fact is that Bush and Cheney misled the public when they implied that Iraq was involved in the terrorist attacks of 9/11. Iraq had nothing to do with the attacks. That was the work of Osama bin Laden and his Al Qaeda team. Cheney and Bush blew the effort to trap Bin Laden in Afghanistan by their sluggish and inept response after the 9/11 attacks. They then foolishly sent U.S. forces into Iraq...

There is one more point about 1972 for Cheney's consideration. ... I won the Democratic presidential nomination. I then lost the general election to President Nixon. ... But lest Cheney has forgotten, a few months after the election, investigations by the Senate and an impeachment proceeding in the House forced Nixon to become the only president in American history to resign the presidency in disgrace.

Who was the real loser of '72?

The vice president spoke with contempt of my '72 campaign, but he might do well to recall that I began that effort with these words: "I make one pledge above all others — to seek and speak the truth." ... I never broke my pledge to speak the truth. ... In contrast, Cheney and Bush have repeatedly lied to the American people.

It is my firm belief that the Cheney-Bush team has committed offenses that are worse than those that drove Nixon, Vice President Spiro Agnew and Atty. Gen. John Mitchell from office after 1972. Indeed, as their repeated violations of the Constitution and federal statutes, as well as their repudiation of international law, come under increased consideration, I expect to see Cheney and Bush forced to resign their offices before 2008 is over.

Aside from a growing list of impeachable offenses, the vice president has demonstrated his ignorance of foreign policy by attacking House Speaker Nancy Pelosi for visiting Syria. Apparently he thinks it is wrong to visit important Middle East states that sometimes disagree with us. Isn't it generally agreed that Nixon's greatest achievement was talking to the Chinese Communist leaders, which opened the door to that nation? And wasn't President Reagan's greatest achievement talking with Soviet leader Mikhail Gorbachev until the two men worked out an end to the Cold War? Does Cheney believe that it's better to go to war rather than talk with countries with which we have differences? ...

There's more, but let's augment this by going back to 1972 and seeing what George McGovern actually said. This is from McGovern's acceptance speech for the Democratic nomination for president given on July 14, 1972. I'll let you judge whether Cheney's portrayal of those views as dangerous and reckless is accurate. Though the focus at the beginning is on the war, the speech also talks about jobs, housing, single-payer health care, welfare reform, tax reform, and other issues:

George McGovern Acceptance Speech, July 14th, 1972, Miami Beach, FL: ...This is the time for truth, not falsehood. In a Democratic nation, no one likes to say that his inspiration came from secret arrangements by closed doors, but in the sense that is how my candidacy began. I am here as your candidate tonight in large part because during four administrations of both parties, a terrible war has been chartered behind closed doors.

I want those doors opened and I want that war closed. And I make these pledges above all others: the doors of government will be opened, and that war will be closed. Truth is a habit of integrity, not a strategy of politics, and if we nurture the habit of truth in this campaign, we will continue to be truthful once we are in the White House.

Let us say to Americans, as Woodrow Wilson said in his first campaign of 1912, “Let me inside the government and I will tell you what is going on there.” Wilson believed, and I believe, that the destiny of America is always safer in the hands of the people then in the conference rooms of any elite.

So let us give our – let us give your country the chance to elect a Government that will seek and speak the truth, for this is the time for the truth in the life of this country.

Continue reading "George McGovern Says Dick Cheney "Twisted My Views and Those of My Party Beyond Recognition"" »

Wednesday, April 18, 2007

Alesina and Ichino: Women Should Pay Less Tax

Alberto Alesina of Harvard University and Andrea Ichino of the University of Bologna argue that optimal taxation requires men to be taxed more than women:

Why women should pay less tax, by Alberto Alesina and Andrea Ichino, Commentary, Financial Times: Normally, free-marketeers and those who are worried about the efficiency costs of taxation are in opposite camps from those social activists who believe you need extensive government intervention to achieve a range of social goals. Here is a policy proposal that should make the two camps agree: reduce income taxes on women and increase, by less, income taxes on men.

As surprising as it may look, this can be done while keeping total tax revenue constant and reducing average tax rates. Thus, this policy would at the same time reduce overall tax distortions and increase women’s participation in the labour force. It would achieve similar goals to affirmative action policies, quotas or subsidised childcare and could substitute for those policies. It would also make gender discrimination more costly for employers and would be fair because it would compensate women for bearing the brunt of maternity and for the fact that the possibility of having children can negatively affect their career prospects.

How is it possible to achieve the miracle of raising taxes on men by less than the reduction on women while also holding tax revenue constant? The answer is well known to any graduate student in public finance. The supply of labour of women is more responsive to their after-tax wage, so a reduction in taxes increases the labour participation of women substantially. Men’s labour supply is more rigid, so an increase in taxes does not reduce their labour supply by much, if at all. Ergo, for a given tax cut on women, with a smaller tax increase on men, one maintains the same total revenue with fewer tax distortions. This is simply an application of the general principle of public finance that goods with a more elastic supply should be taxed less. Our computations, available in our working paper, Gender Based Taxation, suggest that the difference in tax rates across gender that would be implied by our proposal ... could be quite large, especially in countries where the labour participation of women is not as high, such as the Nordic countries. ...

In the long run, gender-based taxation may contribute to changing the traditional division of labour within the family, which currently encourages men to work more in the market and women more often at home. If and when a change happens (and many social activists consider that a desirable goal), the response of male and female labour supply ... may become less different from each other... At that point, one may need to reconsider the differences in tax rates, precisely as the basic principles of optimal taxation suggest.

In conclusion: would it be unfair for the fiscal authority to treat women and men differently? We do not believe so. There is nothing more hypocritical than to invoke equal treatment in some areas (taxation) for those who are not treated equally in many other areas (the labour market; sometimes in the family allocation of tasks, such as rearing children or caring for elder family members). ... And do not forget that a large part of the redistribution of the tax burden implied by this proposal would occur within the same family: the husbands of married women who choose to work would also benefit from their wife earning a higher take-home salary.

Do's and Don'ts

Speaking of presidential advisers, Robert Waldmann has some wise advice for Republican candidates:

Very Dumb New Right Wing Talking Point, by Robert: Three cases make a syndrome but two are plenty for a blog post. The latest idiotic right wing talking point is that the tax code is too progressive and has gotten more progressive since Reagan was elected. This insanity appears on the WSJ editorial page (see Chait slice and dice Fleisher) and see Jared Bernstein attempt to seize defeat from the jaws of victory discussing Larry Kudlow's show. This claim is dumb in two ways. First it is, of course, false. Second, they really really don't want to go there.

Let me give a bit of advice to Republicans.

Talk about
statistics no
anectdotes ok
Bush no
Iraq no
WMD no
Democracy promotion no
the surge no
victory no
terrorism ok
Pelosi no
health care no
The French yes
French health care no
Hillarycare no
the veterans' admin no
Walter Reed no
HMO's no
Medicare plan D no
big Pharma no
the postal service finally you got it
Cheney no
Arabs yes
Rove no
the average American yes
the median American no
Islam yes
the average tax burden yes
government spending no
the deficit no
the bridge to nowhere no
Sunni Islam no
Social security no
socialism yes
Shi'ite Islam no
law and order yes
the rule of law no
Class war ok
tax progressivity No. Never. not ever. NO. Change the subject. Talk about Abramoff. Talk about Katrina. Do not admit you know what the words mean. Tell jokes about Cheney with a shot gun. Anything but tax progressivity. If the American people start thinking about tax progressivity, your candidate will finish fifth after Patrick Buchanan, Ralph Nader and Lyndon Larouche. Don't go there. Ever.

Sunday, April 15, 2007

Robert Frank Responds to Greg Mankiw

When Greg Mankiw saw Robert Frank's Economic Scene article in the New York Times saying that trickle-down theories don’t hold up against actual evidence, he responded "Frank needs to read more widely":

Frank needs to read more widely, by Greg Mankiw: In today's NY Times, Robert Frank says there is little point to cutting marginal tax rates of high-income individuals:

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.

Apparently, Bob has not read this survey by Stiglitz and come to grips with this theoretical conclusion...:

Pareto efficient taxation requires that the marginal tax rate on the most able individual should be negative.

The reason for this conclusion is that a negative marginal tax rate on the most skilled worker induces him to work more, and if skilled and unskilled labor are complementary inputs, the wage for unskilled labor rises in general equilibrium.

Nor does it seem that Bob has read this empirical work by Gruber and Saez:

A central tax policy parameter that has recently received much attention, but about which there is substantial uncertainty, is the overall elasticity of taxable income. We provide new estimates of this elasticity...We estimate that this overall elasticity is primarily due to a very elastic response of taxable income for taxpayers who have incomes above $100,000 per year, who have an elasticity of 0.57, while for those with incomes below $100,000 per year the elasticity is less than one-third as large...

Bob is perfectly free to believe whatever he likes and to advocate increasing the top marginal tax rate. But to suggest that there is neither theory nor evidence to support the beneficial effects of lower marginal tax rates on high-income taxpayers indicates a lack of appreciation of the academic literature in public finance.

Bob also makes this argument:

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.

This seems just wrong to me, if the goal is to analyze tax policy. When comparing work hours today versus a century ago, you have to consider both income and substitution effects of wages on labor supply, which are offsetting to a large degree. But, according to standard theory, the distortionary effect of taxes depends only on the substitution effect. The evidence cited suggests that income effects are larger than substitution effects, not that substitution effects are small.

I'm guessing Frank had read the Stiglitz essay (after-all, it's not exactly new, the working paper Greg links is dated 1987), but in any case my reaction was that the Stiglitz paper comes to a theoretical conclusion while the claim Frank makes is mainly about the empirical evidence, i.e. his assertion is that the evidence doesn't support trickle-down claims. Frank wasn't denying that there are theories that allow for the possibility of supply-side effects, though he did point out that the theoretical predictions depend upon the magnitude of responses, i.e. the sign of the response to a change in taxes is not determined unambiguously by theory and hence it is an empirical issue. His point is that the empirical evidence doesn't support the claims made by those promoting supply-side policies. I'm not sure how citing Stiglitz rebuts the claim that there is no evidence for the theory [though to be fair it was offered to rebut that theory does not support supply-side policy, though I interpreted Frank as saying theory doesn't speak unambiguously on the matter, not that there is no valid theory supporting trickle-down effects].

My other reaction was that the criticism was a bit unfair. If you are going to accuse someone of not being aware of or lacking appreciation for research in the area, you owe it to us to cite more than one or two papers yourself and hopefully work a little more current than 1987 and 2000, especially if you were Chair of the CEA where public finance issues are at the forefront giving you a strong incentive to be familiar with the cutting-edge work in the area (and not under a word limit). I expected a summary of the research on both sides of the issue, some analysis about why one set of results ought to be preferred over the other, etc., but citing a single paper from 2000 as though that settles the empirical issue doesn't do it, at least not for me.

Graciously, Greg has offered Robert Frank the opportunity to respond to his objections [I cut Frank's response down a bit, Greg has the full response]:

Bob Frank replies, by Greg Mankiw: A few days ago, I expressed here my skeptical view of a recent column by Bob Frank. I offered Bob an opportunity to respond. Below I am reprinting, in its entirety, what he sends along. There is much that one could debate here, and I am sure the commenters will, but I will refrain. Since I picked this fight, and since I have ample opportunity in this forum to express my perspective, in fairness I will let Bob have the last word--at least for now.

First, my thanks to Greg for his gracious invitation to respond... Here I’ll attempt to explain why Greg’s defense of trickle-down theory falls short.

Greg discounts the significance of the negative relationship I cite between wage growth and the average workweek over that last century...

Greg is right about what this particular piece of evidence shows. But ... the argument I advanced in my column had nothing to do with whether taxes on the rich are distortionary. ... My only point in the column, however, was to question a very different claim—namely, that higher taxes on the rich would reduce work effort. ... In other words, it’s a claim about the combined impact of the income and substitution effects. So the fact that the workweek declined over the last century in the face of substantial growth in real wages is directly supportive of my argument.

A necessary and sufficient condition for trickle-down theory’s argument to the contrary is that the elasticity of supply of labor with respect to real wages be significantly positive. The most comprehensive recent econometric study of labor supply elasticity in the United States will be published in the next issue of The Journal of Labor Economics. The authors, Fran Blau and Larry Kahn, estimate that the labor supply curve for men has been essentially vertical for many decades. The clear implication is that higher taxes on top earners, most of whom are men, will not significantly reduce work effort.

Greg also mentions research suggesting that higher taxes on the rich may reduce the amount of income they report to the IRS. Perhaps so, but that by itself would not imply any reduction in output. And with even the supply-sider Bruce Bartlett now conceding that tax cuts for top earners don’t boost total tax revenues, it’s important not to exaggerate the problem of unreported income. But irrespective of its magnitude, why isn’t the best solution to this problem a simpler and more strictly enforced tax code rather than tax rates that are too low to sustain minimally adequate public services? ...

As evidence for his claim that I need to do additional reading, Greg cites a 1988 paper in which Joe Stiglitz argued that the socially optimal marginal tax rate on the most productive person might actually be negative. ... In the abstract, this is an interesting claim. (Is it any more than that? Stiglitz, for one, never thought to offer tax policy proposals on the basis of it.) But if we’re going to discuss externalities, then complementarities between skilled and unskilled labor are surely not the most important ones to consider.

For present purposes, by far the most important externalities are those stemming from the link between context and evaluation. As decades of behavioral evidence clearly demonstrates, virtually every evaluation is heavily shaped by local context. As Richard Layard put it, “In a poor society a man proves to his wife that he loves her by giving her a rose, but in a rich society he must give a dozen roses.” ... The upshot is that almost every consumer choice generates significant context externalities. Consider, for example, a job applicant’s decision about how much to spend on an interview suit. His goal is to make a favorable impression. But his ability to do so depends far less on the absolute quality of his suit than on how it compares with those worn by other applicants. And when he spends more on a suit, he shifts the context within which other candidates will be evaluated.

Context externalities are pervasive. ... The dependence of evaluation on context lays waste to any presumption that individual decisions about how many hours to work or how much to spend on interview suits will be socially optimal. ... For the discussion at hand, the relevant finding is that evaluations of leisure tend to be far less context-sensitive than evaluations of income. The implication is that individual valuations of leisure tend to understate social valuations. Thus people work longer hours in the hope of moving higher on the income ladder, only to discover that when others do likewise, their position remains unchanged.

It would be unfair to single out Greg for ignoring context externalities. After all, most of the standard economic models ... make no mention of these... But even absent explicit mentions of context externalities, most practical policy analysts already seem to recognize that trickle-down theory’s portrait bears little relation to the behavior of people in the real world.

My point is not that people don’t care about money. On the contrary, when the pay in one occupation goes down relative to others, fewer people enter that occupation. ...

But trickle-down theory is about what happens when after-tax pay falls not just in some occupations but for top earners generally. In a largely meritocratic society like the United States, most top earners are extremely driven people. And as recent studies have shown, most of them will never spend more than a small fraction of their earnings. The trickle-down theorist’s insistence that they will begin slacking off in response to a small increase in their marginal tax rates strains credulity.

While serving as chairman of the Council of Economic Advisers, Greg actively supported the Bush tax cuts targeted at top earners by arguing that the cuts would spur them to work harder. Greg would have been astonished to observe such a response from his colleagues at Harvard. Does he have a behavioral model that leads him to expect different behavior from high achievers in other occupations? Or does he have one that explains why any such differences consistently fail to reveal themselves in the data? In the absence of a plausible behavioral model backed by persuasive empirical evidence to the contrary, I stand by my conclusion that trickle-down theory is supported neither by economic theory nor by empirical evidence.

The tax cuts that were sold by invoking this theory did little to promote the well-being of even the well-to-do Americans who were their ostensible beneficiaries. ... In light of what we know about the empirical magnitude of context externalities, the principal effect of such spending was simply to redefine what counts as adequate. As in the familiar stadium metaphor, all stand to get a better view, yet none sees better than if all had remained seated.

Greg titled his response to my column “Frank Needs To Read More Widely.” On that point, he is surely right. I don’t know Greg well enough to presume to know what he needs. But he would almost surely offer better policy advice if equipped with an economic model that better fits current scientific knowledge about human behavior.

Again, my thanks to Greg for inviting me to respond to his critique of my column.

I hope Greg will make his case at some point and I encourage him to do so because, as I noted, he hasn't made it yet. It would be very useful to hear an unbiased, professional presentation that summarizes and evaluates of the vast work on both sides of this issue rather than an attempt to prove a point.

Thursday, April 12, 2007

Jamie Galbraith Speaks for the "Vulgar Keynesians"

Here's more on the series of posts on supply-side economics, what we knew in the late 1970s and early 1980s, the gulf between academia and Washington, and other issues. This is Jamie Galbraith from comments with a view from inside "the trenches," a view from a "vulgar Keynesian" who stood "against the Reagan Revolution in the early 1980s":

James Galbraith: Bruce Bartlett joined the staff of the Joint Economic Committee in 1981, when I did. I was the executive director in charge of the Democratic staff; Bruce was the deputy director in charge of the Republican staff. We set up the committee (which had ten Democrats and ten Republicans, chaired by my boss, Rep. Henry S. Reuss of Wisconsin) so that both sides could fully make their case to the Congress and public. And we battled merrily for a couple of years, and then in 1983 switched jobs, so that we could continue battling under a Senate Republican chairman.

Bruce has been a friend ever since, though neither of us yields an inch, I don't believe, on our economic differences.

This little history makes me, I believe, a useful representative of the despised sect of "vulgar Keynesians," "crude Keynesians," "discredited Keynesians" and so forth, not yet heard from in this discussion. I was in fact a product of an eclectic economics training at Harvard (Leontief, notably), a bracing year among the Old Keynesians (Kaldor, Robinson) at Cambridge, and a Ph.D. at Yale,in the environment of Tobin but not under his wing.

Paul Krugman and I became friends at Yale, and remain so, though we too have had strong differences over the years.

Those of us who were in the trenches, standing against the Reagan Revolution in the early 1980s, saw things differently from either the shock troops of that revolution, such as Bruce, or the academic bystanders, including Paul.

I and those around me -- the Democratic staff at the Joint Economic Committee -- were bitterly opposed to Reaganomics, both as economics and politics. Why?

First, because as politics Reaganomics was aimed at enriching the rich and destroying the economic life of working Americans and the poor. And this is no joke: it did exactly that. Recession, unemployment, the wanton and irreversible destruction of major industries and the fiscal base of the cities, the destruction of unions: all that happened. The cost of curing inflation in 1981-82 was enormous, far higher than the airy comments made above concede. We crude Keynesians believed then, and I believe now, that the steps taken were brutal and unnecessary, and that with hard policy work the problem could have been managed in ways that were far less costly, but that were rejected on ideological rather than economic grounds.

Brad DeLong's summary of Bruce's summary of our vulgar Keynesian policy beliefs is, here, reasonably close to the mark, except in one respect. No one in my circle doubted the capacity of monetary policy to crush the economy if pushed sufficiently far. Rather, we believed (accurately, as events would prove), that monetary policy worked against inflation *only* insofar as it brought on a brutal recession. We did not accept the monetarist/supply-side claim, which was presented at the start of the Reagan administration in official projections, that the trick could be pulled off without a recession. We were, of course, perfectly right about that.

Second, as a matter of economics, we thought that the combination of supply-side economics and monetarism was fundamentally incoherent -- and we were well aware that the supply-siders and monetarists disagreed with each other more violently than they disagreed with us. As an anti-monetarist and one of the very few Democrats willing to criticize the sainted Paul Volcker, I found myself in rough alliance with the supply-siders more than once (and I have a few handwritten notes from Jack Kemp in my files somewhere).

I ultimately came to see the supply-siders as the most effective practical Keynesians around. They were not only willing to run deficits when the situation required, but able to do so, because they skewed the benefits toward the rich, and thus brought political power into play behind the cause of fiscal expansion. This of course is also what George Bush did in 2001 and in 2003-5.

I didn't like the redistributive bias, and for that reason I fought the Reagan tax cuts. But I had no doubt, from 1981 onward, that the tax cuts and military buildup, coupled with a reversal of the tight money policy, would produce a strong recovery in time for Reagan's 1984 re-election campaign. And it's worth noting that Reagan had a Tory Keynesian (Murray Weidenbaum) as his CEA chief, who knew this very well.

Jude Wanniski was a hugely influential force in the supply-side camp, and his views were the epitome of the supply-side position in Washington. I thought Jude was a crackpot in economics and economic history (his idea that Smoot-Hawley caused the Great Depression, notably; also his passionate advocacy of the gold standard), but there is no doubt that he played a crucial role. There is no complete or accurate account of supply-siderism without Jude Wanniski; he cannot be airbrushed from history simply because sober academic types now think him inconvenient.

Notwithstanding our disagreements, Jude and I also became friends; late in his life he staged a vehement and prescient stand against the Iraq war.

Incidentally, it is not correct that we crude and vulgar Keynesians were wedded to high marginal tax rates for their own sake. The Bradley-Kemp tax bill, which had much more Bradley than Kemp in it, was endorsed by the JEC Democrats in 1984, in a report that I wrote. It became law in 1986. We made the argument for that bill, because we did understand the usefulness of a broad-based income tax, and the difference between high marginal rates per se and progressive tax system. We also understood that the previous income tax structure was politically indefensible, and that alternatives such as a VAT, which were serious threats, would be worse.

The 1986 tax reform saved the income tax, and laid the groundwork for the 1993 upper-bracket increases, which did quite a bit to restore the overall progressivity of the code, and which laid a template for future tax changes.

Turning to the monetarists, it's another forgotten fact that the lead monetarists on Capitol Hill at that time were Democrats. One of them was Bob Weintraub, who worked for Parren Mitchell, chairman of the congressional Black Caucus. Another was Bob Auerbach, a Milton Friedman student. Bob Auerbach and I both worked for Reuss, and we shared an office at the House Banking Committee for three years in the late 1970s. Bob A. abandoned monetarism when it fell apart in the 1980s; he now teaches at the LBJ School, and as a matter of fact, we had dinner together tonight.

As for the MIT and other conventional-Keynesian academics, those of us in the trenches found them sometimes helpful but often preoccupied with their models and largely unaware of the political issues within which these economic questions were embedded. For instance, we did not have a lot of use for the theoretical supply-side effects of tax policy on individual behavior that respectable liberal economists were prepared to concede. The fact was, dwelling on those supposed effects simply gave aid and comfort to the Reaganauts; there was no way to make the point in political debate and not give away the store when it came time to write a tax bill. As a technical matter, it also seemed clear that the income effects of these tax changes would dwarf the substitution effects, and the evidence I've encountered since does not incline me to change this view.

Among academic economists at that time, Bob Eisner was my hero and closest friend and ally; I think no one would call Bob either crude or vulgar, and that is perhaps why he is seldom mentioned in these discussions. (His daughter, Mary Eccles, was on my staff.)

As Brad notes, Rudi Dornbusch was, indeed, a politically- attuned advocate of the effect of monetary policy, and as he did more politics, he became more Keynesian. (Rudi's future wife, Sandra Masur, was also on my staff.)

But the idea that monetary policy worked to control inflation expectations directly seemed to us to be a gross overstatement of its powers. Bob Auerbach and I designed the Humphrey-Hawkins hearings beginning in 1975, and wrote those provisions of the HH law in 1978. We did it to extract information from the Federal Reserve and not because we thought that setting monetary targets would have some fundamental effect on the psychology of the nation. And while I'm proud of those hearings, that's because they established the constitutional authority of the Congress over the Federal Reserve, not because they somehow cured inflation expectations, as it seems some magical-thinking economists appear to believe.

To Paul, these issues were sufficiently "academic" at the time that he could in good conscience accept a staff position in the Reagan administration (on the CEA under Martin Feldstein, after the first wave of Reaganomics had passed). To him, at the time, it basically wasn't a political assignment, just a chance to see Washington under the redoubtable Feldstein.

Perhaps Paul and all the others who lined up in the Reagan camp were right - that these were academic issues to be debated and resolved among people who all shared the same larger objectives for the economy. In some ways, I accept this as a subjective matter. I came to respect the sincerity of Bruce, Jude, Murray and others working in the Reagan administration about their goals. Otherwise, I could hardly think as well of them now, as I do.

But to me and those in my camp, at the time, it would have been unthinkable to go over to their side. At the time, I saw the Reagan administration as, objectively, a vicious assault on the economic life of ordinary Americans, brought about by the willful and arbitrary rejection of useful policies that aimed to solve problems without inflicting savage harm on the weakest economic agents. I thought, also, that with honorable exceptions the academic economists on the sidelines were weak and indifferent to that harm.

I don't think I was wrong about that.


Update: Bruce Bartlett, whose column in the NY Times began this discussion, responds to Jamie in comments.

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.