Category Archive for: Taxes [Return to Main]

Thursday, September 06, 2007

Out of the Mainstream?

Megan McArdle says supply-siders -- the ones who say tax cuts pay for themselves -- are out of the mainstream of the Republican party:

I'm all for someone taking on the sillier kind of supply siders who fanny about claiming that tax cuts increase tax revenue, but they've been rather thin on the ground lately. ...

Yes, very thin on the ground. A quick search of this site turns up, with little effort, Bush, McCain, Romney, Giuliani, Hassett, Stossel, and the WSJ Editorial page all making the Laffer curve claim.

The second three may be a "motley collection of names" and have little influence over the party, but the first four? Are Bush, McCain, Romney, and Giuliani part of the "barking moonbats"? [yes...] I agree they are making a silly assertion, but don't they run counter to the claim that nobody of importance in the party tries to sell tax cuts by saying they pay for themselves?

And, right on cue, in today's Washington Times we have this piece of hackery:

Tax cut extension needed, by David Limbaugh, Commentary, Washington Times: ...Contrary to liberal propaganda, the Reagan tax cuts led to dramatic increases in federal revenues even after adjusting for inflation. ...

Since President Bush's tax cuts took effect, Democrats have been condemning them because of their alleged responsibility for soaring deficits. ... Recent reports definitively confirm ... federal revenues increasing; the deficits are decreasing, just as in the later Reagan years. ... It's past time to extend the Bush tax cuts.

The idea that tax cuts pay for themselves, wrong as it is, is still being actively promoted as part of the sales pitch to cut taxes. It may not be official party policy, but influential members of the Republican party are more than willing to play along and even help to promote this idea, and they do so even though they ought be aware by now that there's no evidence to support such claims.

Update: Brendan Nyhan extends the list of statements from the administration claiming that tax cuts pay for themselves.

Monday, September 03, 2007

How the Supply-Side Cult Hijacked American Politics

Jonathan Chait looks at the Laffer curve cult (there's quite a bit more in the article):

How a cult hijacked American politics: Flight of the Wingnuts, by Jonathan Chait, TNR: American politics has been hijacked by a tiny coterie of right-wing economic extremists, some of them ideological zealots, others merely greedy, a few of them possibly insane. ... Notions that would have been laughed at a generation ago ... are now so pervasive, they barely attract any notice. ...

It was not always this way. A generation ago, Republican economics was relentlessly sober. ... Over the last three decades, however, such Republicans have passed almost completely from the scene, at least in Washington, to be replaced by, essentially, a cult. ...

The cult in question generally traces its political origins to a meeting in Washington in late 1974 between Arthur Laffer, an economist; Jude Wanniski, an editorial page writer for The Wall Street Journal; and Dick Cheney, then deputy assistant to President Ford. ... Wanniski and Laffer believed it was possible to simultaneously expand the economy and tamp down inflation by cutting taxes, especially the high tax rates faced by upper-income earners. ...

Wanniski and Laffer were laboring with little success to explain the new theory to Cheney. Laffer pulled out a cocktail napkin and drew a parabola-shaped curve on it..., the Laffer Curve... Cheney apparently found the Laffer Curve a revelation, for it presented in a simple, easily digestible form the messianic power of tax cuts.

The significance of the evening was not the conversion of Cheney but the creation of a powerful symbol that could spread the word of supply-side economics..., ... the Curve explained it all. ...

With astonishing speed, the message of the Laffer Curve spread through the ranks of conservatives and Republicans. Wanniski evangelized tirelessly ..., both on the Journal's editorial pages and in person. ...

Today, ... the core beliefs of the supply-siders are not even subject to question among Republicans. Every major conservative opinion outlet promotes supply-side economics..., deviation from the supply-side creed has become unthinkable for any Republican with national aspirations. ...

Like most crank doctrines, supply- side economics has at its core a central insight that does have a ring of plausibility. The government can't simply raise tax rates as high as it wants without some adverse consequences. ... And there are justifiable conservative arguments to be made on behalf of reducing tax rates.. But what sets the supply-siders apart from sensible economists is their sheer monomania. ... They believe that economic history is a function of tax rates...

It doesn't take a great deal of expertise to see how implausible this sort of analysis is. ... All this is to say that the supply-siders have taken the germ of a decent point--that marginal tax rates matter--and stretched it, beyond all plausibility, into a monocausal explanation of the world.

Aside from popular articles in places like the Journal's editorial page, two classic tomes defined the tenets of supply-side economics: Wanniski's The Way the World Works and George Gilder's 1981 manifesto, Wealth and Poverty. Both have had enormous influence...

Here is what makes the rise of supply-side ideology even more baffling. One might expect that a radical ideology that successfully passed itself off as a sophisticated new doctrine would at least have the benefit of smooth, reassuring, intellectual front men... Yet, if you look at its two most eminent authors, good sense is not the impression you get. Let me put this delicately. No, on second thought, let me put it straightforwardly: They are deranged. ... [...continue reading...]

Sunday, September 02, 2007

Will the Housing Crash Cause Police to Give More Speeding Tickets?

Judith Chevalier examines the impact of changes in local government budgets on revenues from traffic enforcement:

Welcome, Stranger. Here’s a Speeding Ticket., by Judith Chevalier, Economic View, NY Times: Driving through a tiny Vermont town a few weeks ago..., I saw flashing yellow lights appear in my rearview mirror. My car had picked up speed coming down a hill, and a police officer pulled me over. As I waited for a ticket, I wondered: Does this town supplement its finances by giving tickets to visitors like me?

I never got to the bottom of the situation in that particular town, but the broader question — whether police officers in some towns are motivated by fund-raising as well as safety when writing traffic tickets — has been examined systematically by ... Michael D. Makowsky, a doctoral student in economics, and Thomas Stratmann, an economics professor, both at George Mason University, ... in a recent paper, “Political Economy at Any Speed: What Determines Traffic Citations?”

Continue reading "Will the Housing Crash Cause Police to Give More Speeding Tickets?" »

Saturday, August 25, 2007

The Deceptive Presentation of the FairTax Proposal

Bruce Bartlett says when you read the fine print and uncover the deceptions, the FairTax proposal is far less attractive then its supporters woudl have you believe:

FairTax, Flawed Tax, by Bruce Bartlett, Commentary, WSJ [Update: open link]: Former Arkansas Gov. Mike Huckabee's unexpectedly strong second-place showing in the recent Iowa Republican straw poll is widely attributed to his support for the FairTax.

For those who never heard about it, the FairTax is a national retail sales tax that would replace the entire current federal tax system. ...

Rep. John Linder (R., Ga.) and Sen. Saxby Chambliss (R., Ga.) have introduced legislation ... to implement the FairTax. They assert that a rate of 23% would be sufficient to replace federal individual and corporate income taxes as well as payroll and estate taxes. Mr. Linder's Web site claims that U.S. gross domestic product will rise 10.5% the first year after enactment, exports will grow by 26%, and real investment spending will increase an astonishing 76%.

In reality, the FairTax rate is not 23%. Messrs. Linder and Chambliss get this figure by calculating the tax as if it were already incorporated into the price of goods and services. ...[T]hink of it this way. If a product costs $1 at retail, the FairTax adds 30%, for a total of $1.30. Since the 30-cent tax is 23% of $1.30, FairTax supporters say the rate is 23% rather than 30%.

This is only the beginning of the deceptions in the FairTax. Under the Linder-Chambliss bill, the federal government would have to pay taxes to itself on all of its purchases of goods and services. Thus if the Defense Department buys a tank that now costs $1 million, the manufacturer would have to add the FairTax.... The tank would then cost the federal government $300,000 more than it does today, but its tax collection will also be $300,000 higher.

This legerdemain is done solely to make revenues under the FairTax seem larger than they really are, so that its supporters can claim that it is revenue-neutral. ...

Similarly, state and local governments would have to pay the FairTax on most of their purchases. This means that it is partly financed by higher state and local taxes. ...

State sales taxes have long exempted all but a few services because of the enormous difficulty in taxing intangibles. But the FairTax would apply to 100% of services, including medical care, thus increasing their cost by 30%. No state comes close to taxing services so broadly. Consumers would also find themselves taxed on newly constructed homes. Imagine paying 30% ... on top of the purchase price...

Since sales taxes are regressive ... some provision is needed to prevent a vast increase in taxation on the nonwealthy. The FairTax does this by sending monthly checks to every household based on income. Aside from the incredible complexity and intrusiveness of tracking every American's monthly income ... the FairTax does not include the cost of this rebate in the tax rate. ...

Rejecting all the tricks of FairTax supporters and calculating the tax rate honestly ... professional revenue estimators have always concluded that a national retail sales tax would have to be much, much higher than 23%.

A 2000 estimate by Congress's Joint Committee on Taxation found the ... rate would be 57%. In 2005, the U.S. Treasury Department calculated that a ... rate of 34% would be needed just to replace the income tax, leaving the payroll tax in place. ...

Perhaps the biggest deception in the FairTax, however, is its promise to relieve individuals from having to file income tax returns, keep extensive financial records and potentially suffer audits. Judging by the emphasis FairTax supporters place on the idea of making April 15 just another day, this seems to be a major selling point for their proposal.

Yet all but six states now have state income taxes. So unless one lives in one of those states, this promise is an empty one indeed. In short, the FairTax is too good to be true, and voters should not take seriously any candidate who supports it.

Thursday, August 16, 2007

Alan Auerbach: How to Tax Capital Gains

Alan Auerbach explains how to tax capital gains:

How to Tax Capital Gains, by Alan Auerbach, Commentary, WSJ: The recent controversy over the taxation of "carried interest" ... demonstrates the problems that can arise from taxing capital gains differently from other types of income. While it's relatively simple to change the way we treat carried interest, it would be far better to undertake an overall reconsideration of the way we tax capital gains.

As President Reagan and others who crafted the Tax Reform Act of 1986 understood, different tax rates on different types of income-producing activities often distort economic decisions and increase the tax system's complexity. Their solution was a broad-based tax with low and uniform marginal tax rates. The identical rate was applied to capital gains and to wage and salary income. But the reform survived only a few years, and we now confront the old problems magnified by two decades of financial innovation.

We can do better, and here are some guidelines:

Increase the capital gains tax rate, but not the "lock-in" effect. ...[T]axing capital gains has a big impact on investors' decisions about when to sell capital assets. Higher tax rates delay sales, causing investors to be "locked in" to their current holdings...

By itself, an increase in the capital gains tax rate worsens the lock-in effect. But this impact can be offset by other desirable changes, such as indexing capital gains for inflation ... and taxing capital gains at death. (Currently, we do not collect capital gains taxes when someone dies; this makes people want to hold onto appreciated assets throughout their lifetimes.) So-called "constructive realization" (i.e., taxation of capital gains at death) could help solve our current estate tax impasse by substituting capital gains revenues for some of the lost estate taxes. ...

Reconsider how best to encourage innovation and risk-taking. Some argue that low capital gains tax rates can spur the formation and development of new enterprises, for the payoffs from successful start-ups flow to their owners largely in the form of capital gains. But ... only a miniscule fraction of the economy's capital gains are associated with new ventures. A low capital gains tax rate is a very poor way to encourage entrepreneurial activity. It would be far better to carefully tailor tax provisions to spur innovation...

Don't raise the cost of capital. ...Lowering capital income taxes reduces the cost of capital and spurs investment; raising these taxes increases the cost of capital and discourages investment.

But not all capital income taxes equally influence the cost of capital. Capital gains taxes have a relatively weak impact on the cost of capital because a large share of the tax revenues is associated with income not generated by new investment. Thus only a small portion of the capital gains realized over the next several years will result from today's investment, so changing the tax rate on the gains won't influence today's investment much. By contrast, tax provisions targeted toward new investment, such as the bonus depreciation scheme introduced in 2002, tie tax reductions to new investment and thereby produce a bigger bang for each buck of tax reduction. Offsetting an increase in the capital gains tax rate with a revenue-neutral tax reduction that targets new investment is likely to reduce the cost of capital. ...

There are, of course, more sweeping tax reform alternatives available. Some proposals would move us from taxing income toward taxing consumption, or toward taxing capital gains as they accrue, rather than only when assets are sold. There are coherent and attractive proposals available to implement either of these approaches. But we need not wait for the next grand tax reform to improve on our current method of taxing capital gains.

Thursday, August 09, 2007

PGL: Bush on Bridge Safety: Spend Smarter Not More

PGL at Angry Bear is driven to shrillness by the latest from the president:

President Bush on Bridge Safety: Spend Smarter Not More, by PGL: AP reports that President Bush is opposed to raising gasoline taxes so we can have more bridge inspections:

A week after a deadly bridge collapse in Minneapolis, President Bush on Thursday dismissed raising the federal gasoline tax to repair bridges at least until Congress changes how it spends highway money. "The way it seems to have worked is that each member on that (Transportation) committee gets to set his or her own priorities first," Bush said. "That's not the right way to prioritize the people's money. Before we raise taxes, which could affect economic growth, I would strongly urge the Congress to examine how they set priorities."

Alice Rivlin would be impressed. Her counsel to John Kerry during the 2004 Presidential race was spend smarter, not more. So President Bush is arguing that we should spend more transportation dollars on repairing bridges and less on bridges to nowhere. I would find this to be a credible argument from a President who had a track record of allocating our Federal dollars where most needed for public policy reasons. But when President Bush has discussed priorities in the past, it would seem his mantra for spending our Federal monies wisely was more driven by some Karl Rove calculus to maximize GOP votes than to maximize the General Welfare. But if President Bush has decided to finally adopt the fiscal wisdom of Alice Rivlin, I say: IT’S ABOUT TIME!

Joseph Stiglitz: Greenspan, Bush Errors Finally Come Home to Roost

Joseph Stiglitz says George Bush and Alan Greenspan have some explaining to do:

Greenspan, Bush errors finally home to roost, by Joseph Stiglitz, Project Syndicate: The pessimists who have long forecast that America's economy was in for trouble finally seem to be coming into their own. Of course, there is no glee in seeing stock prices tumble as a result of soaring mortgage defaults. But it was largely predictable, as are the likely consequences...

The story goes back to the recession of 2001. With the support of US Federal Reserve Chairman Alan Greenspan, US President George W. Bush pushed through a tax cut designed to benefit the richest Americans but not to lift the economy out of the recession that followed the collapse of the Internet bubble.

Given that mistake, the Fed had little choice if it was to fulfill its mandate to maintain growth and employment: it had to lower interest rates. ... But, given that overinvestment in the 1990s was part of the problem underpinning the recession, lower interest rates did not stimulate much investment.

The economy grew, but mainly because American families were persuaded to take on more debt, refinancing their mortgages and spending some of the proceeds. And, as long as housing prices rose as a result of lower interest rates, Americans could ignore their growing indebtedness.

In fact, even this did not stimulate the economy enough. To get more people to borrow more money, credit standards were lowered, fueling growth in so-called "subprime" mortgages. Moreover, new products were invented ... making it easier for individuals to take bigger mortgages. ...

Alan Greenspan egged them to pile on the risk by encouraging these variable-rate mortgages. But did Greenspan really expect interest rates to remain permanently at one percent - a negative real interest rate? Did he not think about what would happen to poor Americans with variable-rate mortgages if interest rates rose, as they almost surely would?  ...

Fortunately, most Americans did not follow Greenspan's advice to switch to variable-rate mortgages. Even as short-term interest rates began to rise, the day of reckoning was postponed... [But the] housing price bubble eventually broke, and, with prices declining, some have discovered that their mortgages are larger than the value of their house.

Too many Americans built no cushion into their budgets, and mortgage companies, focusing on the fees generated by new mortgages, did not encourage them to do so.

Just as the collapse of the real estate bubble was predictable, so are its consequences... By some reckonings, more than two-thirds of the increase in output and employment over the past six years has been real estate-related, reflecting both new housing and households borrowing against their homes to support a consumption binge.

The housing bubble induced Americans to live beyond their means - net savings has been negative for the past couple of years. With this engine of growth turned off, it is hard to see how the American economy will not suffer from a slowdown.

There is an old adage about how people's mistakes continue to live long after they are gone. That is certainly true of Greenspan.

In Bush's case, we are beginning to bear the consequences even before he has departed.

Monday, August 06, 2007

Not Laffing

Mathew Yglesias notes the press's failure to challenge false statements about tax-cuts made by Giuliani in the GOP debate:

Laffer Press Roundup, by Mathew Yglesias: Here's an interesting test case for the press. It seems that at yesterday's GOP debate, Rudy Giuliani derided the idea that higher taxes raise revenues as a "Democratic, liberal" assumption and put forward his alternative view that you generate revenue by lowering tax rates. This is a stunning confession of total ignorance of tax policy and economics by the GOP front runner. So how did the press cover it? Chris Cilizza at the Fix lives down to my expectations by totally ignoring the fact that Giuliani is incorrect:

"There is a liberal Democratic assumption that if you raise taxes, you raise more money," said Giuliani to huge applause from the crowd assembled at Drake University.

Michael Shear in The Washington Post's page A1 story also doesn't care about the merits of the issue:

Former New York mayor Rudolph W. Giuliani sparked loud applause when he declared that "the knee-jerk liberal Democratic reaction -- raise taxes to get money -- very often is a very big mistake."...

Nor does Stephen Braun of The Los Angeles Times care at all whether or not GOP tax policy makes sense:

Referring to last week's devastating bridge collapse in Minneapolis, the GOP rivals found common ground in insisting that increased private investment from cutting taxes would provide more money to repair the nation's failing infrastructure. ...

Mike Glover at the AP doesn't seem to mention the issue at all.

Adam Nagourney at The New York Times, by contrast, doesn't go nearly as far as I'd like, but does way better than his colleagues at the major papers. Here he is on the NYT political blog:

Mr. Giuliani proceeded to explain that when he was mayor of New York he had cut taxes, and that those tax cuts had produced revenues that allowed him to finance bridge reconstruction. (Actually, there’s a good argument that it was the stock market boom in New York that brought all that money into the city’s coffers, but we’ll let that pass for now).

And here he is teamed up with Michael Cooper in the print edition:

Mr. Giuliani said that as mayor of New York, he had increased revenues to pay for bridge and road repair by cutting taxes, thereby jolting the economy, and that he would do the same thing as president. The city’s treasury in that period was flush largely with revenues produced by the stock-market boom of the late 1990s.

It'd be nice to see reporters go further than Nagourney does here, but improvements at the margin deserve recognition and the Times is doing a much better job than the Post here.

Even Nagourney's "we’ll let that pass for now" is inadequate. Any reporter who thinks there's a debate about whether cutting taxes has increased tax revenues has not been paying attention and has no business covering economics. Let's take a cue from Paul Krugman and ask what the press should have asked, what does this say about Giuliani's character? First, I disagree with the characterization of his statements as ignorant. I don't believe he is ignorant about this topic, so that is no excuse (and if he were ignorant, i.e. if he has not bothered to find out about the consequences of tax cuts by now, that would tell us a lot too.)  He noted that he is aware of the evidence, but chooses to portray it as a "liberal Democratic assumption" even though it is nothing of the sort (see Andrew Samwick and Greg Mankiw's statements about this, both of whom served under Bush in the Council of Economic Advisers, or any reputable conservative economist for that matter, or this recent CBO report).

What this tells us is that just like George Bush in the run-up to the Iraq war, Giuliani is not an honest broker. He is willing to tell people what they want to hear in spite of compelling evidence to the contrary, and to surround himself with people who will not challenge him when he uses misleading statements to push a policy. He has no problem using dishonest statements to sell policy. There's a lot to be gleaned about his character from his willingness to engage in this type of dishonest salesmanship, a style of leadership that led us into our current predicament, and it's disappointing to see the press not even bother to make the connections.

Friday, August 03, 2007

Paul Krugman: A Test for Democrats

Paul Krugman on good Democrats, bad Democrats, and the ugly thing the bad Democrats are about to do:

A Test for Democrats, by Paul Krugman, Commentary, New York Times: It’s been a good Democrats, bad Democrats kind of week. The bill expanding children’s health insurance that just passed in the House makes you want to stand up and cheer. Reports that Senator Charles Schumer opposes plans to close the hedge fund tax loophole make you want to sit down and cry.

Let’s start with the good news: The House bill ... would provide coverage to five million children who would otherwise be uninsured.

The bill is so good that it has Republicans spluttering. “The bill uses children as pawns,” declared Representative Pete Sessions of Texas. Yes, the Democrats are exploiting children — by providing them with health care.

The horror, the horror!

What’s especially encouraging is the way House Democrats were willing to take on the insurance companies. The bill pays for children’s health care in part by cutting subsidies to Medicare Advantage, a privatization scheme that yields big profits for insurers...

All in all, the bill is both a fine piece of legislation and a demonstration that Democrats can stand up to special interests. Happy days are here again.

Or maybe not.

The hedge fund tax loophole is a crystal-clear example of unjustified privilege. ... For example, ... pension fund ... manag[ers] ... are taxed ... at rates up to 35 percent. But if that money is invested with a hedge fund ... the fees the ... manager receives ... are mainly taxed as capital gains, with a maximum rate of 15 percent. ...

We’re told that the tax rate on hedge fund managers has to be kept low to encourage risk-taking. But the managers aren’t risking their own money. The only risk ... is the uncertainty of their fees — and as any ... salesman who depends on commissions can tell you, most people with uncertain incomes don’t get any special tax breaks.

We’re also told that management fees would rise, reducing returns to investors... — as if someone with a $100-million-a-year hedge fund job would walk away if his take-home pay fell from $85 million to $65 million.

And we’re talking about a lot of lost revenue here. The Economic Policy Institute estimates ... $6.3 billion a year — the cost of providing health care to three million children. Of that total, almost $2 billion a year ... goes to just 25 individuals.

If being a Democrat means anything, it means opposing this kind of exorbitant privilege. Yet ... Mr. Schumer says that he opposes any increase in hedge fund taxes unless tax breaks for the energy and real estate industries are also eliminated, and pigs start flying. Seriously, his claim that he really would support closing the hedge fund loophole if other, deeply entrenched tax privileges were eliminated ... is a fig leaf that hides nothing.

Mr. Schumer ... insists that the large financial contributions that hedge funds make to his party aren’t influencing him. Well, I can’t read his mind, but from the outside his position looks remarkably like money-driven politics as usual. And that’s not acceptable.

Look, the worst thing that could happen to Democrats is for voters to conclude that there’s no real difference between the parties, that when you replace Republicans with Democrats, all you do is replace sweet deals for Halliburton with sweet deals for hedge funds. The hedge fund loophole is a test — and it’s one that Mr. Schumer is failing.

Previous (7/30) column: Paul Krugman: An Immoral Philosophy
Next (8/6) column: Paul Krugman: The Substance Thing

Wednesday, August 01, 2007

The High-Tech Solution to Voter Irrationality?

I can't resist commenting on this post from Bryan Caplan (here's his co-blogger disagreeing with me today, but that's not what motivated this):

The High-Tech Solution to Voter Irrationality, by Bryan Caplan: This didn't make it into the book, but one of my favorite remedies for voter irrationality has long been to simply clone John Stossel. His column today just reinforces my support for the clone-Stossel solution:

More practically, [Caplan] thinks that "Everyone who knows some economics" should grab every opportunity to teach it. That's what I try to do with my "20/20" segments, television specials and the Stossel in the Classroom program, which brings economic ideas to high-school and college classrooms.

I wonder if Stossel realizes that when I was writing this section, I had him in mind?

Is it John Stossel's "The Tax-Cut Myth" that Bryan has in mind? John Stossel says it's a myth that tax cuts increase the deficit:

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. ...

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."

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. ...

Bryan has argued that many voters are uninformed - he uses economics as his prime example - and that perhaps we should consider giving the uninformed less say in the political process. So I'm curious, should endorsing "myths," and what Stossel said is a myth, that's clear, should being uninformed about the effect of tax cuts disqualify him from voting?

Tuesday, July 31, 2007

In a Surprise, a Republican is Using Scare Tactics Based upon Misleading Claims

In a thoroughly misleading article designed to scare people about what might happen to the economy because the Republicans did not have the courage to make the tax cuts they enacted permanent, GOP Senator John Kyl says:

Failing to extend the tax relief we have passed would result in a de facto tax hike that could cripple our economy...

But according to a recent CBO report:

CBO director Peter Orszag said, “The short-term effects of [the 2001 and 2003 tax cuts] in stimulating aggregate demand in the economy have largely dissipated by now, and the supply-side effects of those policies are uncertain but are probably small.”

Some of the tax cuts’ provisions “increased incentives for people to work and save (which can increase growth), but other provisions had no effect on incentives. In addition, the two tax laws increased the budget deficit, and doing so tends to reduce economic growth over the medium and long term. At this point in time (several years after enactment), once those various factors have been taken into account, the overall impact of the tax legislation on the economy is likely to be modest”

Thus, despite the scare tactics claiming otherwise, it won't "cripple our economy" if we allow the Republican's tax policy to be enacted exactly as written. There's simply no evidence that these tax cuts had a substantial impact on saving, investment, and growth.

Kyl also uses careful wording to describe tax cuts and deficit reduction:

The tax relief has helped produce an economy that has generated higher than expected tax revenues for the federal government. Tax receipts have risen 37 percent over the last three years and are projected to increase another 7 percent this year. These rising tax receipts have, in turn, helped drive down the deficit...

Though it makes it sound like the tax cuts reduced the deficit without actually saying so, i.e. the standard Laffer curve nonsense, as I hope you know by now that didn't happen (as noted above, "the two tax laws increased the budget deficit"). In fact, the supply-side impact of the tax cuts is estimated to be very small, so small that it generated very little tax revenue. From the CBO report:

the tax cuts’ indirect impact on economic growth, investment and saving and could affect this year’s budget deficit anywhere from an increase of $3 billion to a reduction of $14 billion...

The CBO report also points out that "without the tax cuts, the budget would probably be in surplus this year".

Thus, while there is evidence that leaving the Republican tax legislation exactly as they wrote it and allowing the tax cuts to expire will improve the government's fiscal position, there is no evidence that keeping the Republican tax legislation in place will cripple the economy as claimed.

Sunday, July 29, 2007

Alan Blinder: Low Capital Gains Taxes Cause Distortions

Alan Blinder discusses distortions that are introduced into the economy when the tax rate on capital gains is lower than the tax rate on other types of income. He begins by explaining the current debate over whether income from private-equity and hedge fund management should be taxed as capital gains or as regular income, and comes down on the side of treating it like ordinary income (see the article for details), and then he asks why the rates should differ at all:

The Under-Taxed Kings of Private Equity, by Alan S. Blinder, Economic View, NY Times: An arcane debate is raging in Congress over the appropriate taxation of the bountiful incomes of people who manage private-equity and hedge funds — incomes that can range into the hundreds of millions a year. I don’t recommend trying to master the details unless you have either an accounting degree or insomnia. But one thing is easy to understand, though hard to swallow: Some people who are richer than Croesus are paying 15 cents in federal income taxes on the marginal dollar, while you may be paying 25 or 35 cents...

Why do we have a preference for capital gains in the first place? The main argument is that lower taxes on capital gains boost investment. But the evidence on that point is iffy at best, and there are better ways to spur investment, like, say, the investment tax credit. Besides, lower taxes on capital gains reduce the tax bills of the rich relative to the rest of us — after all, they own most of the capital. But in this age of hyper-inequality, shouldn’t we be making the tax code more progressive, not less?

A far more important objection is that the tax preference for capital gains undermines capitalism — a system in which capitalists, not the state, are supposed to make the investment decisions. When I discuss this issue with my Economics 101 students, I show them an example of a proposed investment that loses money before tax (and which, therefore, should be rejected) but which actually turns a profit after tax because of the preferentially low capital gains rate. ... The government thus induces people to make bad investments, which is a good way to run an economy into the ground. Come to think of it, that’s just what the old Soviet Union did. It invested copiously, but badly.

But would taxing capital gains like other types of income imperil our economy? No. The Tax Reform Act of 1986 did exactly that, and it did not end capitalism as we know it. In fact, the gross domestic product in 1987 and 1988 grew at about the same rate as in 1985 and 1986, and the investment share of G.D.P. barely budged.

As the tax debate unfolds, you may find it difficult to follow the mind-numbing complexities. Who doesn’t? So just remember one simple principle: If we tax Activity A at 15 percent and Activity B at 38 percent, a free-market economy will give us more A and less B. Some of this shifting will represent genuine movements of resources out of B and into A — including those bad investments I just mentioned. The rest will be paper manipulations devised to avoid taxes.

Which of these do you think our tax code should favor?

Thursday, July 26, 2007

David Wessel: Globalization Study Moves Past Rhetoric

While I've had issues with material on the Wall Street Journal's editorial page, and today is no exception, I want to be careful to separate what goes on there from what gets presented elsewhere in the WSJ.

David Wessel's Capital column is not on the editorial page, and it does not belong there. I don't always agree with everything he says, and I don't always disagree either, but I never get the impression that facts are twisted to sell a preconceived notion:

Globalization Study Moves Past Rhetoric, by David Wessel, WSJ: Most of the policy briefs, working papers and trade-association reports that cross a columnist's desk slide easily into the trash can or onto the read-someday pile.

But a recent study on globalization, commissioned by the Financial Services Forum, an association of the chief executives of 20 huge financial companies, ranging from American International Group and Citigroup to UBS and Wachovia, stands out.

The analysis, written by a former member of President Clinton's Council of Economic Advisers, a former member of President Bush's and a former Bush Commerce Department official, says:

(1) Globalization is good for the U.S. economy. (No surprise coming from a bunch of financial firms that make money doing business across borders.)

(2) Gains from globalization aren't evenly shared. (A little surprising, but in the past couple of years, there has been a willingness among business to publicly acknowledge that economic reality.)

(3) To avoid a backlash against globalization, governments and businesses must come up with new ways to spread its benefits more widely and assist those hurt by all sorts of economic change. (Very surprising, more like a Democratic candidate's talking points than a report issued and promoted by an outfit led by Citigroup Chief Executive Charles Prince and Don Evans, the former Bush commerce secretary.

What's Going On? Business interests with a strong stake in globalization ... see rising public anxiety about globalization as a threat. And they realize that preaching the gospel of comparative advantage isn't going to win the debate.

"The mounting opposition is in response to the other side of globalization -- outsourcing of jobs, economic dislocation, anxiety and fear," the forum said ... early this year. "Making the case for trade and globalization requires...a list of specific, meaningful, practical, cost-efficient, and effective public- and private-sector responses to the reality that while the aggregate benefits of free trade and globalization are tremendous, it can sometimes bring with it painful dislocations for individuals, families, towns, regions, even entire industries." ...

Some business executives, prodded by politicians such as House Ways and Means Chairman Charles Rangel, finally are realizing that trade-friendly Democrats will be overwhelmed by trade skeptics unless there is something tangible to offer workers worried about their livelihoods and their children's. A new Pew Global Attitudes survey finds Americans generally optimistic about the next five years, but only 31% expect their children's lives will be better than their own; Europeans are even more pessimistic. By contrast, 81% of the Chinese expect their children to do better.

The Financial Services Forum report is, in part, a response to that. The specifics are intriguing ... because they move beyond inadequate approaches such as making the failing Trade Adjustment Assistance program for dislocated workers a tad more generous.

Among the Proposals: Raise taxes on winners to share benefits of globalization more widely. Replace TAA and unemployment insurance with a big new program for displaced workers that offers wage insurance to ease the pain of taking a lower-paying job. Provide for portable health insurance and retraining. Create a way for communities to ensure their tax base against big factory closures. Eliminate tax hurdles for businesses that do what International Business Machines is proposing: Offer 50 cents for every $1 (up to $1,000 a year) that workers set aside to pay for training. ...

Grant Aldonas of the Center for Strategic and International Studies think tank, one of the report's three authors [said] "...We are renegotiating the social contract in America, but we're letting it be done by the United Auto Workers and Delphi, and leaving a lot of others out -- including the poor and the businesses on the leading edge."

Mr. Aldonas and his co-authors, Dartmouth's Matthew Slaughter and Harvard's Robert Lawrence, ... say the U.S. need not accept as inevitable the steady widening of the gap between economic winners and losers, an inequality that threatens to produce barriers to trade, investment and immigration that will hurt U.S. prosperity. ...

Now the question is whether business will go beyond talk. As C. Fred Bergsten ... puts it: "They haven't gone to the mat and talked to Charlie Rangel and Democrats who are wavering, if not worse, and said, 'We want to support a meaningful program of wage insurance, and we'll be willing to give up some of our beloved tax breaks to pay for it.' "

One troubling sign: Although forum chief executives issued statements blessing the new report, not one has been willing to talk to a Wall Street Journal reporter about it.

One thing that bothers me about the whole inequality debate is the presumption that the winners deserve their incomes because it reflects their contribution to the firm, i.e. it is the wage that would be earned in well-functioning competitive markets, with the reward is equal to the person's marginal contribution to the firm. Thus, the analysis often begins with the idea that any tax takes away someone's hard-earned income and redistributes it elsewhere.

But for the incomes where inequality is rising most - those at the very top of the income distribution - this is a questionable claim. The idea that the salary of a CEO or hedge fund manager is set by competitive markets, or even approximately so, seems unlikely, or at least open to serious question. It should not just be assumed in these debates.

If the incomes of the winners are higher than they would be in a competitive market, then many of the arguments against taxing their "hard-earned money" melt away. For example, if a person would earn $1,000,000 in a competitive market, but because of market imperfections earns $1,200,000 instead, is it unfair to tax away the extra $200,000?

At a 33% tax rate in a competitive market, after-tax income would be $667,000, i.e. the competitive income of $1,000,000 minus 33%. At the non-competitive income of $1,200,000, it would take a tax rate of around 44% to leave the person equally well off (i.e. $1,200,000 - 44% of $1,200,000 =  approx. $667,000).

For this reason, I would argue that tax rates such as the 44% rate in this example are not as high as they might seem. Part of the tax simply levels the playing field, i.e. taxes away the income in excess of the competitive level, and the tax rate is then 33%, not 44%, on the part of income that would be earned in a competitive market.

Update: Free Exchange at the Economist has a different take on this issue.

Sunday, July 22, 2007

Supply-Side Effects of 2001 and 2003 Tax Cuts "Small"

About that Laffer curve:

CBO: Tax Cuts’ Impact Has Faded, by Greg Ip, WSJ Washington Wire: The stimulative effect of Bush’s tax cuts has worn off and the supply-side benefits are “small,” the Congressional Budget Office says. At the request of House Budget Committee [chair] John Spratt (D., S.C.), the CBO analyzed the impact on the economy other than through the direct impact on tax revenues of the Economic Growth and Taxpayer Relief Act of 2001 (EGTRRA) and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA).

In a letter to Spratt released Friday, CBO director Peter Orszag said, “The short-term effects of EGTRRA and JGTRRA in stimulating aggregate demand in the economy have largely dissipated by now, and the supply-side effects of those policies are uncertain but are probably small.”

Some of the tax cuts’ provisions “increased incentives for people to work and save (which can increase growth), but other provisions had no effect on incentives. In addition, the two tax laws increased the budget deficit, and doing so tends to reduce economic growth over the medium and long term. At this point in time (several years after enactment), once those various factors have been taken into account, the overall impact of the tax legislation on the economy is likely to be modest,” Orszag wrote.

Orszag concluded that the tax cuts’ indirect impact on economic growth, investment and saving and could affect this year’s budget deficit anywhere from an increase of $3 billion to a reduction of $14 billion, depending on the assumptions used. That is separate from the direct boost to the deficit through lost revenue and the added interest on borrowing to cover the gap of $211 billion.

It currently expects this year’s deficit to be between $150 billion and $200 billion, implying that without the tax cuts, the budget would probably be in surplus this year.

Saturday, July 21, 2007

"Economics is the Dope of the Religious People"

This is from Joan Robinson. It's about using economics as an ideological defense of wealth. Keep in mind as you read this that it was written in 1936, not today.

A lot of the discussion is about tax cuts, and I was amused at the end where she says that even though her opponent wasn't clever enough to think of it, to be fair, there is a way a tax cut can affect employment. She then goes on to foreshadow supply-side arguments, then dismisses them as unlikely to have much of an impact in alleviating short-run economic difficulties.

The introduction to this section of the book where this essay appears (the fourth volume of Collected Economic Papers by Joan Robinson) says that "Keynes read the drafts and I cut out anything that I could not persuade him was correct..." And, though it doesn't relate to the essay that follows, given the charges that the traditional Keynesian model ignores inflation, this is an interesting statement (it is in reference to an essay called "Full Employment" in the same section), "It is certainly absurd to suppose [Keynes] was not aware of the prospect of inflation setting in when near-full employment is maintained for a run of years." Here's her essay, "An Economist's Sermon":

An Economist's Sermon: Economics is the Dope of the Religious People, by Joan Robinson, 1936: Consider the case of a man to-day who has an honest intelligence, a strong social conscience and an independent income.

His intelligence tells him that he has no particular right to enjoy a privileged position. 'Right' is a vague phrase. A doctor has in a sense a right to a motor-car because it makes him do his work better than he could without it. And if he uses it to visit his friends as well as his patients, no harm is done to anyone. But our man is too honest to try to persuade himself that his own comfort really makes very much difference to the amount of benefit that he does to other people. His conscience tells him that he would be doing a good act if he endowed a hospital with his wealth and worked for his living. But his inde­pendent income is not easy to give up.

He cannot keep all three - integrity of mind, a quiet conscience, and the privileges of wealth. One must be sacrificed. If he is a saint he sacrifices the wealth - but we will suppose that he is not. If he is a man of no definite religious creed he can keep his mental honesty and his income by sacrificing his conscience. He can say "I am a selfish individual. I don't pretend to have any better right than anyone else to a comfortable life, but I propose to enjoy it if I can."

But if he belongs to a definite religion this line of escape is impossible for him. Conscience is more precious than anything else. Without its approval he can have no peace. He will have to sacrifice his honesty of mind instead, and make up arguments to show that it is right for him to be better off than the majority of his neighbours.

Now, it is here that the economist is a godsend to him. The economist is a self-appointed expert. It is his business to know about these things. A man may have an honest and independent mind and yet take on trust the opinion of experts on a subject that he has not time to master for himself. If the economist tells him it is all right, then he can keep his integrity, his income and his conscience all intact.

One of the main effects (I will not say purposes) of orthodox traditional economics was to fill this want. It was a plan for explaining to the privileged class that their position was morally right and was necessary for the welfare of society. Even the poor were better off under the existing system than they would be under any other. There is a significant passage in the reminiscences of Alfred Marshall. As a young man, a mathematician and philosopher, before he had embarked upon economics, he began to be troubled by social conscience:

Continue reading ""Economics is the Dope of the Religious People"" »

Tuesday, July 17, 2007

Keeping the Tax Rate Constant Can More Than Pay for Itself!

I've been a critic of the "tax cuts pay for themselves" school of thought since there's no evidence the economy is currently or has ever been in a position where that could happen, so let me discuss this a little further and allow for the possibility of a situation (even now) where a reduction in taxes could, in fact, pay for itself.

When taxes are cut, there are two separate things that happen that get confused in discussions of this topic. First, and obviously, there is a change in disposable income and this can generate economic effects. Second, there can be a reduction in the economic distortions induced by taxes, and reducing these distortions can generate higher economic growth. Thus, this second effect is the change in economic efficiency from the change in taxes.

The efficiency effect means that keeping taxes constant can increase tax revenue, and it's easy to see how. Suppose, as in the US, there is an income tax and without changing anyone's net tax burden at all (all things considered), it is replaced by a consumption tax. Since in general consumption taxes are more efficient than income taxes, output can increase without changing overall taxes one bit just by restructuring where they are levied (or choose your own favorite example of an efficiency enhancing shift in taxes, this is just an example).

This can easily generate Laffer curve type results. Suppose that in the example above, everything is the same except that after the consumption taxes are levied to replace the income taxes, overall taxes are reduced by one dollar. Because of the increase in efficiency, which could be large under the right conditions, it would look like this one dollar reduction in taxes causes amazing output effects. E.g. suppose output went up by a mere million dollars from the increase in efficiency, not much in the overall US economy. With a tax rate of 25%, the result would be a $250,000 increase in taxes from a $1 tax cut. This would appear to be quite amazing if it was attributed solely to the $1 change in after tax income rather than to the change in efficiency. Note, however, there is nothing special in this example about the tax reduction. Just as easily we could have overall taxes increase by $1 in the example and then it would look like increasing taxes increases economic activity. This means that even if a tax cut did pay for itself, which they don't, we need to be careful abut what the increase in revenue is attributed to.

An implication of this is that it is not necessary to reduce taxes on the wealthy, i.e. produce an increase in their take-home pay, to produce revenue enhancing effects from changes in tax policy. Simply changing where and how the taxes are levied can potentially produce much stronger effects. Since there is little evidence that tax cuts on the wealthy stimulate substantial additional effort or any additional economic activity, before we cut taxes to try to increase economic growth we ought to make sure that our taxes are levied and collected as efficiently as possible first, and that can involve restructuring how taxes are collected within income classes, i.e. trading one kind of tax for another, and other types of changes (I am setting aside equity considerations in this discussion, but there may be efficiency-equity tradeoffs to consider).

Continuing with this point, Stephen Gordon at Worthwhile Canadian Initiative has comments on a recent Romer and Romer paper looking at tax changes and economic growth. Given recent events around here, I am going to send you to his site instead of presenting his comments here:

Why doesn't the US have a consumption tax?, by Stephen Gordon

Update: I didn't mean to limit the discussion to consumption versus other types of taxes at all, restructuring taxes within income classes is more what I had in mind here, but I just noticed that Greg Mankiw discusses the question "If a government reduces a payroll tax and raises a consumption tax, how does the tax shift affect the economy?" and gives a "tentative" answer to the question. One issue that comes up is fraud under VAT taxes. If you are interested in that issue, see this five part series from Richard Baldwin at Vox EU on VAT fraud.

Kenneth Rogoff: US Will Learn Deficits Do Matter

Ken Rogoff says we will learn, soon enough, that budget deficits are not to be taken lightly:

Kenneth Rogoff: US will learn deficits do matter: The Bush administration was beside itself with glee ... when it announced that the fiscal year 2007 federal deficit was set to fall to just over $200bn, or 1.5 per cent of US gross domestic product ..., less than half what it was in 2004.

Publicly, some Democrats are still condemning Bush II profligacy and preaching a return to Clinton I fiscal conservatism. Privately, though, many are starting to question why a 2008 Democratic president should bother improving the government’s balance sheet if the end result is just a bigger pot for a future Republican president to lavish on his or her friends. Certainly the 2000s ... seem to have thrown cold water on the notion that sustained US budget deficits will automatically lead to high interest rates and low growth. Or have they?

First, the good news. Explosive financial globalisation has made US federal budget policy far less important as a determinant of global real interest rates. ...

And let us give credit where credit is due. The Bush administration’s decision to borrow massively, over a period where global long-term interest rates fell massively, was not a bad market call. ... One can question whether the Bush administration should have skewed tax cuts towards the wealthiest Americans... One can complain how money was thrown away on the catastrophic invasion of Iraq. But the Bush deficits have not been the short-term growth disaster that some predicted.

Of course, ...[the] Bush administration ... probably did not envision hitting up China, Saudi Arabia and Russia for money. Instead, the political types were seduced by the misguided belief that if the government cut marginal tax rates, the economy would grow so much that total tax revenues would actually rise.

Unfortunately, ... the ... “Laffer” curve ... effect was hardly big enough to keep this decade’s US federal budget from going deep into the red. Remember, too, that the $200bn figure ... incorporates the surplus on Social Security. Without this accounting gimmick (which the Bush administration did not invent) the projected 2007 deficit would be more than twice as large.

Both the Organisation for Economic Co-operation and Development and the International Monetary Fund have argued that US deficit policy is much more damaging than it seems. The US ought to be racking up big surpluses in preparation for impending old-age retirements and rising medical costs. ...

It is well understood that the Social Security pensions system can be fixed by indexing the retirement age to life expectancy and by modestly raising taxes. Medical care involves far trickier challenges...

[If] countries ... cannot resolve ... intergenerational frictions ...,[the] result will be paralysis, with huge potential implications for interest rates, inflation rates and growth. But this need not occur... Perhaps, [this] ... will simply bring forward the necessary conversations on pensions and medical spending. Of course, [it] might also bring forward a catastrophically divisive debate.

If there is a shorter-term Achilles heel to ... deficit policies, it is dependence on foreign financing. ... Incredibly, US borrowing accounts for roughly two-thirds of total net saving of all the world’s surplus countries. Although rebalancing of the world economy is likely to help ... somewhat this year, the global and US economies remain quite vulnerable to a scenario that forces faster rebalancing. ...

Here’s betting that the next US president, Democrat or Republican, is not going to end up going too far towards restoring fiscal prudence. Unfortunately, continuing this approach will eventually bring a shipwreck... The US government’s big shift into the red may have been fortuitously timed, but eventually, the deficits will matter.

Monday, July 16, 2007

Brendan Nyhan: Greg Mankiw and Tax Cut Rhetoric

Since Laffer curves have come up a lot recently, i.e. the idea that if we cut taxes it will pay for itself - a notion thoroughly discarded by recent research from the CBO and others - and since the political issue has been raised by Brad DeLong:

PGL and Mark Thoma on Greg Mankiw, by Brad DeLong:  ...Greg [Mankiw] is deciding whether he wants to be an economist or a politician. I fear he is making the wrong choice...

Let me pass along something I was made aware of by email that weighs in on the political question. This is Brendan Nyhan:

Greg Mankiw and tax cut rhetoric, by Brendan Nyhan: I'm quoted in a Harvard Crimson story on Greg Mankiw, the Harvard economics professor and former Bush administration economist:

N. Gregory Mankiw is not unfamiliar with the demands that come with being one of the foremost economists in the country.

After all, the Beren Professor of Economics survived a stint in the very public domain of Washington politics, serving as the Chairman of the Council of Economic Advisors from 2003 to 2005. But now, he's facing a new and perhaps even more public challenge - the wrath of online bloggers.

Several professors and economists have called on Mankiw to explain what they see as his changing views on tax cuts from before he began advising President George W. Bush to when he served as Bush's top economic advisor.

According to an online blog post by Jared Bernstein of the Economic Policy Institute, Mankiw had previously criticized certain supply-side arguments - namely, that lowering tax rates could actually generate more tax revenue - and then reversed his opinion while working in Washington.

But Mankiw said that he never made such a policy switch.

"[Bernstein] made a claim that I'd been inconsistent about the tax cuts and I don't think I had been," Mankiw said. "Being opposed to a tax cut as a policy and being critical of an argument for tax cuts are two different things." ...

Brendan J. Nyhan, a political science graduate student at Duke University and frequent blogger, points out that while Mankiw said he was "skeptical"of the claim that tax cuts could pay for themselves during his Senate confirmation hearing, Mankiw also denied that the administration had used "self-financing" arguments.

Nyhan then lists on his blog specific quotes from then-Press Secretary Ari Fleis[c]her, Vice President Dick Cheney, and President Bush, all of whom said in the early months of 2003 that the tax cuts would lead to more tax revenue.

"Mankiw failed to get the Bush administration to say things that were accurate about the effects of tax cuts on revenue and other economic issues," Nyhan said. "That Mankiw is unwilling to acknowledge that the Bush administration made these claims is exemplary of White House experts who are unwilling to publicly contradict their bosses in the administration."

J. Bradford Delong '82, a prominent economist at UC Berkeley, also weighed in on the debate on his blog, questioning whether it is "worth the sacrifice of the economics profession's outside credibility and the further confusion of the public that is entailed when good economists defend bad policies on the outside that they are working to change on the inside." ...

Mankiw announced in late 2006 that he had signed on as an advisor to the presidential campaign of former Massachusetts Gov. Mitt Romney, and the Republican candidate seems to be employing these very same supply-side arguments.

"If you lower taxes enough, you create more growth," Romney said in a video excerpt on his Web site from a closed-door presentation he made to the Club for Growth, a political organization that favors low taxes, in March 2007.

"And if you create growth, you get more jobs," Romney continued. "You get more jobs, more people are paying taxes. You get more taxes paid, the government has more money by charging lower tax rates"

It would appear that this is the very same argument for taxes that Mankiw has said he opposed.

Nyhan said that economists with ties to politicians need to be more honest with the public regarding their actual views, whether or not they clash with the prominent figures they're advising.

"We need to drive this idea out of the mainstream, because it is not accurate," Nyhan said.

Here are the links that are referenced in the piece:

-My Spinsanity piece on Mankiw's confirmation hearing claim
-The full timeline of Bush administration officials suggesting that tax cuts increase revenue
-The Romney video in which he states that tax cuts increase revenue (click on "On the Issues" then select "On Fighting for Lower Taxes")

It's especially sad to see that Romney -- who Mankiw advises -- is making these claims. After John McCain started saying that tax cuts increase revenue, Mankiw badmouthed McCain on his blog:

Senator McCain tells the National Review:

Tax cuts, starting with Kennedy, as we all know, increase revenues.

The interviewer, however, did not ask the natural follow-up questions:

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?

I doubt that, in fact, Senator McCain believes we are on the wrong side of the Laffer curve. But unfortunately, fealty to the most extreme supply-side views is de rigeur in some segments of the Republican party.

It's a strange point for Mankiw to make. He has failed to acknowledge publicly that the Bush administration makes the same exact claims. In addition, I noted the apparent implication that Romney, whose [campaign] Mankiw had recently joined as an adviser, would not make similar claims. Judging by the quote above, however, the former Massachusetts governor is following McCain and Rudy Giuliani down the rabbit hole. Will Mankiw passively endorse this rhetoric again?

Sunday, July 15, 2007

Principles of Taxation: What is a Fair tax?

Greg Mankiw on fair taxes, with comments at the end:

Fair Taxes? Depends What You Mean by 'Fair', by Greg Mankiw, Economic View, NY Times: Do the rich pay their fair share in taxes? This is likely to become a defining question during the presidential campaign.

At a recent fund-raiser for Hillary Clinton, ... Warren E. Buffett said that rich guys like him weren’t paying enough. Mr. Buffett asserted that his taxes last year equaled only 17.7 percent of his taxable income, compared with about 30 percent for his receptionist. ... These claims are enough to get populist juices flowing. The problem with them is that they don’t hold up under close examination.

The best source for objective data on the distribution of the tax burden is the Congressional Budget Office. ... The C.B.O.’s most recent calculations of federal tax rates show a highly progressive system. ... The poorest fifth of the population, with average annual income of $15,400, pays only 4.5 percent of its income in federal taxes. The middle fifth, with income of $56,200, pays 13.9 percent. And the top fifth, with income of $207,200, pays 25.1 percent.

At the very top of the income distribution, the C.B.O. reports even higher tax rates. The richest 1 percent has average income of $1,259,700 and forks over 31.1 percent of its income to the federal government.

One might wonder how Mr. Buffett gets away with a tax rate of only 17.7 percent, while a typical millionaire is paying so much more. Most likely, part of the answer is that Mr. Buffett’s income is made up largely of dividends and capital gains, which are taxed at only 15 percent. By contrast, many other top earners pay the maximum ordinary income tax rate of 35 percent on their salaries, bonuses and business income.

The distinction is crucial for understanding how much the rich pay. Indeed, the share of top incomes coming from capital is much lower now than it has been historically. ... If your image of the typical rich person is someone who collects interest and dividend checks and spends long afternoons relaxing on his yacht, you are decades out of date. The leisure class has been replaced by the working rich. ...

None of these calculations, however, say whether the rich are paying their fair share. Fairness is not an economic concept. If you want to talk fairness, you have to leave the department of economics and head over to philosophy.

Continue reading "Principles of Taxation: What is a Fair tax?" »

Saturday, July 14, 2007

Church Attendance and Supply-Side Economics

When did supply-side economics come to mean breaking up monopolies to increase competition? I don't know whether increasing competition among churches increases membership or not, and the fact that religion is involved here is coincidental, but this is not supply-side economics as claimed in the article. This is nothing more than the standard result that increasing competition improves market outcomes:

In Europe, God Is (Not) Dead, by Andrew Higgins, WSJ (free): ...After decades of secularization, religion in Europe has slowed its slide toward what had seemed inevitable oblivion. There are even nascent signs of a modest comeback. Most church pews are still empty. But belief in heaven, hell and concepts such as the soul has risen in parts of Europe, especially among the young...

God's tentative return to Europe has scholars and theologians debating a hot question: Why? Part of the reason, pretty much everyone agrees, is an influx of devout immigrants. ... At the same time, anxiety over immigration, globalization and cutbacks to social-welfare systems has eroded people's contentment in the here-and-now, prodding some to seek firmer ground in the spiritual.

Some scholars and Christian activists, however, are pushing a more controversial explanation: the laws of economics. As centuries-old churches long favored by the state lose their monopoly grip, Europe's highly regulated market for religion is opening up to leaner, more-aggressive religious "firms." The result, they say, is a supply-side stimulus to faith.

"Monopoly churches get lazy," says Eva Hamberg, a professor at Lund University's Centre for Theology and Religious Studies and co-author of academic articles that, based on Swedish data, suggest a correlation between an increase in religious competition and a rise in church-going..."

Upstarts are now plugging new spiritual services across Europe, from U.S.-influenced evangelical churches to a Christian sect that uses a hallucinogenic herbal brew as a stand-in for sacramental wine. Niklas Piensoho, chief preacher at Stockholm's biggest Pentecostal church, says even sometimes oddball, quasi-religious fads "tell me you can sell spirituality." His own career suggests that a free market in faith is taking root. ...

The enemy of faith, say the supply-siders, is not modernity but state-regulated markets that shield big, established churches from competition. In America, where church and state stand apart, more than 50% of the population worships at least once a month. In Europe, where the state has often supported -- but also controlled -- the church with money and favors, the rate in many countries is 20% or less.

Continue reading "Church Attendance and Supply-Side Economics" »

Friday, July 13, 2007

Paul Krugman: An Unjustified Privilege

Paul Krugman urges Democrats to close the loophole that allows Warren Buffet to be taxed at 17.7 percent while his receptionist is taxed at around 30 percent:

An Unjustified Privilege, by Paul Krugman, Commentary, NY Times: During the 2000 presidential campaign, Ralph Nader mocked politicians of both parties as “Republicrats,” equally subservient to corporations and the wealthy. It was nonsense, of course: the modern G.O.P. is so devoted to the cause of making the rich richer that it makes even the most business-friendly Democrats look like F.D.R.

But right now, as I watch Senate Democrats waffle over what should be a clear issue of justice and sound tax policy..., I’m starting to feel that Mr. Nader wasn’t all wrong.

What’s at stake here is a proposal by House Democrats to tax “carried interest” as regular income. This would close a tax loophole that ... basically lets fund managers take a large part of the fees they earn ... and redefine those fees, for tax purposes, as capital gains.

The effect of this redefinition is that income that should be considered ... ordinary income taxed at a 35 percent rate is treated as capital gains, taxed at only 15 percent instead. So fund managers get to pay a low tax rate that is supposed to provide incentives to risk-taking investors, even though they aren’t investors and they aren’t taking risks.

For example, the typical hedge-fund manager ... gets a fee equal to 2 percent of the funds under management, plus 20 percent of whatever his fund earns. It’s not exactly straight salary, but none of this income comes from putting his own wealth at risk. Except for the fact that he might make a billion dollars a year, he resembles a waitress whose income depends on a mix of wages and tips, or a salesman who lives on a mix of salary and commissions, more than he resembles an entrepreneur who sinks his life savings into a new business. ...

There’s a larger question one could ask: should we even be giving preferential tax treatment to true capital gains? I’d say no, because there’s very little evidence that taxing capital gains as ordinary income would actually hurt the economy. ...

But even those who ... think the special treatment of capital gains is justified, should be able to agree that treating the income of fund managers differently from ... everyone else who works for a living makes no sense. And that’s why it’s very disheartening to read that prominent Democratic senators are taking seriously the claims of fund managers that making them pay taxes like regular people would discourage risk-taking.

The immediate response should be: what risk-taking? ...

Look, this isn’t about envy, about punishing success. ... [C]losing the carried interest loophole should be a simple question of fairness: other Americans also earn their pay, but they don’t get special tax breaks. Plus, we’re talking about a lot of lost revenue due to that loophole — revenue that could, for example, be paying for the health care of tens if not hundreds of thousands of children.

And since we’re living in the real world of politics, there’s also the Republicrat issue: the hesitation of the Senate Democrats is terrible for the party’s image. It conveys the impression that they’re as beholden to hedge funds, one of the few types of businesses whose campaign contributions strongly favor Democrats, as Republicans are to the oil and drug industries.

So here’s a plea to Democratic senators on the fence: do the right thing and close this unjustified tax loophole.

Previous (7/9) column: Paul Krugman: Health Care Terror
Next (7/16) column: Paul Krugman: The Waiting Game

Yet Again, Tax Cuts Do Not Pay for Themselves

The Wall Street Journal says Kevin Hassett has discovered the Laffer curve, but I think these data might say something else. Here's the picture from the editorial where they are making their usual plea for more tax cuts:


The blue line is supposed to be the Laffer curve, but this is far from compelling. Since it looks like all that's been done here is to draw a line through an outlier, Norway (an outlier that in other contexts we are told to ignore because it is an outlier, e.g. see below), and since this is clearly not the best fitting line to these data, here's another possibility:


I haven't actually run the regression, but it looks clear to me that revenues rise with tax rates, and the fit also looks better than in the first graph. Toss out Norway, and the fit looks even better (and to quote The Economist blog on this point, "Throwing out Norway...").

I know how much supply-siders want to find a Laffer curve, they've become frustrated going this long without success. But if they really think one exists they'll need to keep looking because they haven't found it yet. [Update: Max has estimates.][Update: Response(s) to a post at The Economist's blog,  Free Exchange.]

Thursday, July 05, 2007

Winner-Take-All-Markets and Efficiency

Robert Frank says raising taxes paid by hedge fund managers can improve economic efficiency:

A Career in Hedge Funds and the Price of Overcrowding, by Robert Frank, Economic Scene, NY Times: ...I haven’t seen a formal survey, but a rapidly growing percentage of the best students I teach say they want to manage hedge funds or private equity firms. Little wonder. ... The combined income of the top 25 hedge fund managers exceeded $14 billion in 2006.

These managers also enjoy remarkably favorable tax treatment. For example, even though ... their 20 percent commission on portfolio gains ... has the look and feel of ordinary income, it is taxed at the 15 percent capital gains rate rather than the 35 percent top rate for ordinary income. ...

Congress is now considering a proposal to tax carried interest as ordinary income. To no one’s surprise, private equity lobbyists were quick to insist that doing so would cause grave economic damage. ... Yet..., economic analysis suggests that it would actually increase production in other sectors of the economy by reducing wasteful overcrowding in the market for aspiring portfolio managers.

Continue reading "Winner-Take-All-Markets and Efficiency" »

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.