Category Archive for: Taxes [Return to Main]

Tuesday, February 06, 2007

An Argument Against the Privatization of Lotteries

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

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

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

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

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

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

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

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

Friday, January 19, 2007

Bartlett: Time for Tax Reform?

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

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

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

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

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

Friday, January 12, 2007

"Catch and Release" at the IRS

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Tuesday, January 09, 2007

Untruth and Consequences

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

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

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

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

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

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

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

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

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

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

Wednesday, January 03, 2007

Vox Baby's New Year's Plea

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

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

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

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

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

Tuesday, January 02, 2007

The Deficit Hawk Faction

In a message on his sidebar, Brad DeLong says:

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

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

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

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

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

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

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

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

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

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

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

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

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

Wednesday, December 27, 2006

Avoiding the Budgetary Bait and Switch

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

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

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

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

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

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

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

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

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

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

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


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

Sunday, December 24, 2006

Republicans and the Deficit

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Saturday, December 23, 2006

More on Democrats and the Deficit

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

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

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

The genial Tyler Cowen is ... uncharacteristically cutting:

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

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

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

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

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

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

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

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

Democrats and the Deficit

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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


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

Wednesday, December 20, 2006

Are All Charities Created Equal?

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

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

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

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

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

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

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

Monday, December 11, 2006

Who Feeds the Iraq War Beast?

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

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

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

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

Sunday, December 10, 2006

Summers: Restoring Fairness

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

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

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

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

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

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

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

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

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

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

Saturday, December 09, 2006

Falling State Corporate Income Taxes

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

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

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

Continue reading "Falling State Corporate Income Taxes" »

Wednesday, December 06, 2006

An Interview With David Card

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

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

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

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

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

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

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

Continue reading "An Interview With David Card" »

Tuesday, November 28, 2006

Changes in the Distribution of Income and Taxes

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

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

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

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

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

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

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

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

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

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

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

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

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

Thursday, November 23, 2006

Milton Friedman's Social Welfare Program

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

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

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

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

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

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

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

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

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

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

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

Tuesday, November 14, 2006

Pigouvian Redistribution

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

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

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

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

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

Saturday, November 11, 2006

What Happened to the Surplus?

Greg Mankiw:

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

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

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

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

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

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

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

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

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

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

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

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

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

Update: This notice appears with the article:

BELATED FULL DISCLOSURE

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

Thursday, November 09, 2006

401(not okay) Accounts?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Friday, November 03, 2006

Whe Gets the Cookies?

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

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

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

For more see: Tax Policy Center...

Tuesday, October 31, 2006

What Tax Cut?

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

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

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

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

Continue reading "What Tax Cut?" »

Sunday, October 22, 2006

Supply-Side Economics: Used and Abused

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

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

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

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

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

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

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

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

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

One note. Jonathan Chait says:

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

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

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

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

Wednesday, October 18, 2006

Still Searching for Laffer's Curve

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

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

New Economist discusses the paper in more detail.

Tuesday, October 17, 2006

Raise Taxes on the Poor?

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

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

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

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

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

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

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

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

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

Phelps: Tax Cuts are Not the Answer

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Tuesday, October 10, 2006

Stockholm's Congestion Tax

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

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

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

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

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

Tuesday, October 03, 2006

Oink

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

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

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

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

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

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

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

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

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

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

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

Fixing Global Imbalances

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

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

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

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

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

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

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

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

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

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

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

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

Sunday, October 01, 2006

Vintage Varian: Raise Gasoline Taxes

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Saturday, September 23, 2006

Inequality "Jumps Sharply"

New data show that inequality continues to increase:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Friday, September 22, 2006

Will Bush Raise Your Taxes?

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

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

Here's what Bush said:

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

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

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

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

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

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

Update: From comments:

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

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

Wednesday, September 20, 2006

An Interview with Martin Feldstein

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

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

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

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

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

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

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

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

Continue reading "An Interview with Martin Feldstein" »

Thursday, September 14, 2006

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

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

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

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

Tax191406

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

Tax391406

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

Tax491406

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

Tax691406

Bingo. And how have estate taxes changed?:

Tax591406

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

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

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

Monday, September 11, 2006

Luck, Skill, and Progressive Taxes

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Friday, September 08, 2006

Promises, Promises

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

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

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

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

Huh? No. 

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

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

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

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

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

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

Update: PGL at Angry Bear adds:

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

Sunday, September 03, 2006

Income Inequality Follow-Up

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

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

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

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

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

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

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

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

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

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

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

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

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

Friday, September 01, 2006

Opportunity Costs

What has your state given up?:

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

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

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

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

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

Thursday, August 31, 2006

Are Taxes on Interest Income Unconstitutional?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Update: Bernard Yomtov, in comments, adds:

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

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

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

Monday, August 21, 2006

Paul Krugman: Tax Farmers, Mercenaries and Viceroys

Back to a bad old future:

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

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

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

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

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

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

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

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

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

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

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

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

Saturday, August 12, 2006

Reviving Estate Tax Reform

The WSJ's Washington Wire reports:

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

Give it up.

Tuesday, August 08, 2006

Without Tax Cuts, the Budget Would Be Balanced

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

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

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

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

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

Tuesday, August 01, 2006

Gimme Tax Shelter

It's just a sham away:

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

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

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

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

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

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

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

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

Saturday, July 29, 2006

How Would You Solve the Deficit Problem?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Friday, July 28, 2006

Dynamic Scoring Undermines the Arguments of Tax-Cut Advocates

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

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

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

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

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

Misunderstanding of the Treasury Study Mars Some News Accounts

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

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

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

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

The following are four key findings from the report.

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

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

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

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

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

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

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

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

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

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

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

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

Update: David Altig clarifies in comments:

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

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

Wednesday, July 26, 2006

Tax Cuts and Changes in Output

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Tuesday, July 25, 2006

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

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

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

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

The NY Times article also notes that:

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

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

Sunday, July 23, 2006

Florida's "Biblical Use" Exemption

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

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

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

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

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

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

Thursday, July 20, 2006

Yet Another Robert Samuelson Edition...

Robert Samuelson repeats a familiar refrain on the budget deficit:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

But Samuelson explains this away:

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

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

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

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

Monday, July 17, 2006

Income Redistribution and Tax Revenue

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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