Archives: 06/2011

The “Tax Expenditure” Con Job

For both political and policy reasons, the left is desperately trying to maneuver Republicans into going along with a tax increase. And they are smart to make this their top goal. After all, it will be very difficult – if not impossible – to increase the burden of government spending without more revenue coming to Washington.

But how to make this happen? President Obama is mostly arguing in favor of class-warfare tax increases, but that’s a non-serious gambit driven by 2012 political considerations. Moreover, there’s presumably zero chance that Republicans would surrender to higher tax rates on work, saving, and investment.

The real threat is back-door hikes resulting from the elimination and/or reduction of so-called tax breaks. The big spenders on the left are being very clever about this effort, appealing to anti-spending and pro-tax reform sentiments by arguing that it is important to get rid of “tax expenditures” and “spending in the tax code.”

recently warned, however, that GOPers shouldn’t fall for this sophistry, noting that “If legislation is enacted that results in more money coming into Washington, that is a tax increase.” I also explained that tax breaks are not spending, stating that “When politicians tax (or borrow) money from one person and give it to another, that’s government spending. But if politicians allow a person keep more of their own money, that’s a tax cut.”

To be sure, the tax code is riddled with inefficient and corrupt loopholes. But those provisions should be eliminated as part of fundamental tax reform, such as a flat tax. More specifically, every penny of revenue generated by shutting down tax preferences should be used to lower tax rates. This is a win-win situation that would make America more prosperous and competitive.

It’s also important to understand what’s a loophole and what isn’t. Ideally, you determine special tax breaks by first deciding on the right benchmark and then measuring how the current tax system deviates from that ideal. That presumably means all income should be taxed, but only one time.

So what can we say about the internal revenue code using this neutral benchmark? Well, there are lots of genuine loopholes. The government completely exempts compensation in the form of employer-provided health insurance, for instance, and everyone agrees that’s a special tax break. There’s also the standard deduction and personal exemptions, but most people think it’s appropriate to protect poor people from the income tax (though perhaps we’ve gone too far in that direction since only 49 percent of households now pay income tax).

Sometimes the tax code goes overboard in the other direction, however, subjecting some income to double taxation. Indeed, because of the capital gains tax, corporate income tax, personal income tax, and death tax, it’s possible for some types of income to be taxed as many of three or four times.

Double taxation is a special tax penalty, which is the opposite of a special tax break. The good news is that there are some provisions in the tax code, such as IRAs and 401(k)s, that reduce these tax penalties.

The bad news is that these provisions get added to “tax expenditure” lists, and therefore get mixed up with the provisions that provide special tax breaks. This may sound too strange to be true, but here’s a list of the biggest so-called tax expenditures from the Tax Policy Center (which is a left-leaning organization, but their numbers are basically the same as the ones found at the Joint Committee on Taxation).

Since this post already is too long, I’ll close by simply noting that items 2, 4, 7, 8, 11, and 12 are not loopholes. They are not “tax expenditures.” And they are not “spending in the tax code.” Every one of those provisions is designed to mitigate a penalty in the tax code.

So even if lawmakers have good motives (i.e., pursuing real tax reform such as the flat tax) when looking to get rid of special tax breaks, they need to understand what’s actually a loophole.

But since politicians rarely have good motives, there’s a real threat that they will take existing tax penalties and make them even worse. That’s another reason why tax increases should be a non-starter.

The Federal Government and Financial Literacy

Almost 600 pages into the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act is a provision directing the Government Accountability Office to assess the feasibility of the federal government certifying organizations that provide financial literacy. The GAO released its report this week and concluded that “While a federal process for certifying financial literacy providers appears to be feasible, doing so would pose challenges.”

The challenges cited by the GAO are generally of the bureaucratic variety: What agency or agencies would be in charge? What criteria would be used? How would oversight be conducted? And most importantly, how much would it cost [taxpayers] to implement and operate a federal process for certifying financial literacy providers?

Fortunately, the GAO says that the majority of the representatives of private sector financial literacy organizations, federal agencies, and academic experts that it interviewed said that the disadvantages outweighed the advantages. Numerous concerns were cited, but one in particular stands out: Financial literacy certification may not be an appropriate role for the federal government.

Well, Hallelujah. I’ve read my share of GAO reports – almost all of which have dealt with activities that are not a proper role of the federal government – and I don’t recall that concern being mentioned.

Not only is individual financial literacy not an appropriate concern of the federal government, the federal government itself is a monument to financial illiteracy. It isn’t just that GAO report after GAO report continues to document financial mismanagement across the entire government complex. No, it’s the fact that Washington’s financial mismanagement has left us with a bloated government that’s mired in debt and crippled by massive “entitlement” programs that operate like Ponzi schemes.

The additional irony is the Dodd-Frank regulatory overhaul was passed in the wake of an economic meltdown perpetrated in large part by government failure. Alas, there might not be a lot of shame in Washington, but the hypocrisy is seemingly without limit.

Rafael Correa’s Flat in Belgium

It is traditional for a Latin American nationalist to criticize people who take their money out of their country and invest it somewhere else. President Rafael Correa has done it several times. In 2009 he forced private banks to repatriate part of their assets.

What is unusual is finding evidence that he who preaches does not necessarily practice what he preaches. Last week, Ecuadorians were surprised to hear the news—with our tax authority (Servicio de Rentas Internas–SRI) and then the presidency as a source—that Correa had transferred $330,000 to his bank account in Germany. The President then clarified (“…don’t be stupid, the money was sent to Belgium not Germany”) [in Spanish] that the money was transferred to pay for an apartment for his family in Belgium, given that his children may pursue studies in that country.

But the story did not end there. Earlier this week, the director of the SRI, Carlos Marx Carrasco, announced [in Spanish] that he will publish a list of all citizens that have taken money out of the country with the amount they have paid in taxes for doing so (currently there is a 2% tax on all transactions that imply taking money out of Ecuador). Marx Carrasco said that this has to be done “so that the citizens can see (the behavior) of those who represent El Universo, Diario Hoy, El Comercio and all media, who with human misery have allowed themselves to question (what the president has done)”.

This is how, those who concentrate political power in Ecuador, use information collected for the purpose of charging taxes to take reprisals.

Rise of the Transfer State

Perhaps this is best thought of as the chart of the day, as I will not attempt to discuss its many implications or drivers.  The following chart tracks the percentage of federal spending that is simply a direct transfer of income.  Now we could debate whether all government spending is little more than a transfer of wealth, but let’s save that for another day.  The chart shows a dramatic increase in the share of government that does not go to buying or producing anything, but simply takes the form of a check, increasing from around a third of federal spending to about two-thirds today.

There is one aspect of this trend which merits study in our current economic environment.  While there is a wide range of estimates* for how much government spending adds (or subtracts from) overall economic activity - the so called “fiscal multiplier” - that multiplier is likely to differ for transfer payments versus the government purchase of goods and services.  If government simply takes from A and gives to B, then the magnitude and sign (- or +) will depend on A’s marginal propensity to consume relatives to B’s, minus any resources A spends to avoid said transfer.  This suggests to me that the multiplier for transfers is likely to be about zero, if not negative.  Some of that transfer will be saved by the receiving party, while consumption will likely decline by the losing party.

With direct government purchases of good and services, little, if any, of the initial spending will be saved.  Hence it seems reasonable to believe that the multilpier for direct spending is higher than than for transfer payments, although it still may be less than one.

The point of all this is that the shift of federal spending towards transfer spending has likely reduced the fiscal multiplier, all else equal.  As this is an empirical question, I would certainly be interested in knowing if anyone has tried to measure it.

* for an overview of current Keynesian thinking on the fiscal multiplier see Michael Woodford’s recent piece in the AEA Journal Macroeconomics.

Gay Marriage in New York

In the Wall Street Journal today, Cato senior fellow Walter Olson praises the New York legislature both for passing a marriage equality bill and for including guarantees of religious freedom in the bill:

For those of us who support same-sex marriage and also consider ourselves to be right of center, there were special reasons to take satisfaction in last Friday’s vote in Albany. New York expanded its marriage law not under court order but after deliberation by elected lawmakers with the signature of an elected governor. Of the key group of affluent New Yorkers said to have pushed the campaign for the bill, many self-identify as conservative or libertarian. A GOP-run state Senate gave the measure its approval….

To their credit, New York lawmakers devoted much attention to the drafting of exemptions to protect churches and religious organizations from being charged with bias for declining to assist in same-sex marriages. Exemptions of this sort are sometimes dismissed as a mere sop to placate opponents. But in fact they’re worth supporting in their own right—and an important recognition that pluralism and liberty can and should advance together as allies….

Critics have charged that same-sex marriage will constrict the free workings of religious institutions and violate the conscience of individuals who act on religious scruples. Many of the examples they give are by now familiar….

Observe, however, that it isn’t the legal status of same-sex marriage that keeps generating these troublesome cases; it’s plain old discrimination law. Thus New York’s highest court ordered Yeshiva University, an Orthodox Jewish institution, to let same-sex couples into its married-student housing. But that ruling happened a decade ago and had nothing to do with last week’s vote in Albany. In the case of the wedding photographer ordered not to act on her scruples, New Mexico didn’t then and doesn’t now recognize same-sex marriage. While some of these rulings are to be deplored as infringements on individual liberty, they’re not consequences of the state of marriage law itself.

Also: Cato’s forum on the legal challenge to California’s Proposition 8, featuring Ted Olson, David Boies, John Podesta, and Robert Levy. And an earlier forum on gays and conservatism featuring Andrew Sullivan, Maggie Gallagher, and British Cabinet minister Nick Herbert.