Tag: deficit

Greece’s Problem Is High Tax Rates, Not Tax Evasion

The New York Times has an article describing widespread tax evasion in Greece, along with an implication that the country’s fiscal crisis is largely the result of unpaid taxes and could be mostly solved if taxpayers were more obedient to the state. This is grossly inaccurate. A quick look at the budget numbers reveals that tax revenues have remained relatively constant in recent years, consuming nearly 40 percent of GDP. The burden of government spending, by contrast, has jumped significantly and now exceeds 50 percent of Greek economic output.

The article also is flawed in assuming that harsher enforcement is the key to compliance. As this video shows, even the economists at the Paris-based Organization for Economic Cooperation and Development admit that tax evasion is driven by high tax rates (which is remarkable since the OECD is the international bureaucracy pushing for global tax rules to undermine tax competition and reduce fiscal sovereignty).

Ironically, the New York Times article quotes Friedrich Schneider of Johannes Kepler University in Austria, but only to provide an estimate of Greece’s shadow economy. The reporter should have looked at an article that Schneider wrote for the International Monetary Fund, which found that:

Macroeconomic and microeconomic modeling studies based on data for several countries suggest that the major driving forces behind the size and growth of the shadow economy are an increasing burden of tax and social security payments… The bigger the difference between the total cost of labor in the official economy and the after-tax earnings from work, the greater the incentive for employers and employees to avoid this difference and participate in the shadow economy. …Several studies have found strong evidence that the tax regime influences the shadow economy. …In Austria, the burden of direct taxes (including social security payments) has been the biggest influence on the growth of the shadow economy… Other studies show similar results for the Scandinavian countries, Germany, and the United States. In the United States, analysis shows that as the marginal federal personal income tax rate increases by one percentage point, other things being equal, the shadow economy grows by 1.4 percentage points. …A study of Quebec City in Canada shows that people are highly mobile between the official and the shadow economy, and that as net wages in the official economy go up, they work less in the shadow economy. This study also emphasizes that where people perceive the tax rate as too high, an increase in the (marginal) tax rate will lead to a decrease in tax revenue.

It is worth noting the Schneider’s research also shows why Obama’s tax policy is very misguided. The President wants to boost the top tax rate by nearly five percentage points, and that’s on top of the big increase in the tax rate on saving and investment included in Obamacare. Based on Schneider’s research, we can expect America’s underground economy to expand.

Shifting back to Greece, Schneider does not claim that tax rates are the only factor determining compliance. But his research indicates that more onerous enforcement regimes are unlikely to put much of a dent in tax evasion unless accompanied by better tax policy (i.e., lower tax rates). Moreover, compliance also is undermined by the rampant corruption and incompetence of the Greek government, but that problem won’t be solved unless politicians reduce the size and scope of the public sector. Needless to say, that’s not very likely. So when I read some of the details in this excerpt from the New York Times, much of my sympathy is for taxpayers rather than the greedy politicians that turned Greece into a fiscal mess:

In the wealthy, northern suburbs of this city, where summer temperatures often hit the high 90s, just 324 residents checked the box on their tax returns admitting that they owned pools. So tax investigators studied satellite photos of the area — a sprawling collection of expensive villas tucked behind tall gates — and came back with a decidedly different number: 16,974 pools. That kind of wholesale lying about assets, and other eye-popping cases that are surfacing in the news media here, points to the staggering breadth of tax dodging that has long been a way of life here. …Such evasion has played a significant role in Greece’s debt crisis, and as the country struggles to get its financial house in order, it is going after tax cheats as never before. …To get more attentive care in the country’s national health system, Greeks routinely pay doctors cash on the side, a practice known as “fakelaki,” Greek for little envelope. And bribing government officials to grease the wheels of bureaucracy is so standard that people know the rates. They say, for instance, that 300 euros, about $400, will get you an emission inspection sticker. …Various studies have concluded that Greece’s shadow economy represented 20 to 30 percent of its gross domestic product. Friedrich Schneider, the chairman of the economics department at Johannes Kepler University of Linz, studies Europe’s shadow economies; he said that Greece’s was at 25 percent last year and estimated that it would rise to 25.2 percent in 2010.

Bernanke’s Hollow Deficit Warning

Even though I’ve been in Washington almost 25 years, I am endlessly amazed at the chutzpah of people who support higher spending and bigger government while piously lecturing the rest of us about the need to control deficits. Fed Chairman Ben Bernanke is a good (though “bad” might be a better term) example of this hypocrisy. He was an avid supporter of bailouts and so-called stimulus, yet the Washington Post reports that he is now hectoring us to be fiscally responsible:

Federal Reserve Chairman Ben S. Bernanke warned Wednesday that Americans may have to accept higher taxes or changes in cherished entitlements such as Medicare and Social Security if the nation is to avoid staggering budget deficits that threaten to choke off economic growth. “These choices are difficult, and it always seems easier to put them off – until the day they cannot be put off anymore,” Bernanke said in a speech. “But unless we as a nation demonstrate a strong commitment to fiscal responsibility, in the longer run we will have neither financial stability nor healthy economic growth.”

Senator Bunning Exposes Washington’s Fiscal Frauds

President Obama and many other politicians in Washington are big fans of pay-as-you-go budgeting, which means they want any new spending or tax relief offset (or “paid for”) with tax increases or spending cuts from other parts of the budget. Or at least that’s what they claim. But when Senator Bunning took them at their word and blocked a $10 billion spending bill because his colleagues were unwilling to make some tiny changes elsewhere, he was treated like a leper. Even his Republicans colleagues largely disapproved of his actions (so much for having learned any lessons from the drubbings they took at the polls in 2006 and 2008). Attacked from all sides, Bunning eventually relented in exchange for an offset vote (which was defeated, of course). What makes this episode interesting is not the specific policies that were being considered. As I posted earlier this week, Bunning was not even trying to shrink the size of government. Indeed, his “offset” was actually a tax increase (getting rid of a special tax break for paper manufacturing).

But this incident does expose the gross hypocrisy of the supposed deficit hawks in Washington. President Obama and the Democrats (and many Republicans) pretend they care about deficits, but their concerns magically disappear whenever there is a chance to buy votes by spending other people’s money. When tax cuts or tax increases are being debated, however, many of these same politicians piously declare their unwavering opposition to red ink (unless, of course, it’s a special tax break for a contributor). But perhaps it’s no surprise to discover that politicians think higher taxes are the solution to the over-spending problem in Washington.

What about the organizations that supposedly exist to fight deficits, such as the Concord Coalition and the Committee for a Responsible Federal Budget (they should be fighting spending instead, but let’s set that issue aside). Folks from these groups often ask politicians to be courageous and make “tough choices.” So I went to the Concord Coalition’s homepage and was shocked, shocked to find nothing about Bunning’s effort. I checked the blog and the press releases and found lots of tough rhetoric, but not one word of praise (or one word of any sort) for a Senator who tried to put the Concord Coalition’s words into action. And what about the Committee for a Responsible Federal Budget? Same song, second verse. Not a mention of Bunning on the homepage, blog, or in the press releases. (See update below)

Anybody care to make any predictions whether these groups will be similarly silent when President Obama’s “Fiscal Responsibility Commission” unveils a big tax hike?

Mea Culpa: On another matter, I have to confess an error. I did an interview for NBC affiliate stations on the financial mess at the Postal Service. I haven’t spent any time on that issue, so I quickly scanned some material from my Cato colleagues Chris Edwards and Tad DeHaven and saw that Congress had given an indirect bailout to the Postal Service by suspending $4 billion of required pre-funding for retiree health benefits. I then went on the air and said that this was a taxpayer subsidy for the Postal Service’s lavish pay and benefits. The Postal Service does have lavish pay and benefits, and the indirect bailout may lead to a direct infusion of taxpayer money at some point in the near future, but what I said I was wrong because no taxpayer money is currently being allocated (and I would have avoided the mistake if I paid closer attention to what Chris and Tad wrote). So, please, postal workers, don’t go…um…postal on me.

Mea Culpa, Part II: I am getting sloppy in my old age. Maya MacGuineas of the Committee for a Responsible Federal Budget nailed me fair and square. CFRB did say something nice about Bunning on its blog back on February 26. I should have scrolled down farther. I did just check the Concord Coalition blog, all the way back to the beginning of the year, and was relieved (from a personal perspective, not on policy grounds) to find no mention of Bunning’s effort.

A Value-Added Tax Is Not the Answer…Unless the Question Is How to Finance Bigger Government

While admitting that spending restraint is the ideal approach, Tyler Cowen of Marginal Revolution asks whether a value-added tax (VAT) might be the most desirable of all realistic options for dealing with an unsustainable budget situation.

Read his post for yourself, but I think a fair summary is that he is basically saying that a) there will be a crisis if we don’t do something about future deficits, b) a crisis will result in very bad policy, and c) if we support a VAT now, we will at least be able to extract concessions from the other side.

I have no idea whether there will be a future crisis, but I think the rest of Tyler’s argument is wrong.

But before explaining my position, let’s start by stating what I assume to be our mutual objective, which is to control the size of government. We all agree that there is a problem because government is too big now, and it is projected to get even bigger because of the built-in growth of entitlement programs. One symptom of growing government is deficits, which are very large today and will be even bigger in the near future as more and more baby boomers retire and push up costs for Social Security, Medicare, and Medicaid.

Our side (broadly speaking) wants to solve the budgetary situation by restraining the growth of government. One proposed solution is Congressman Paul Ryan’s Roadmap Plan, which would reform entitlements and curtail other programs so that the long-term burden of federal spending is reduced to less than 20 percent of GDP. Since long-term federal tax revenues under current law - even if the 2001 and 2003 tax cuts are made permanent - are expected to be about 19 percent of GDP, this solves the budet problem  (the tax reform component of the Roadmap includes a VAT, which is a poison pill in an otherwise excellent plan, but let’s set that aside for another day).

The left, by contrast, generally wants to let federal spending consume ever-larger shares of economic output, and they believe that increasing the tax burden is the right way of keeping the deficit from getting too large. No statist has put forth a detailed plan to match Rep. Ryan, but several high-ranking Democrats have made no secret about their desire for a VAT (see here, here, and here). And everyone agrees that a VAT is capable of extracting a lot of money from the productive sector of the economy.

These two visions are fundamentally incompatible, which helps to explain why there is a standoff. The bad guys do not want to control the size of government and the good guys do not want to raise taxes. But now we have to add one more piece to the puzzle. While gridlock normally is a good result, inaction to some degree favors the other side because entitlement programs automatically expand. The helps to explain why Tyler (with reluctance) thinks that it may be best to acquiesce to a VAT now rather than to wait for a fiscal crisis.

Now, let’s explain why Tyler is wrong. First, it is far from clear that surrendering to a VAT now will result in better (less worse) policy than what will happen during a crisis. It certainly is true that some past crises have led to terrible policy, such as the failed policies of Hoover and Roosevelt in the 1930s or the more recent Bush-Paulson-Obama-Geithner TARP debacle. But at other points in time, a crisis atmosphere has paved the way for better policy, with Reagan’s presidency being the most obvious example.

The wait-for-a-crisis strategy clearly is a bit of a gamble, but even if we lose, we get a VAT in the future rather than a VAT today. So what’s the downside? Tyler and others might say that the future legislation in the midst of a crisis could be a vehicle for other bad provisions, but he offers no evidence for this proposition. And it may be the case that the other side would be forced to add good provisions instead. Moreover, the lack of a VAT in the period between today and the future crisis might help lead to some much-needed spending restraint.

What about Tyler’s argument that the good guys could extract some concessions from the other side by putting a VAT on the table. This is horribly naive. Even though George Mason University is less than 20 miles from Washington, and even though Tyler is a renassaince man with many talents, he does not understand how Washington really works.

Imagine there is a budget summit where politicians from both sides get together to work on this supposed deal. Here are the inevitable ground rules - and the consequences they will produce:

1. The deal will be 50 percent spending cuts and 50 percent tax increases, but the supposed spending “cuts” will be nothing more than reductions in already-legislated increases. The tax increases, by contrast, will be on top of all the additional revenue that is already exepected under current law (not a trivial matter since receipts will be $1.5 trillion higher in 2015 than they are today according to OMB). For proponents of limited government, using the “current services baseline” as a benchmark in budget negotiations is like playing a five-minute basketball game after spotting the other team a 20-point lead.

2. All spending and revenue decisions will be examined through the prism of CBO income distribution tables, and the left will successfully insist that nothing is done to make the tax code less progressive. But since a VAT is a proportional tax, the only way of preserving overall progressivity is to raise tax rates on those wicked and evil rich people and/or to massively increase “refundable” tax credits (what normal people call income redistribution). Any proposal to lower income tax rates or eliminate the corporate income tax, as Tyler envisions, would be laughed out of the room (though Democrats will offer a fig leaf or two in order to seduce a sufficient number of gullible Republicans into supporting a terrible agreement, and that might include a cosmetic change to the corporate tax regime).

3. Many of the supposed spending cuts, for all intents and purposes, will be back-door tax increases on saving and investment. More specifically, a big chunk of the supposed spending cut portion of a budget deal will be from means-testing entitlement programs. This sounds good. After all, who wants to send a Social Security check to Bill Gates when he retires? But consider how such a system actually will work. The government will say that people with income (and/or assets) above a certain level are ineligible for some or all of the benefits available to less-fortunate retirees. From an economic persepective, this is very much akin to a higher tax rate on people who save and invest during their working years. And since means testing would only generate substantial budgetary savings if it applied to millions of regular people in addition to Bill Gates, we would wind up with a system that created big penalties on middle-class families who were dumb enough to save and invest.

I’ve already pontificated enough for one blog post, so let me summarize by stating that Tyler’s approach, while not unreasonable, is about how to lose gracefully. Even if his strategy works perfectly, the result is bigger government. I’d much rather fight. If you want some inspiration for the battle, watch this video. If you haven’t had enough of me already, here’s my video explaining why the VAT is a horrible idea.

Update: Tyler has emailed to object to how his position is being characterized. He writes, “I am asking anti-VAT forces to strengthen their argument and am very clearly agnostic and certainly not calling for a VAT today.” Everyone I’ve spoken with has interpreted his post as pro-VAT, and that’s certainly how I read it, but I want to add this addendum to my post so people can see Tyler’s response in case I’m not being fair.

Taxing the Rich Won’t Work

The new budget reportedly hopes to raise $364 billion over ten years by raising the top two tax rates, plus $105 billion by raising the tax on dividends and capital gains to 20% from 15%, and $500 billion through discriminatory caps and limits on personal exemptions and deductions allowed to other taxpayers.

The $364 billion from raising the top two tax rates pales in comparison to the $2.56 trillion from keeping the rest of the Bush tax cuts in place, including $600 per couple (the 10% bracket) for everyone still rich enough to pay taxes (the Obama plan would exempt half of  U.S. workers from paying income tax).  That contrast between $364 billion and $2.56 trillion is definitive proof that Democrats’ endless complaint about the Bush tax cuts going “mainly to the rich” was one of the biggest big lies of the past decade.

The President’s urge to penalize mature, two-earner educated couples earning more than $250,000 is symbolic populism, having essentially nothing to do with reducing the deficit. Table S-2 of the Budget (p. 147) lists “Upper-income tax provisions dedicated to deficit reduction” as just $34 billion in 2011 — less than 1% of estimated spending of $3.8 trillion. Errors in estimating next year’s deficit have often been much larger than $34 billion, particularly during the early stages of economic recoveries.

Still, the false belief that higher tax rates on the rich could eventually raise significant sums over the next decade is a dangerous delusion, because it means long-term deficits are seriously understated.

Here are just a few reasons why punitive marginal tax rates on high-income families cannot possibly raise even the relatively trivial sums the Budget is counting on:

1.    Professionals and companies who currently file under the individual income tax (including most trial lawyers and hedge fund managers) would form C-corporation to shelter income, because the corporate tax rate would then be lower with fewer arbitrary limits on deductions for costs of earning income.

2.    Investors who jumped into dividend-paying stocks in 2003 when the tax rate fell to 15% would dump some of those shares in favor of tax-free municipal bonds if the dividend tax went up, and keep the rest in tax-free IRA or 401k accounts.   Prices of dividend-paying stocks and funds could be depressed, reducing the yield of the capital gains tax.

3.    If faced with a higher capital gains tax next year, investors would rush to realize taxable capital gains (those not in IRAs and 401ks) later this year.  After 2010, investors would make greater efforts to avoid realizing gains in taxable accounts unless they had offsetting losses, and they would also make fewer investments in assets subject to the capital gains tax.

4.    Many two-earner couples would become one-earner couples, early retirement would become more popular, physicians would play more golf, etc.

That is a small sampling of known behavioral responses which economists call “the elasticity of taxable income” or ETI for short.  What that means is this: When the marginal tax rate goes up, the amount of reported incomes goes down.  As a forthcoming study by Joel Slemrod, Seth Giertz and Emmanuel Saez concludes, “There is much evidence to suggest that the ETI is higher for high-income individuals who have more access to avoidance opportunities.”

I presented a 60-page paper in 2008 full of graphs and tables, many derived from the tax data of Thomas Piketty and Emmanuel Saez, offering undeniable evidence that static revenue estimates (which ignore or minimize the ways in which people react to higher tax rates) greatly exaggerate potential revenue from higher tax rates on individual salaries, dividends and capital gains.

I concluded, “There is a serious fiscal risk in the future that overly-optimistic revenue estimates based on the assumption of zero or 0.25 elasticity of taxable income could lead the federal government to make long-term spending plans on the basis of phantom revenues from higher tax rates, embarking on major new entitlement programs (in the guise of refundable tax credits) in the false hope that these static or nearly-static revenue estimates are realistic.”

Obama’s Spending Freeze: Is It Real or Is He Copying Bush?

As reported by the Wall Street Journal, the Obama Administration will propose a three-year freeze for a portion of the budget known as “non-defense discretionary” spending. Many critics will correctly note that this is like going on a drunken binge in Vegas and then temporarily joining Alcoholics Anonymous. Others will point out that more than 80 percent of the budget has been exempted, which also is an accurate criticism. Nonetheless, even a partial freeze would be a semi-meaningful achievement.

But don’t get too excited yet. It is not clear whether the White House is proposing a genuine spending freeze, meaning “budget outlays” for these programs stay at $447 billion for three years, or a make-believe freeze that applies only to “budget authority.” This is an enormously important distinction. Budget outlays matter because they represent the actual burden of government spending. Budget authority, by contrast, is a bookkeeping measure that – at best – signals future intentions. During the profligate Bush years, for instance, apologists for the Administration tried to appease fiscal conservatives by asserting that budget authority was growing at ever-slower rates. In some cases, they were technically correct, but their arguments were deceptive because real-world spending kept climbing to record levels. And needless to say (but I’ll say it anyhow), future intentions never became reality.

Domestic discretionary spending soared from less than $350 billion to more than $600 billion during the Bush years (and rose almost another $100 billion in Obama’s first year!). If the Obama Administration proposes a genuine outlay freeze, he will be taking a genuine (albeit small) step in the right direction. If the “freeze” applies only to budget authority, however, that will be another indication we are in George W. Bush’s third term.

To attack the $1.4 trillion deficit, the White House will propose limits on discretionary spending unrelated to the military, veterans, homeland security and international affairs, according to senior administration officials. Also untouched are big entitlement programs such as Social Security and Medicare. The freeze would affect $447 billion in spending, or 17% of the total federal budget, and would likely be overtaken by growth in the untouched areas of discretionary spending. It’s designed to save $250 billion over the coming decade, compared with what would have been spent had this area been allowed to rise along with inflation. …administration officials acknowledged the freeze is directed at only a small part of overall spending, but that fiscal discipline has to start somewhere. President Obama had requested a 7.3% increase last year in the areas he now seeks to freeze.

The Problem Is Spending, not Deficits

Reckless spending increases under both Bush and Obama have resulted in unprecedented deficits. Congress will soon be forced to increase the nation’s debt limit by an astounding $1.8 trillion. Government borrowing has become such a big issue that some politicians are proposing a deficit reduction commission, which may mean they are like alcoholics trying for a self-imposed intervention.

But all this fretting about deficits and debt is misplaced. Government borrowing is a bad thing, of course, but this video explains that the real problem is excessive government spending.

 

Fixating on the deficit allows politicians to pull a bait and switch, since they can raise taxes, claim they are solving the problem, when all they are doing is replacing debt-financed spending with tax-financed spending. At best, that’s merely taking a different route to the wrong destination. The more likely result is that the tax increases will weaken the economy, further exacerbating America’s fiscal position.