Tag: Supply-side economics

The Barack Obama Tax Reform Plan?


In my fiscal policy speeches, I sometimes try to get a laugh out of audiences by including a Powerpoint slide with this image. Leading up to this slide, I talk about the Armey/Forbes flat tax and explain that it would eliminate the corrupt internal revenue code and replace it with a simple 10-line postcard. But I then warn that simplicity is not the same as low taxes and show the Obama slide.

But maybe jokes about Obama tax reform were a bit premature. According to the New York Times, the White House is giving serious consideration to a sweeping plan to streamline the tax system.

While administration officials cautioned on Thursday that no decisions have been made and that any debate in Congress could take years, Mr. Obama has directed his economic team and Treasury Department analysts to review options for closing loopholes and simplifying income taxes for corporations and individuals, though the study of the corporate tax system is farther along, officials said. The objective is to rid the code of its complex buildup of deductions, credits and exemptions, thereby broadening the base of taxes collected and allowing for lower rates — much like a bipartisan majority on Mr. Obama’s debt-reduction commission recommended last week in its final blueprint for reducing the debt through 2020. Doing so would offer not only an opportunity to begin confronting the growth in the national debt but also a way to address warnings by American business that corporate tax rates and the costs of complying with the tax code are cutting into their global competitiveness.

There’s actually much to like in the Administration’s potential plan. Lower tax rates will help the economy by improving incentives for productive behavior. And getting rid of distortions will further enhance growth since people no longer would have an incentive to make inefficient decisions just for tax purposes. And simplification could have a profound impact on cleaning up the horrible mess at the IRS. Moreover, a plan that trades lower tax rates for fewer tax distortions would be a welcome change from the poisonous soak-the-rich tax policy the White House has been pursuing.

This sounds like good news, but there’s a catch. The White House is looking at this exercise as a way to not only clean up the tax code, but also as a way of getting more money for politicians. This blog post explains why this is the wrong approach from an economic perspective, but politics will be an even bigger obstacle.

The American people want tax reform, but they don’t want more of their money going to Washington. And most Republican politicians have wisely pledged not to support legislation that increases the overall tax burden.

So the ball is in Obama’s court. If he genuinely wants to make America more prosperous and competitive, he should move forward with plans to lower tax rates and eliminate tax distortions, but he needs to tell his staff that tax reform should not a Trojan Horse for a tax increase.

Words I Don’t Say Very Often: ‘I Applaud Senate Republicans’

Much to my surprise, Senate Republicans held firm earlier today and blocked President Obama’s soak-the-rich proposal to raise tax rates next year on investors, entrepreneurs and small business owners.

I fully expected that GOPers would fold on this issue several months ago because Democrats were using the class-warfare argument that Republicans were holding the middle class hostage in order to protect “millionaires and billionaires.” Republicans usually have a hard time fighting back against such demagoguery, and I was especially pessimistic since every Republican senator had to stay united to block Senate Democrats from pushing through Obama’s plan for higher tax rates on the so-called rich.

But the GOP surprised me earlier this year with their united opposition to higher taxes, and they stayed strong again today in blocking a bill that would raise tax rates on upper-income taxpayers. Here’s an excerpt from the New York Times.

Republicans voted unanimously against the House-passed bill, and they were joined by four Democrats — Senators Russ Feingold of Wisconsin, Joe Manchin III of West Virginia, Ben Nelson of Nebraska, and Jim Webb of Virginia — as well as by Senator Joseph I. Lieberman, independent of Connecticut. “You don’t raise taxes if your ultimate goal, if the main thing is to create jobs,” said Senator John Thune, Republican of South Dakota, echoing an argument made repeatedly by his colleagues during the floor debate. The Senate on Saturday also rejected an alternative proposal, championed by Senator Charles E. Schumer of New York, to raise the threshold at which the tax breaks would expire to $1 million. Some Democrats said that the Republicans’ opposition to that plan showed them to be siding with “millionaires and billionaires” over the middle class.

Not only did GOPers stand firm, but they were joined by five other senators (including four that have to face the voters in 2012). This presumably means Democrats will now have to compromise and agree to a plan to extend all of the 2001 and 2003 tax cuts.

At the risk of being a Pollyanna, I wonder if the politics of hate and envy is falling out of fashion. Obama’s plan for higher tax rates hopefully is now dead, but that’s just one positive indicator. It’s also interesting that both of the big “deficit reduction” plans recently unveiled, the President’s Fiscal Commission and the Domenici-Rivlin Debt Reduction Task Force Report, endorsed lower marginal tax rates - including lower tax rates for those evil rich people. Both proposals also included lots of tax increases, so the overall tax burden would be significantly higher under both plans, but it is remarkable that the beltway insiders who dominated the two panels understood the destructive impact of class-warfare tax rates. Maybe they watched this video.

Overhauling CBO and JCT Is a Real Test of GOP Resolve, not the ‘Pledge to America’

While I’m glad Republicans are finally talking about smaller government, I’ve expressed some disappointment with the GOP Pledge to America. Why “reform” Fannie and Freddie, I asked, when the right approach is to get the government completely out of the housing sector. Jacob Sullum of Reason is similarly underwhelmed. He writes:

In the “Pledge to America” they unveiled last week, House Republicans promise they will “launch a sustained effort to stem the relentless growth in government that has occurred over the past decade.” Who better for the job than the folks who ran the government for most of that time? …Republicans, you may recall, had a spending spree of their own during George W. Bush’s recently concluded administration, when both discretionary and total spending doubled – nearly 10 times the growth seen during Bill Clinton’s two terms. In fact, says Veronique de Rugy, a senior research fellow at George Mason University’s Mercatus Center, “President Bush increased government spending more than any of the six presidents preceding him, including LBJ.” Republicans controlled the House of Representatives for six of Bush’s eight years.

Redemption is a good thing, however, so maybe the GOP actually intends to do the right thing this time around. One key test is whether Republicans do a top-to-bottom housecleaning at both the Congressional Budget Office and the Joint Committee on Taxation.

These Capitol Hill bureaucracies are not well known, but they have enormous authority and influence. As the official scorekeepers of spending (CBO) and tax (JCT) bills, these two bureaucracies can mortally wound legislation or grease the skids for quick passage.

Unfortunately, that clout gets used to dramatically tilt the playing field in favor of bigger government. It was CBO that claimed that Obama’s stimulus created jobs, even though the head of CBO was forced to admit that the jobs-created number was the result of a Keynesian model that was rigged to show exactly that result . You would think that would shame the bureaucrats into producing honest numbers, but CBO continues to produce absurd job creation estimates regardless of the actual rate of unemployment.

CBO favors deficits and debt when it is asked to analyze proposals for more spending, but it rather conveniently changes its tune when the discussion shifts to tax increases. Since we’re on the topic of twisted economic analysis, CBO actually relies on a model which, for all intents and purposes, predicts that economic performance is maximized with 100 percent tax rates.

The Joint Committee on Taxation, meanwhile, is infamous for its assumption that taxes have no impact - at all - on economic output. In other words, instead of showing a Laffer Curve, JCT would show a straight line, with tax revenues continuing to rapidly climb even as tax rates approach 100 percent.  This creates a huge bias against good tax policy, yet JCT is impervious to evidence that its approach is wildly flawed.

And don’t forget that CBO and JCT both bear responsibility for Obamacare since they cranked out preposterous estimates that a giant new entitlement would lead to lower budget deficits.

Not that we need additional evidence, but the head of the CBO just repeated his higher-taxes-equal-more-growth nonsense in testimony to the Senate Budget Committee. With this type of mindset, is it any surprise that fiscal policy is such a mess?

Douglas Elmendorf said extending breaks due to expire at year’s end would increase demand in the next few years by putting more money in consumers’ pockets. Over the long term, he said, the tax cuts would hurt the economy because the government would have to borrow so much money to finance them that it would begin competing with private companies seeking loans. That, in turn, would drive up interest rates, Elmendorf said.

I’ve already written once about how the GOP sabotaged itself when it didn’t fix the problems with these scorekeeping bureaucracies after 1994. If Republicans take power and don’t raze CBO and JCT, they will deserve to become a permanent minority party.

A Debate Between John F. Kennedy and Barack Obama

Here’s a clever video produced by the Winston Group, comparing the tax policies of two Democratic Presidents. Having previously highlighted Kennedy’s tax-cutting approach, it is painful for me to observe the class warfare approach of the Obama Administration.
 

What’s especially fascinating is that JFK intuitively understood the Laffer Curve, particularly the insight that deficits usually are the result of slow growth, not the cause of slow growth.

The Laffer Curve Strikes Again

In the private sector, no business owner would be dumb enough to assume that higher prices automatically translate into proportionately higher revenues. If McDonald’s boosted hamburger prices by 30 percent, for instance, the experts at the company would fully expect that sales would decline. Depending on the magnitude of the drop, total revenue might still climb, but by far less than 30 percent. And it’s quite possible that the company would lose revenue. In the public sector, however, there is very little understanding of how the real world works. Here’s a Reuters story I saw on Tim Worstall’s blog, which reveals that Bulgaria and Romania both are losing revenue after increasing tobacco taxes.

Cash-strapped Bulgaria and Romania hoped taxing cigarettes would be an easy way to raise money but the hikes are driving smokers to a growing black market instead. Criminal gangs and impoverished Roma communities near borders with countries where prices are lower – Serbia, Macedonia, Moldova and Ukraine – have taken to smuggling which has wiped out gains from higher excise duties. Bulgaria increased taxes by nearly half this year and stepped up customs controls and police checks at shops and markets. Customs office data, however, shows tax revenues from cigarette sales so far in 2010 have fallen by nearly a third. …Overall losses from smuggling will probably outweigh tax gains as Bulgaria struggle to fight the growing black market, which has risen to over 30 percent of all cigarette sales and could cost 500 million levs in lost revenues this year, said Bezlov at the Center for the Study of Democracy. While the government expected higher income from taxes in 2010 it has already revised that to the same level as last year. “However, this (too) looks unlikely at present,” Bezlov added. Romania, desperately trying to keep a 20 billion-euro International Monetary Fund-led bailout deal on track, has a similar problem after nearly doubling cigarette prices in 2009 then hiking value added tax. Romania’s top three cigarette makers – units of British American Tobacco, Japan Tobacco International and Philip Morris – contributed roughly 2 billion euros to the budget in taxes in 2009, or just under 2 percent of GDP. They estimate about a third of cigarettes in Romania are smuggled and say this could cost the state over 1 billion euros.

Congressional Budget Office Says We Can Maximize Long-Run Economic Output with 100 Percent Tax Rates

I hope the title of this post is an exaggeration, but it’s certainly a logical conclusion based on what is written in the Congressional Budget Office’s updated Economic and Budget Outlook. The Capitol Hill bureaucracy basically has a deficit-über-alles view of fiscal policy. CBO’s long-run perspective, as shown by this excerpt, is that deficits reduce output by “crowding out” private capital and that anything that results in lower deficits (or larger surpluses) will improve economic performance – even if this means big increases in tax rates.

CBO has also examined an alternative fiscal scenario reflecting several changes to current law that are widely expected to occur or that would modify some provisions of law that might be difficult to sustain for a long period. That alternative scenario embodies small differences in outlays relative to those projected under current law but significant differences in revenues: Under that scenario, most of the cuts in individual income taxes enacted in 2001 and 2003 and now scheduled to expire at the end of this year (except the lower rates applying to high-income taxpayers) are extended through 2020; relief from the AMT, which expired after 2009, continues through 2020; and the 2009 estate tax rates and exemption amounts (adjusted for inflation) apply through 2020. …Under those alternative assumptions, real GDP would be…lower in subsequent years than under CBO’s baseline forecast. …Under that alternative fiscal scenario, real GDP would fall below the level in CBO’s baseline projections later in the coming decade because the larger budget deficits would reduce or “crowd out” investment in productive capital and result in a smaller capital stock.

There’s nothing necessarily wrong with CBO’s concern about deficits, but looking at fiscal policy through that prism is akin to deciding who wins a baseball game by looking at what happened during the 6th inning. Yes, government borrowing drains capital from the productive sector of the economy. And nations such as Greece are painful examples of what happens when governments go too far down this path. But taxes also undermine economic performance by reducing incentives to work, save, and invest. And nations such as France are gloomy reminders of what happens when punitive tax rates discourage productive behavior.

What’s missing for CBO’s analysis is any recognition or understanding that the real problem is excessive government spending. Regardless of whether spending is financed by borrowing or taxes, resources are being diverted from the private sector to government. In other words, government spending is the disease and deficits are basically a symptom of that underlying problem. Indeed, it’s worth noting that there’s not much evidence that deficits cause economic damage but plenty of evidence that bloated public sectors stunt growth. This video is a good antidote to CBO’s myopic focus on budget deficits.

What’s the Ideal Point on the Laffer Curve?

There’s been a bit of chatter in the blogosphere about a recent post on Ezra Klein’s blog, featuring estimates from various economists about the revenue-maximizing tax rate. It won’t come as a surprise that people on the right tended to give lower estimates and folks on the left had higher guesses. Donald Luskin of National Review estimated 19 percent, for instance, while Emmanuel Saez, Dean Baker, Bruce Bartlett, and Brad DeLong all gave answers around 70 percent.

There are two things that are worth noting.

First, every single answer is to the right of the Joint Committee on Taxation. The revenue-estimators on Capitol Hill assume that taxes have no impact on overall economic performance. As such, even confiscatory tax rates have very little impact on taxable income. The JCT operates in a totally non-transparent fashion, so it is difficult to know whether they would say the revenue-maximizing tax rate is 90 percent, 95 percent, or 100 percent, but it is remarkable that a mini-bureaucracy with so much power is so far out of the mainstream (it’s even more remarkable that Republicans controlled Congress for 12 years, yet never fixed this problem, but that’s a separate story).

Second, very few of the respondents made the critically important observation that it should not be the goal of tax policy to maximize revenue. After all, the revenue-maximizing point is where the damage to the overall economy is so great that taxable income falls enough to offset the impact of the higher tax rates. Greg Mankiw of Harvard and Steve Moore of the Wall Street Journal indicated they understood this point since they both explained that the long-run revenue-maximizing rate was lower than the short-run revenue-maximizing rate. But Martin Feldstein of Harvard explicitly addressed this issue and hit the nail on the head.

Why look for the rate that maximizes revenue? As the tax rate rises, the “deadweight loss” (real loss to the economy) rises. So as the rate gets close to maximizing revenue the loss to the economy exceeds the gain in revenue…. I dislike budget deficits as much as anyone else. But would I really want to give up say $1 billion of GDP in order to reduce the deficit by $100 million? No. National income is a goal in itself. That is what drives consumption and our standard of living.

For more information, I think my three-part video series on the Laffer Curve is a good summary of the key issues. I posted them in May 2009, but Cato-at-Liberty has been growing rapidly and many people have not seen them. Part I addresses the theory, and explicitly notes that policy makers should target the growth-maximizing tax rate rather than the revenue-maximizing tax rate. Part II reviews some of the evidence, including analysis of the huge increase in taxable income and tax revenue from upper-income taxpayers following the Reagan tax-rate reductions. Part III looks at the Joint Committee on Taxation’s dismal performance.