Tag: Tax Reform

Congressman Ryan’s Budget Is a Big Step in the Right Direction

The chairman of the House Budget Committee, Rep. Paul Ryan of Wisconsin, will unveil his FY2012 budget tomorrow. Not all the details are public yet, but what we do know is very encouraging.

Ryan’s plan is a broad reform package, including limits on so-called discretionary spending, limits on excessive pay for federal bureaucrats, and steep reductions in corporate welfare.

But the two most exciting parts are entitlement reform and tax reform. Ryan’s proposals would simultaneously address the long-run threat of bloated government and put in place tax policies that will boost growth and improve competitiveness.

  1. The long-run fiscal threat to America is entitlement spending. Ryan’s plan will address this crisis by block-granting Medicaid to the states (repeating the success of the welfare reform legislation of the 1990s) and transforming Medicare for future retirees into a “premium-support” plan (similar to what was proposed as part of the bipartisan Domenici-Rivlin Debt Reduction Task Force).
  2. America’s tax system is a complicated disgrace that manages to both undermine growth and promote corruption. The answer is a simple and fair flat tax, and Ryan’s plan will take an important step in that direction with lower tax rates, less double taxation of saving and investment, and fewer distorting loopholes.

One potential criticism is that the plan reportedly will not balance the budget within 10 years, at least based on the antiquated and inaccurate scoring systems used by the Congressional Budget Office and Joint Committee on Taxation. While I would prefer more spending reductions, I’m not overly fixated on getting to balance with 10 years.

What matters most is “bending the cost curve” of government. Obama’s budget leaves government on auto-pilot and leaves America on a path to becoming a decrepit European-style welfare state. Ryan’s budget, by contrast, would shrink the burden of federal spending relative to the productive sector of the economy.

Along with other Cato colleagues, I’ll have more analysis of the plan when it is officially released.

Time to Get Rid of the Corporate Income Tax?

Here’s a video arguing for the abolition of the corporate income tax. The visuals are good and it touches on key issues such as competitiveness.

 

I do have one complaint about the video, though it is merely a sin of omission. There is not enough attention paid to the issue of double taxation. Yes, America’s corporate tax rate is very high, but that is just one of the layers of taxation imposed by the internal revenue code. Both the capital gains tax and the tax on dividends result in corporate income being taxed at least two times.

These are points I made in my very first video, which is a good companion to the other video.

There is a good argument, by the way, for keeping the corporate tax and instead getting rid of the extra layers of tax on dividends and capital gains. Either approach would get rid of double taxation, so the economic benefits would be identical. But the compliance costs of taxing income at the corporate level (requiring a relatively small number of tax returns) are much lower than the compliance costs of taxing income at the individual level (requiring the IRS to track down tens of millions of shareholders).

Indeed, this desire for administrative simplicity is why the flat tax adopts the latter approach (this choice does not exist with a national sales tax since the government collects money when income is spent rather than when it is earned).

But that’s a secondary issue. If there’s a chance to get rid of the corporate income tax, lawmakers should jump at the opportunity.

U.S. Corporate Tax Rate the Highest

Japan has announced that it will cut its corporate tax rate by five percentage points. Japan and the United States had been the global laggards on corporate tax reform, so this leaves America with the highest corporate rate among the 34 wealthy nations of the Organization for Economic Cooperation and Development.

That is not a good position for us to be in. Most of the competition faced by U.S. businesses comes from businesses headquartered in other OECD countries. America also competes with other OECD nations as a location for investment. Our high corporate tax rate scares away investment in new factories, makes it difficult for U.S. companies to compete in foreign markets, and provides strong incentives for corporations to avoid and evade taxes.

The chart shows KPMG data on statutory corporate tax rates in the OECD for 2010, but I’ve also put in the new lower rate for Japan. With the Japanese reform, the average rate in the OECD will be 25.6 percent. That means that the 40 percent U.S. rate is 56 percent higher than the wealthy-nation average.

Most fiscal experts agree that cutting the U.S. corporate tax rate is a high priority, and President Obama’s fiscal commission endorsed the idea. If the president wants to get the economy firing on all cylinders–and generate a new pragmatic and centrist image for himself–he should lead the charge to drop the corporate rate to at least 20 percent.

With state-level taxes on top, a federal corporate rate of 20 percent would put America at about the OECD average, and give all those corporations sitting on piles of cash a great reason to start investing again.

Dan Mitchell’s comments are here.

Buy Global Tax Revolution here.

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.

Tax Loopholes Are Corrupt and Inefficient, but They Should only Be Eliminated if Every Penny of New Revenue Is Used to Lower Tax Rates

There’s been a lot of heated discussion about various preferences, deductions, credits, shelters, and other loopholes in the tax code. Some of this debate has revolved around whether it is legitimate to refer to these provisions as “tax expenditures” or “subsidies.”

Michael Cannon vociferously argues that subsidies and expenditures only occur when the government takes money from person A and gives it to person B. On the other side of the debate are people like Josh Barro of the Manhattan Institute, who argues that tax preferences are akin to subsidies or expenditures since they can be just as damaging as government spending programs when looking at whether resources are efficiently allocated.

Since I’m a can’t-we-all-get-along, uniter-not-divider kind of person, allow me to suggest that this debate should be set aside. After all, we all agree that tax preferences can lead to inefficient outcomes. So let’s call them “tax distortions” and focus on the real issue, which is how best to eliminate them.

This is an important issue because both the Domenici-Rivlin Task Force and the Chairmen of the Simpson-Bowles Commission have unveiled plans that would reduce or eliminate many of these tax distortions and also lower marginal tax rates. That’s the good news.

The bad news is that their plans result in more revenue going to Washington. In other words, the tax increase resulting from fewer tax distortions is larger than the tax decrease resulting from lower tax rates. To put it bluntly, the plans would increase the overall tax burden.

Some argue that this is an acceptable price to pay. They point out, quite correctly, that lower tax rates will help the economy by improving incentives for productive behavior. And they also are right in arguing that fewer tax distortions will help the economy by improving efficiency. Seems like a win-win situation. What’s not to like?

The problem is on the spending side of the fiscal ledger. The Simpson-Bowles Commission and the Domenici-Rivlin Task Force were charged with figuring out how to reduce red ink. We already know from Congressional Budget Office data, however, that we can balance the budget fairly quickly by limiting the growth of government spending. As the chart illustrates, the deficit disappears by 2016-2017 with a hard freeze and goes away by 2019-2020 if spending increases by two percent each year (and this assumes all the 2001 and 2003 tax cuts are made permanent).

If tax revenue is increased, that simply means that the budget gets balanced at a higher level of spending. And since government spending, at current levels and composition, hinders economic growth by diverting labor and capital to less productive (or unproductive) uses, any proposal that enables higher levels of government spending will further undermine economic performance.

It goes without saying (but I’ll say it anyhow) that this analysis is overly optimistic since it assumes that politicians actually will balance the budget. In all likelihood, as explained in today’s Wall Street Journal, any tax increase would probably be followed by even more spending. So if politicians raise the tax burden, we might still have a deficit of $685 billion in 2020 (CBO’s most-recent estimate assuming  all programs are left on auto-pilot), but the overall levels of both spending and taxes would be higher. This modified cartoon captures this real-world effect.

This is why revenue-neutral tax reform, like the flat tax, is the only pro-growth way of eliminating tax distortions.

There Ain’t No Such Thing as a Tax Subsidy, Either

I hit a nerve with my post, “There Ain’t No Such Thing as a Tax Expenditure.”  To recap: The federal tax code has credits, deductions, exemptions, and exclusions that reduce tax revenue.  By convention, budget experts call that forgone revenue a “tax expenditure,” a “tax subsidy,” or even “backdoor spending in the tax code.”  This is incorrect.  To claim that forgone tax revenue is a government expenditure implies that the money at stake actually belongs to the government, which is graciously letting taxpayers keep it, rather than to the people who earned it.  Government is not spending that money; it is merely not extracting that money from the private sector.  Statists deliberately use terms like “tax expenditure” precisely because that erroneous impression obscures their efforts to raise your taxes.

Less than an hour after posting, Matthew Yglesias of the Center for American Progress Action Fund called me “daringly inaccurate.”  (Why be timid?)  The Manhattan Institute’s Josh Barro devoted a very thoughtful 1,155 words to the topic at NRO.

Yglesias explains in an email:

I understand why you might want to object to the “tax expenditure” phrasing, but surely we can agree that there’s such a thing as a “tax subsidy,” right? If the government declares that fuel-efficient hybrid cars are now tax-deductible, that’s a subsidy to the makers and purchasers of Priuses.

I’m afraid I cannot agree to that.

  • The term “tax expenditure” is nonsense because not taking Peter’s money, conditional on Peter buying a Prius, is not the same as spending the same amount of money on a Prius.  The outcome may be exactly the same.  But no one can spend money that he doesn’t possess.
  • The term “tax subsidy” is likewise nonsense because a subsidy involves giving something to someone else.  Not taking Peter’s money, conditional on Peter buying a Prius, is not a subsidy to Peter.  The government is not giving Peter anything.  Nor is it a subsidy to Paul, even though he profits from Prius sales: the government is not giving anything to Paul, either.  Again, the outcome may be exactly the same as a government subsidy.  Notably, Paul’s income rises.   Yet it does not rise because Paul received a subsidy.  Paul’s income rises because the state used coercion in a different way: to alter, for Peter, the cost of a Prius relative to other uses of Peter’s income.
  • To see the absurdity, consider what it would mean to eliminate a “tax subsidy.”  All else equal, eliminating an actual government subsidy reduces the tax burden.  Eliminating a “tax subsidy” increases someone’s tax burden.  Which is the whole point, isn’t it?

Barro makes more of our disagreement than actually exists.

  • We agree targeted tax preferences are harmful.  (I argue, for example, that the tax exclusion for employer-sponsored health insurance operates more like a tax hike than a tax break because, among other atrocities, it denies the typical parent control over $10,000 of her earnings.)
  • We agree they expand government power.
  • We agree government should account for them.  (Along those lines, the Congressional Budget Office has developed a concept it calls the “federal budgetary commitment to health care,” which is the sum of all federal health spending and all tax revenue forgone due to health-related tax loopholes.  The CBO calls them “tax expenditures” –  grrrr.  I dislike “budgetary commitment” for the same reason: the government can’t commit resources it doesn’t possess. But the CBO is on to something. We need an aggregate measure of “federal budgetary interference in the economy.”)
  • Finally, Barro and I probably agree that Congress should simultaneously eliminate all such loopholes and reduce marginal payroll- and income-tax rates – perhaps to zero.

I reject the term “tax expenditure” – as distinct from the concept – because it is nonsensical and biases the debate toward more government control of the economy and our lives.   Barro asks what term I’d prefer. Until someone comes up with something pithier than “tax revenue forgone due to targeted tax preferences,” I’ll stick with that.

Is the FAIR Tax a Political Liability?

In the past 15 years, I’ve debated in favor of a national sales tax, testified before Congress on the merits of a national sales tax, gone on TV to advocate for a national sales tax, and spoken with dozens of reporters to explain why a national sales tax is a good idea. Even though I prefer a flat tax, I’ve been an ardent defender of sales tax proposals such as the FAIR tax because it would be a great idea to replace the current system with any low-rate system that gets rid of the tax bias against saving and investment. I even narrated this video explaining that a national sales tax and flat tax are different sides of the same coin — and therefore either tax reform proposal would significantly improve prosperity and competitiveness.

I will continue to defend the FAIR tax and other national sales tax proposals that replace the income tax, but I wonder whether this is a losing battle. Every election cycle, candidates that endorse (or even say nice things about) the FAIR tax wind up getting attacked and put on the defensive. Their opponents are being dishonest, and their TV ads are grossly misleading, but they are using this approach because the anti-FAIR tax message is politically effective. Many pro-tax-reform candidates have lost elections in favorable states and districts, largely because their opponents were able to successfully demagogue against a national sales tax.

The Wall Street Journal reaches the same conclusion, opining this morning about the false — but effective — campaign against candidates who support a national sales tax.

In 16 House and three Senate races so far, Democrats have blasted GOP candidates for at one point or another voicing an interest in the FAIR tax. …FAIR tax proponents are right to say these Democratic attacks are unfair and don’t mention the tax-cutting side of the proposal, but the attacks do seem to work. Mr. Paul’s lead in Kentucky fell after the assault, and the issue has hurt GOP candidate Ken Buck in a close Colorado Senate race. In a special House election earlier this year in Pennsylvania, Democrat Mark Critz used the FAIR tax cudgel on Republican opponent Tim Burns. In a district that John McCain carried in 2008, Mr. Critz beat the Republican by eight points and is using the issue again in their rematch. This is a political reality that FAIR taxers need to face. …[I]n theory a consumption tax like the FAIR tax is preferable to an income tax because it doesn’t punish the savings and investment that drive economic growth. If we were designing a tax code from scratch, the FAIR tax would be one consumption tax option worth debating. But … voters rightly suspect that any new sales tax scheme will merely be piled on the current code.

We won’t know until next Tuesday what is going to happen in Kentucky and Colorado, and we won’t know until then what will happen in the other campaigns where the FAIR tax is an issue. But if there are two tax reform plans that achieve the same objective, why pick the approach that faces greater political obstacles?

FAIR tax proponents presumably could defuse some of the attacks by refocusing their efforts so that repealing the income tax is the top priority. This would not require any heavy lifting since all honest proponents of a national sales tax want to get rid of the 16th Amendment and replace it with something that unambiguously prohibits any direct tax on income. So why not lead with that initiative, and have the national sales tax as a secondary proposal? This is what I propose in the video, and I think it would be much harder for demagogues to imply that a FAIR tax would mean a new tax on top of the corrupt system that already exists.