Topic: Tax and Budget Policy

Berniecare Outline Leaves Important Questions Unanswered and Would Add Trillions to the Debt Even After Massive Tax Increases

Just before last weekend’s Democratic debate, Bernie Sanders finally released the long-awaited plan for his health care proposal, which would fundamentally transform the health care sector by replacing all health insurance with a single program administered by the federal government. Michael Cannon has ably explained how Obamacare was really the big loser of the back and forth at the debate, but it’s worth looking further into Sanders’ outline of a plan. At just seven pages of text, it leaves most of the major questions unanswered. It does list a bevy of tax increases that it say will finance the needed $1.38 trillion in new federal spending each year, although even this is a significant underestimate. Bernie’s plan promises universal coverage and savings for families and businesses without delving into of the necessary, and often messy, trade-offs. 

While he calls the plan ‘Medicare for all,’ the plan would actually cover even more services than Medicare and do away with the program’s cost-sharing components like co-payments, deductibles, and premiums. Giving people comprehensive coverage of “the entire continuum” at little cost to themselves would seem to significantly increase utilization, which would strain the system’s capacity while also rendering it unaffordable. The plan makes no effort to answer fundamentally important questions: How would the new system determine payment rates for health care providers? What, if anything, would it do to try to rein in the growth of health care costs?

The “Getting Health Care Spending Under Control” section of the plan is one paragraph long and offers little beyond assurances that “creating a single public insurance system will go a long way towards getting health care spending under control” and under Berniecare “government will finally be able to stand up to drug companies.” That this is hardly a comprehensive plan and gives the impression that in this system, cost control measures would somehow be painless.

Hillary Clinton’s Proposed Tax Increase

Presidential candidate Hillary Clinton is proposing to increase taxes on high earners with a four percent surtax on people making more than $5 million.

Imposing such a tax hike would:

  • Encourage more tax avoidance and evasion, the sort of behaviors that Clinton and other politicians bemoan.
  • Increase deadweight losses, or economic damage, of taxation. This damage rises by the square of the tax rate, so for example, a 40 percent rate causes four times the damage of a 20 percent rate. This feature of our tax system means that raising the top rate is the worst way to raise revenue, even if raising more revenue made sense, which it does not.
  • Discourage the work and investment efforts of the most productive people in the economy. Entrepreneurs, executives, angel investors, venture capitalists, and other high earners add enormous value to the economy. Politicians should focus on removing barriers to their efforts, rather than penalizing them. Besides, the income of high earners is more flexible and mobile than the income of other people, so raising their taxes causes the strongest behavioral responses and largest deadweight losses.
  • Raise taxes on the people already paying the highest rates. Average tax rates rise rapidly as income rises. In 2015 those earning more than $1 million paid an average federal tax rate (including income, payroll, and excise taxes) of 33 percent. That is twice the rate of people with middling incomes, and many times the rate of people at the bottom.
  • Push the top U.S. income tax rate substantially higher than our trading partners in the OECD (Table 1.7). The top U.S. federal and average state tax rate is already 46 percent, which compares to the OECD average of 43 percent.
  • Move even further away from the fair and efficient ideal of a proportional, or flat, tax system. The United States already has the most graduated, or progressive, tax system in the OECD.

Perhaps the biggest problem with Clinton’s plan is that the federal government already taxes and spends too much. The American economy and average citizens would be better off if the size and scope of the government were reduced. Clinton’s tax increase would not solve any problems, but rather would add fuel to the fire of rampant bureaucratic failure in Washington.

Ben Carson’s Tax Plan

Presidential candidate Ben Carson released a three-page tax plan yesterday. Based on the limited information the plan includes, it looks like the best GOP plan so far.

Individuals and businesses would be subject to a simple 14.9 percent flat tax. The tax base appears to be of the Hall-Rabushka (HR) design, which is the gold standard of simple and pro-growth tax structures. I say “appears to be” because the Carson three-pager gives some hints, but not full details.

The defining feature of HR is that income is taxed once and only once. The current double taxation of savings and investment would be ended. Capital income would be taxed at the business level under HR, while labor income would be taxed at the individual level. Robert Hall and Alvin Rabushka proposed the HR tax structure back in 1981, as I discuss here. Rabushka, by the way, is a Cato adjunct scholar.

Ben Carson seems to have avoided the dangerous business VAT structure of the Ted Cruz and Rand Paul tax plans. He appears to be critiquing Cruz and Paul in this passage:

Unlike proposals advanced by other candidates, my tax plan does not compromise with special interests on deductions or waffle on tax shelters and loopholes.

Nor does it falsely claim to be a flat tax while still deriving the bulk of its revenues through higher business flat taxes that amount to a European-style value-added tax (VAT).

Adding a VAT on top of the income tax would not only impose an immense tax increase on the American people, but also become a burdensome drag on the U.S. economy.

The War against Cash, Part II

I wrote yesterday that governments want to eliminate cash in order to make it easier to squeeze more money from taxpayers.

But that’s not the only reason why politicians are interested in banning paper money and coins.

They also are worried that paper money inhibits the government’s ability to “stimulate” the economy with artificially low interest rates. Simply stated, they’ve already pushed interest rates close to zero and haven’t gotten the desired effect of more growth, so the thinking in official circles is that if you could implement negative interest rates, people could be pushed to be good little Keynesians because any money they have in their accounts would be losing value.

I’m not joking.

Here’s some of what Kenneth Rogoff, a professor at Harvard and a former economist at the International Monetary Fund, wrote for the U.K.-based Financial Times.

Getting rid of physical currency and replacing it with electronic money would…eliminate the zero bound on policy interest rates that has handcuffed central banks since the financial crisis. At present, if central banks try setting rates too far below zero, people will start bailing out into cash.

And here are some passages from an editorial that also was published in the FT.

…authorities would do well to consider the arguments for phasing out their use as another “barbarous relic”…even a little physical currency can cause a lot of distortion to the economic system. The existence of cash — a bearer instrument with a zero interest rate — limits central banks’ ability to stimulate a depressed economy.

Meanwhile, Bloomberg reports that the Willem Buiter of Citi (the same guy who endorsed military attacks on low-tax jurisdictions) supports the elimination of cash.

Citi’s Willem Buiter looks at this problem, which is known as the effective lower bound (ELB) on nominal interest rates. …the ELB only exists at all due to the existence of cash, which is a bearer instrument that pays zero nominal rates. Why have your money on deposit at a negative rate that reduces your wealth when you can have it in cash and suffer no reduction? Cash therefore gives people an easy and effective way of avoiding negative nominal rates. …Buiter’s solution to cash’s ability to allow people to avoid negative deposit rates is to abolish cash altogether.

So are they right? Should cash be abolished so central bankers and governments have more power to manipulate the economy?

There’s a lot of opposition from very sensible people, particularly in the United Kingdom where the idea of banning cash is viewed as a more serious threat.

The War against Cash, Part I

Politicians hate cash.

That may seem an odd assertion given that they love spending money (other people’s money, of course, as illustrated by this cartoon).

But what I’m talking about is the fact that politicians get upset when there’s not 100 percent compliance with tax laws.

They hate tax havens since the option of a fiscal refuge makes confiscatory taxation impractical.

They hate the underground economy because that means hard-to-tax economic activity.

And they hate cash because it gives consumers an anonymous payment mechanism.

Let’s explore the animosity to cash.

Warren Buffett’s Tax Rate Rhetoric

Billionaire Warren Buffett is campaigning with presidential candidate Hillary Clinton, and he is echoing her class warfare rhetoric. In Nebraska the other day:

As Mr. Buffett introduced Mrs. Clinton, he outlined statistics showing that the richest 400 Americans saw their incomes rise sevenfold between 1992 and 2012, the most recent year IRS data were available. During that period, their average tax rate dropped by about one-third, he said.

Buffett is referring to this data published by the IRS. The sevenfold increase Buffett refers to is not adjusted for inflation. The IRS provides a column with inflation-adjusted income, but Buffett decided not to use that data.

But the main problem with Buffett’s statement is that the one-third tax rate drop is explained by 2012’s lower capital gains and dividend tax rates. Buffett probably wants people to believe that nefarious loopholes caused the drop, but the real reason was a serious policy change widely supported by economists and tax experts.

Under the income tax, dividends and capital gains are generally taxed at both the corporate and individual levels. That double taxation creates serious distortions, such as inducing U.S. corporations to become excessively indebted. The capital gains and dividend tax rate cuts under George W. Bush (now rescinded) partly fixed the double taxation.

In the following table, I roughly recalculate the 1992 and 2012 tax rates for the Top 400 excluding the reduced-rate dividends and capital gains. (Capital gains had a reduced rate both years, and dividends had a reduced rate in 2012).

Without the reduced rates on capital gains and dividends, the average tax rate for the Top 400 was virtually unchanged—25.6 percent in 1992 and 25.4 percent in 2012.

So Buffett’s complaint about the tax rate on top earners is really a complaint about tax reforms for capital gains and dividends. Rather than trying to inflame liberal voters with out-of-context data, Buffett should provide his economic arguments about the proper treatment of capital gains and dividends in the tax code.

I provide the arguments for reduced capital gains tax rates here. Just about every developed country has reduced capital gains tax rates. In 2012 the average tax rate across the OECD was just 16 percent. So Buffett should explain why he thinks all those countries are getting it wrong on capital gains.

There are other interesting things about the IRS data on the Top 400. Buffett, Clinton, Sanders, and the rest would have us believe that this is a permanent group of the wealthy aristocracy. Actually, there is huge turnover in the Top 400, as I discuss here. Most reach this top group for only a single year, often when they are selling their family businesses and realizing a capital gain. The IRS table shows that 68 percent of all income of the Top 400 is capital gains.

Finally, the IRS data show that the share of overall federal taxes paid by the Top 400—even with the reduced capital gains and dividend tax rates in 2012—rose from 1.04 percent in 1992 to 1.89 percent in 2012. Buffett is quoted saying of the Top 400, “the game has been stacked in their direction.” But if the Top 400 are paying a higher share, the game is clearly stacked against them.

Finland to Break New Ground with Basic Income Experiment

Despite some of the breathless headlines, Finland is not adopting a national universal basic income. That is, Finland is not scrapping the existing welfare system and distributing the same cash benefit to every adult citizen without additional strings or eligibility criteria. Finland is moving forward with one of the most extensive and rigorous basic income experiments in decades, which could help answer some of the lingering questions surrounding the basic income. The failures of the current system are well documented, but there are concerns about costs and potential work disincentives with a basic income. Finland’s experiment could prove invaluable in trying to find an answer some of these questions, and whether it is possible some kind of basic income or negative income tax would be a preferable alternative to the tangled web of programs in place now.

The Finnish Social Insurance Institution (Kela) will lead a consortium of think tanks, universities, and businesses in surveying the existing literature, analyzing past experiments, and designing different models to test in Finland. They will present an interim report next March, where the government will decide which models to develop further. The consortium will present a final report in November, after which the government will choose which models to actually test. The experiment will begin in 2017 and last for two years, after which the consortium will begin to evaluate the results.

One of the most important issues with any basic income proposal is deciding whether it would replace the current system or be added on to the existing structure. (The latter, of course, does not have much appeal from a limited-government perspective.) The consortium is considering multiple models, as Kela’s presentation shows: