Topic: Tax and Budget Policy

Libor Lies

“Libor Fog” is the apt warning above the headline of today’s front-page Wall Street Journal piece by Carrick Mollenkamp, “Bankers Cast Doubt on Key Rate Amid Crisis.” The article is about the interest rate on loans between banks—the London Interbank Offered Rate (Libor). “A small increase in Libor can make a big difference for borrowers,” says the author. For example, “A risky ‘subprime’ mortgage loan might carry an interest rate of Libor plus more than six percentage points.”

An accompanying graph shows the spread between the 3-month Libor and the 3-month Treasury bill rate. The article explains that “the gap between the two stood at 1.58 percentage points Tuesday, and has averaged 1.39 percentage points since the crisis began in August.”

Anyone reading this article surely thought Libor had increased “since the crisis began in August.” Why else would the graph be titled “Costly Credit”? Why else would the article have emphasized the way an increase in Libor affects subprime adjustable rate mortgages?

“On Tuesday [April 15],” the article says, ‘the Libor rate for three-month dollar loans stood at 2.716%.” In July 2007– before “the crisis began in August”–that Libor rate was 5.360%.

The reason the spread between Libor and Treasury bills widened is not that Libor rates have increased but that 3-month T-bill rates fell from 4.95% last July to about 1.2% lately, thanks to Fed easing and a flight to quality. That drop of 3.75 percentage points in T-bill rates since last July was even greater than the 2.65 percentage point drop in Libor, so the spread between the two widened. So what??? You and I can’t borrow at the T-bill rate either.

Like other factually misleading news reports, cutting the Libor rate in half (“since the crisis began in August”) is not what most people think of as a “credit crisis.”

Rebate Folly

I was exploring some old CBO reports for information on dynamic budget scoring and I came across this nugget:

If a tax cut—such as a rebate or a higher standard deduction—does not reduce the tax on income from an extra hour of work, the additional income will create an incentive for people to cut back their working hours and spend more time at home. Not everyone will respond, but some people (especially second workers in a family with one full-time earner) may decide to leave the labor force to care for children or aging parents or to pursue other interests.

(Supplement to CBO’s May 9, 2002, Testimony on Federal Budget Estimating May 2002 CONGRESSIONAL BUDGET OFFICE, page 9)

We are about to receive a rebate in May this year as part of the economic stimulus that Congress passed in February. I suppose the folks at the CBO would have pointed out that although a rebate may stimulate consumer spending, it is also likely to reduce labor supply. The net impact, therefore, would not necessarily involve any increase in national output but it would certainly induce stronger inflationary pressures—adding fuel to the inflationary fire the Fed’s apparently stoking by cutting interest rates so rapidly. So it’s perhaps not surprising that the dollar’s value took a nosedive during February this year.

Higher rebate-induced debt and higher inflation implies higher future interest rates and, therefore, increased cost of financing consumer and investment spending. Rebate recipients will benefit today, but everyone will lose in the long-term as the economy becomes more sluggish.

Bottom line: Politicians gain by appearing to be doing something – and most of us lose!

Attention Sen. McCain: Moderation in the Pursuit of Tax and Spending Cuts is No Virtue

Reporters are lighting up my voice mail and inbox with queries about what I make of Sen. John McCain’s call today for suspending SPR fill orders and the federal gasoline tax from Memorial Day to Labor Day in a bid to get gasoline prices down. Color me tepid.

Let’s take these issues one at a time. John McCain is absolutely correct to blame the SPR for helping to drive-up world crude oil prices. Oil economist Phil Verleger, for instance, thinks that federal fill orders for the SPR has driven up the price of crude by at least $10 a barrel and perhaps as much as $30. But why only temporarily stop the madness? Now’s a good time to dump the all federal inventories on the market and shut the SPR down once and for all. If we’re lucky, we’ll burst what may be an oil price bubble along the way and finally have something positive to show for the tens of billions of dollars of taxpayer funds that have been sunk into this white elephant.

The same goes for the federal gasoline tax. John McCain of all people should know that federal gasoline tax revenues are steroids for localized pork and special-interest subsidy. Road construction and maintenance (and the taxes that pay for them) should be turned back to state and local governments. A short-term moratorium on taxes, however, would probably have little impact on pump prices. If gasoline supplies are relatively fixed over the next several months (as I suspect they are), any service station that tried to pass the tax cut on to consumers would find demand increasing beyond where it otherwise would have been, and that increased demand would bid prices back up to where they were before federal taxes were cut. Over the long term, a cut in federal gasoline taxes would indeed reduce pump prices, but that’s not what John McCain is talking about here.

Sen. McCain is on the right track. But half-measures won’t accomplish much.

Supreme Court to Nation: Happy Tax Day!

In a fit of either highly coincidental timing or good humor, the Supreme Court today released opinions in two tax cases. In MeadWestvaco Corp. v. Illinois Department of Revenue, the Court limited the power of states to tax the money that a company based in another state earns when it sells off an investment in a division involved in a separate line of business. In U.S. v. Clintwood Elkhorn Mining Co., the Court decided that a taxpayer seeking a refund for an invalid tax under the Constitution’s Export Clause must seek a refund from the government before bringing a lawsuit.

So the taxpayers went 1-1 today, but the cases were both technical and not worth getting into. Perhaps the only interesting thing about them – aside from this whole Tax Day thing – is that they were both unanimous. This technicality and unanimity could be further evidence of Chief Justice Roberts trying to steer the Court to take on less high-profile (typically business) cases, with narrow issues that prevent the fractured 5-4 decision-making that make the Court seem more political than it really is (or should be).

Flat Tax or National Sales Tax?

On this unfortunate day, when many of us are pulling out our hair as we deal with last minute tax headaches, it is helpful to think there may be a better future. Some of us fantasize about a flat tax while others of us dream about a national sales tax. Both of these tax plans share common principles - including a low rate, no double taxation, and equal treatment of economic activity. That’s the good news. The bad news is that the existence of two attractive tax reform plans has divided the pro-tax reform camp, and this has rebounded to the benefit of the status quo. But this division is not necessary. In a new video released by the Center for Freedom and Prosperity, I explain why it is important to junk the system. More important, I suggest a strategy for uniting tax reform advocates:

As always, I welcome feedback on these videos.

Flat Tax Progress in Hungary and Poland

While most other East European nations have adopted pro-growth flat tax systems, Hungary and Poland are still burdened by class-warfare systems that penalize people for contributing more to economic performance. The Budapest Times, however, reports that Hungary’s small parties may combine to push through an 18 percent flat tax:

MDF leader Ibolya Dávid called for opposition parties to attend talks on 15 April to work out details of a bill to submit to parliament by May. The party wants to emulate regional peers such as Slovakia and Romania by introducing a flat 18% personal income tax to reduce a tax burden it called “unfairly high”. The Free Democrats (SZDSZ) and main opposition party Fidesz - along with its ally the Christian Democrats (KDNP) - have said in the past that they would favour a flat tax. …The MSZP has only 190 seats in the 386-seat parliament, meaning that the opposition parties could force through a flat tax bill by banding together. Hungary is ranked as having the second-highest tax burden for single people, behind Belgium, amongst the members of the Organisation for Economic Cooperation and Development (OECD). Many feel the high burden - made worse in 2006 when the government hiked taxes as part of its economic reforms - damages Hungary’s regional competitiveness.

Meanwhile, the Polish government already has promised to implement a flat tax, but a key official has suggested that the new system may be implemented in 2009 rather than in 2010 or 2011 as originally planned. Because of its size and geography, Poland’s shift to a flat tax would be a momentous development and could sharply increase the pressure for pro-growth reforms in Old Europe:

According to Zbigniew Chlebowski, head of ruling Civic Platform’s (PO) parliamentary club, there is a possibility of introducing a flat tax rate as early as 2009. Chelbowski said that Prime Minister Tusk supports this option and is ready to fight President Kaczynski should he veto it. Chelbowski, however, did not give a concrete rate of the possible flat tax, but stressed that it shall surely be lower than 18 percent, because such a rate would be higher than the present tax rates. The final decision is to be made in July or August. The ruling Civic Platform had originally planned to introduce the new tax in 2010 or 2011.

Who Wins the Tax Competition Debate?

The Wall Street Journal posted an online debate between yours truly and Raymond Baker of the Brookings Institution. We are supposed to decide which is worse: tax havens or high taxes. I began the debate by explaining:

Tax competition is a liberalizing force. When politicians worry that jobs and investment have the freedom to cross borders, their reflexive desire to overtax and overspend is at least somewhat curtailed. Tax havens play a valuable role in this process, and this helps explain why income tax rates have dropped by more than 25 percentage points since 1980 and corporate rates have fallen by more than 20 points. These reforms have greatly strengthened the global economy, improving living standards across the board and helping to lift hundreds of millions of people out of poverty. Efforts by bureaucracies such as the OECD to create a tax cartel – an “OPEC for politicians” – should be rejected.

In his contributions, Mr. Baker largely avoided any debate about tax competition and repeatedly asserted that tax havens were refuges for dirty money. I cited numerous sources that suggest otherwise. I then closed by arguing that: Because of tax havens and tax competition, the world today is much more prosperous and global poverty has been reduced. The OECD should not be allowed to disrupt the world economy by stifling competition and creating an “OPEC for politicians.” Every nation has the sovereign right to determine its own tax and privacy laws – and to control the taxation of economic activity inside its borders. Tax competition is good for America, good for the world, and good for freedom.

It will be interesting to see whether the comments in the reader forum will favor one side or the other.