Topic: Tax and Budget Policy

Finally, Some Not-So-Bad News on the Budget

The big surprise in the Congressional Budget Office mid-year budget estimates released today isn’t that the year-to-year deficit shrank again.  Or that the long-term liabilities in Medicare and Social Security continue to impend. 

The surprise is that federal spending will only grow about 3% in the current fiscal year that ends this October.  That’s a big improvement over the annual average 7% growth we’ve seen since the first day of the George W. Bush presidency.

How did that happen?  Those familiar with my previous research will probably not be surprised to hear that the new political reality – divided government – has something to do with it.

True, agriculture subsidies are lower this year as a result of higher crop prices.  And the run-up in spending on a variety of programs in 2006 – like the payouts on flood insurance policies after Hurricane Katrina – was temporary.  The most remarkable factor in the trends, however, is that non-defense discretionary spending has been frozen for the first time since the maiden budget of the “Republican Revolution” Congress.  (If the trends CBO estimates hold for the remainder of the year, such spending might actually decline by $1 billion.) 

Sure, part of this is also the result of a decline in spending on federal Katrina relief.  But there’s something else going on, too.  Earlier this year, the new Democratic Congress decided to put the federal budget on auto-pilot until October.  Instead of passing new appropriations bills to fund the government for the entire year, they passed what is called a “continuing resolution” to keep the government operating. 

This didn’t happen because the Democrats were all that interested in spending less money.  They just wanted to get the old budget work left to them by the outgoing Republican Congress off the table so they could get on with more ideological-base-friendly legislation, like the minimum wage increase.  And the Democrats knew that the president might finally start vetoing legislation, too.  A protracted battle over the budget wasn’t something they wanted to spend their energy on in the first half of the year.  Thus, the auto-pilot continuing resolution: a piece of legislation that keeps the government running at basically the inflation-adjusted level of the previous year. 

With the White House veto strategy finally a credible threat*, it looks like we might have a similar sort of outcome on spending this year, too.  Isn’t divided government wonderful? 


* As I told David Jackson of USA Today a few weeks ago, George W. Bush “dislikes Democrats more than he likes big government.”

More Thoughts on Trade Enforcement

In addition to the sock safeguard action against Honduras, the U.S. government recently requested arbitration over alleged violations by Canada of the 2006 Softwood Lumber Agreement.  (We’ve written about this long-running dispute here, here, and elsewhere). Under the SLA, Canada is required to restrict the volume of its exports or impose an export tax (or some combination of the two) when the prevailing monthly price falls below U.S. $355 per million board feet.

The deal, which the Canadians signed with guns to their heads, was agreed during a period of a robust housing market and relatively high lumber prices.  With the decline of the U.S. housing market, lumber prices have gone south, and the stipulation that Canada intervene in the lumber market has kicked in.

Enforcement in this case, then, means that the housing market slump will endure longer than it has to.  Builders will be less capable of offsetting rising mortgage rates with lower priced homes, as the cost of their most important input remains artificially high.

Even the cost of nails should be expected to rise and for the same reason –  enforcement.  On Tuesday, the U.S. International Trade Commission determined preliminarily that imports of certain steel nails from China and the United Arab Emirates (co-winners of the 2006 Congressional Pinata of the Year Award) are being sold at less than fair value in the United States and causing material injury to domestic producers.   Additional duties are likely to be formalized by the end of the year. 

Thus, the administration’s indulgence of Congress’s demands for more trade enforcement will have the noble effect of making life more difficult, in particular, for Americans at the lower end of the income spectrum, who will need to devote more of their limited resources to housing and socks.  More often than not, trade enforcement is just another term for regressive taxation.

Denmark’s Meager Tax-Cut Package

The good news is that Danish politicians have announced that taxes will be reduced. This is welcome news in a nation with the world’s highest income tax rate. Indeed, the tax burden is so onerous that even the OECD suggested it might not be a good idea to subject 40 percent of workers to marginal tax rates of more than 70 percent. Unfortunately, the tax cuts that have been proposed are akin to putting a band-aid on a compound fracture. Instead of reducing the top tax rate, the government merely intends to adjust the income level where the top bracket takes effect. While this surely is better than nothing, the government also is raising taxes on energy and increasing an already bloated welfare system. Tax-news.com reports on Denmark’s less-than-exciting reforms:

The Danish government has announced its intention to cut taxes by DKK10 billion (EUR1.34 billion) per year in 2008 and 2009 in a bid to stimulate the labour market, and improve incentives to work. Under the proposed reforms, announced by the government on Tuesday, the income ceiling for the middle and top income tax brackets will be raised to DKK353,000 per year from DKK304,100, and to DKK381,300 per year from DKK365,000, respectively. …In the same announcement, the Danish government also promised that a broad economic plan for the next eight years would not raise any taxes between now and 2015. The economic package also promises DKK50 billion in extra spending to improve Denmark’s welfare system between 2009 and 2018. …To help offset the tax cuts, the government also announced that green taxes on energy consumption would increase from 2008 to match inflation. This would increase taxes on heating, water and electricity.

Czech Republic Joins the Flat Tax Club

Following up on Marian’s earlier post, it’s time to cue up the unofficial theme song of the flat tax revolution and review one of the first English-language news reports about the Czech Republic becoming the 20th jurisdiction to adopt a low-rate flat tax. The Prague Daily Monitor reports that the vote in the Chamber of Deputies clears the only real obstacle to a low-rate tax system:

The cabinet’s package of public-finance reforms passed the final vote in the Chamber of Deputies yesterday thanks to two unaffiliated opposition MPs who voted with the governing coalition. Starting next year, the legislation will gradually reduce corporate and personal-income taxes, cut social spending and introduce cash fees for health care. It still requires Senate approval and President Václav Klaus’s signature, but no resistance is expected from either. …

The reform package will gradually lower the corporate tax rate from today’s 24 percent to 21 percent next year, 20 percent in 2009 and 19 percent in 2010. The existing progressive taxation of personal income at 12 to 32 percent will be replaced by a flat tax of 15 percent in 2008 and 12.5% in 2009. The personal income tax will be calculated from super-gross income, including social and health insurance contributions paid by the employee and the employer. This means effective taxation will be 23.1 percent of gross income in 2008 and 19.4 percent in 2009.

The Czechs Adopt a Flat Tax

The lower house of the Czech parliament passed legislation earlier today implementing a 15 percent flat tax on personal income. The new tax system will take effect on January 1, 2008, and the rate is then scheduled to drop to 12.5 percent in 2009. The legislation also reduces the corporate tax rate from 24 percent today to 19 percent by 2010.

The reform, which was narrowly passed by 101 members of the 200-member parliament, now goes to the upper house, where the government has a massive majority and no obstacles are expected. Once the reform clears that hurdle, it will then be signed into law by the Czech President Vaclav Klaus, who is a free-market economist. That act would make the Czech Republic the 20th country to adopt a flat tax. (The Bulgarian government has agreed to introduce a flat tax by January 2008, but the measure has not yet passed through the Bulgarian parliament.)

The opposition socialists have stated that they will repeal the law if or when they return to power and may even raise constitutional objections to it. For now it seems, however, that the legislation will come into force.

The Czech flat tax is a big step in the right direction, and another sign that tax competition is having a positive effect. But the legislation is not perfect. One of the salient features of a pure flat tax is the elimination of tax exemptions, deductions and loopholes. The Czech legislation is less ambitious and many of the bad features of the current system will remain in force. Also, the 15 percent tax rate will be levied on gross income, including payroll taxes. This means the tax rate is not directly comparable to nations that impose the flat tax only on net income, such as Slovakia.

Get Rid of the National Weather Service

Because of technological advances, there is very little reason for taxpayers to shell out nearly $1 billion annually to finance a national weather service. As John Lott explains at Foxnews.com, private forecasters exist and (gee, what a surprise) they do a better job than government bureaucrats:

Despite dire predictions from the National Hurricane Center, no hurricanes hit the U.S. last year. …private weather forecasting companies predicted the threat to New Orleans well before the National Weather Service. In fact, AccuWeather issued a forecast that the hurricane would hit New Orleans 12 hours earlier than the government service. …It is not just for hurricanes that private forecasting comes out on top. A new study by Forecast Watch, a company that keeps track of past forecasts, found that from Oct. 1, 2006, through June 30, 2007, the government’s National Weather Service did very poorly in predicting the probability of rain or snow. Comparing the National Weather Service to The Weather Channel, CustomWeather, and DTN Meteorlogix, Forecast Watch found that the government’s next-day forecast had a 21 percent greater error rate between predicted probability of precipitation and the rate that precipitation actually occurred. In looking at predicting snow fall from December 2006 through February 2007, the National Weather Service’s average error was 24 percent greater. “All private forecasting companies did much better than the National Weather Service,” the report concludes.

Tax Code Industrial Policy

Millionaire football fans are among the beneficiaries of supposed emergency hurricane tax relief according to an AP report. The only positive aspect of this story is that the special tax breaks deprive politicians of extra money to waste (though they will continue to borrow and waste, so don’t get too excited). Actually, this corrupt form of tax-code industrial policy also has another positive attribute – it is an excellent example of why the internal revenue code should be junked and replaced with a simple and fair flat tax:

…federal tax breaks designed to spur rebuilding are flowing hundreds of miles inland to investors who are buying up luxury condos near the University of Alabama’s football stadium. About 10 condominium projects are going up in and around Tuscaloosa, and builders are asking up to $1 million for units with granite countertops, king-size bathtubs and ‘Bama decor, including crimson couches and Bear Bryant wall art. …And they intend to take full advantage of the generous tax benefits available to investors under the Gulf Opportunity Zone Act of 2005, or GO Zone, according to Associated Press interviews with buyers and real estate officials. …The GO Zone was drawn to include the Tuscaloosa area even though it is about 200 miles from the coast and got only heavy rain and scattered wind damage from Katrina. …The GO Zone investor tax breaks are credited with contributing to the condo boom in Tuscaloosa.