Topic: Tax and Budget Policy

Bush’s Dismal Fiscal Record

Kevin Hassett of the American Enterprise Institute crunches a few numbers to estimate what would have happened to government spending if George Bush had simply maintained Bill Clinton’s non-defense budget. The sad answer is that the federal government would be about $400 billion smaller. The implications, particularly for tax policy, are staggering:

Bush has outspent Clinton by a mile. …If we now had the lower spending levels that Bush inherited, we could extend his tax cuts, repeal the alternative minimum tax, enact the current stimulus package, and still have a 10-year budget surplus of $1.9 trillion. And, remember, that allows spending to be adjusted up for the Iraq war and the war against terrorists. …It makes you sick to think about it. All that money wasted on ethanol and bridges to nowhere has accumulated into a pile that massive. Uncle Sam ate a whopping helping of apple pie every day for seven years, and now he is obese. This is important to bear in mind as we move forward to the general election. We don’t have a deficit because of Iraq, or the tax cuts, or the drug benefit. We have a deficit because the government grew fat. We can’t fix that with tax increases. Uncle Sam must go on a diet.

Puncturing the Two-Americas Myth

John Edwards has dropped out of the presidential race, but the left continues to trumpet his class-warfare arguments. The two-Americas theme is endlessly regurgitated, particularly the notion that the rich are getting richer and poor are getting poorer (with the obvious implication that the rich are somehow causing greater poverty). These assertions have been repeatedly discredited (most recently by a Treasury Department study), but practitioners of the politics-of-envy seem impervious to factual arguments. So it highly unlikely that they will bother to read – much less understand – a powerful op-ed in the New York Times by Michael Cox and Richard Alm of the Dallas Federal Reserve Bank. Cox and Alm look at consumption data rather than income data and they find that there is only a modest difference in the living standards of the rich and poor:

…renewed attention is being given to the gap between the haves and have-nots in America. Most of this debate, however, is focused on the wrong measurement of financial well-being. …Looking at a far more direct measure of American families’ economic status — household consumption — indicates that the gap between rich and poor is far less than most assume, and that the abstract, income-based way in which we measure the so-called poverty rate no longer applies to our society. The top fifth of American households earned an average of $149,963 a year in 2006. …they spent $69,863 on food, clothing, shelter, utilities, transportation, health care and other categories of consumption. The rest of their income went largely to taxes and savings. The bottom fifth earned just $9,974, but spent nearly twice that — an average of $18,153 a year. How is that possible? …those lower-income families have access to various sources of spending money that doesn’t fall under taxable income. These sources include portions of sales of property like homes and cars and securities that are not subject to capital gains taxes, insurance policies redeemed, or the drawing down of bank accounts. While some of these families are mired in poverty, many (the exact proportion is unclear) are headed by retirees and those temporarily between jobs, and thus their low income total doesn’t accurately reflect their long-term financial status. So, bearing this in mind, if we compare the incomes of the top and bottom fifths, we see a ratio of 15 to 1. If we turn to consumption, the gap declines to around 4 to 1. …Let’s take the adjustments one step further. Richer households are larger — an average of 3.1 people in the top fifth, compared with 2.5 people in the middle fifth and 1.7 in the bottom fifth. If we look at consumption per person, the difference between the richest and poorest households falls to just 2.1 to 1.

Rev. Huckabee at CPAC

A Feb 8 memo from Mike Huckabee’s campaign chairman and manger, Ed Rollins and Chip Saltsman, explained how the Governor expected to win the Republican nomination. “Governor Huckabee has done best among hardcore Republicans, the activist base. That’s one reason why we are looking forward to Governor Huckabee.s speech to the legendary CPAC, the Conservative Political Action Conference, in DC … You’d better believe that the folks gathered at the OmniShoreham hotel are the go-getters who make or break primary elections. Just wait till they get a load of Mike Huckabee! … And now, with the endorsement of Dr. James Dobson, who is the ‘gold standard’ of social conservatism, we fully expect that Movement Conservatives – those who fight the good fight on Life, on Marriage, on the Second Amendment – will increasingly rally to our cause.”

Gov. Huckabee, exuding all the charm of a southern preacher, told CPAC that he wasn’t schooled in math (or economics), he was schooled in miracles. But even miracles did not produce good math, even with that crowd. A straw poll of presidential favorites among 1705 attendees showed Mitt Romney first with 21% of the vote, followed by Rudy Giuliani at (17%), Sam Brownback (15%) and New Gingrich (14%). Huckabee was an also-ran among “go-getter conservatives who make or break primary elections,” even though he’s the only one running.

Stirring so much religion into politics seems to make even conservative activist nervous. Let the radical Islamists combine church and state –we prefer ours separate, thanks.

Or perhaps the CPAC activists were not persuaded that government agents trying to collect a 30% sales tax would be any gentler or less intrusive than IRS agents. Abolishing the IRS may sound great until you realize that collecting a huge sales tax at the retail level means the government would have to snoop into everything you buy or sell. And, no, the constitution does not grant feds the police power to force state tax collectors to do such dirty work.

There have been some excellent op eds questioning the Fair Tax in The Wall Street Journal by Bruce Bartlett last August 25 and Jerry Bower  on January 8.  Bartlett, a top Treasury tax official from 1988 to 1992, also wrote a solid longer paper on the topic. Disagree with them if you can, but don’t just shout them down. Logic and evidence tend to be more reliable than miracles.

I wrote to Bartlett and Bower saying they had courage to even mention the FairTax, since doing so always brings a flood of cultish email lecturing about the fairness of being fair and how unfair it is to say otherwise. Don’t bother sending such complaints to me, by the way – it now goes straight to my spam folder. Chances are, I’ve read a bit more about taxes than you have, and don’t really welcome any amateur lectures on the subject.

I just added the following comments about a explanation of “Huckanomics” (written by filmmaker Donovan Quinn) on the mikehuckabee.com site. I post it here on the off-chance that it might get, well, misplaced :

No economist would say, as such FairTax fans do, “With businesses no longer passing on the costs of payroll taxes and other imbedded [embedded] costs to their customers, retail prices will drop.” [although one implied that could happen if and only if wages fell too]

If that were true, then everything would be cheaper in states with no income tax, because all tax savings are assumed to be passed on to consumers. Yet the economists’ “Law of One Price” explains why the same good cannot sell for greatly different prices in two places, aside from shipping costs.

If businesses could simply pass on their income and payroll taxes by raising prices, why don’t we buy everything from tax havens which impose little or no direct taxes?

Why do we import anything from Germany and Japan, where income and payroll taxes are much higher than ours? Aren’t their higher income and payroll taxes embedded in higher prices? No, of course not. Business can’t just set prices wherever they like. Prices are set on global markets by supply and demand, not by average cost.

All taxes (including sales taxes) are borne by people in their capacity as suppliers of labor and capital – they can’t just be shifted at will by changing prices.

Experiments with sales taxes above 10% have always failed because intermediate (wholesale) transactions must be exempt to avoid multiple layers of taxation. With a high tax at the retail level, those with access to tax-free wholesale prices would have a huge incentive to sell on the black market. That is very easy with eBay and Pay Pal, and sellers do not have to be in the USA.

Taking a leap of faith is fine, but not when it comes to learning economics. That takes some work.

My 1991 Critique of Extended Unemployment Benefits

Some things never change. Another President Bush was ambushed with extended unemployment benefits shortly before another presidential campaign. Some data in this oldie are dated (though not wildly different from today), but the arguments seem worth another look:

The Cure for Unemployment
Alan Reynolds
The Wall Street Journal , October 3, 1991

Democratic Congressmen hope to make George Bush look like a hard-hearted villain because of his reluctance to spend an extra $6 billion to extend unemployment benefits beyond the usual six months. Yet the current job situation is scarcely an emergency. Unemployment was higher than it is today in all but two of the dozen years from 1975 through 1986. Today, the average spell of unemployment — 14 weeks — is still lower than it was even as recently as 1987. Half of the unemployed find new jobs in fewer than seven weeks.

The congressional push to extend unemployment benefits aims to help a relatively elite minority of the unemployed. Last year, only 39% of the unemployed collected any benefits at all. This was largely because about half of those unemployed did not lose their jobs. They either quit their jobs, were reentering the labor force after a prolonged absence or were young people who had not held jobs before. Another reason many unemployed do not qualify for benefits is that they already have another job lined up, and are just taking some extra time off between employers. Or, they find a new job within three weeks — the waiting period to qualify. And, of course, unemployed illegal immigrants are less than eager to register with government agencies.

Those who are not eligible for unemployment benefits rarely take six months or more to find a job. Conversely, those unemployed for long periods are usually among those who do receive benefits, and often receive supplemental union benefits that can approximate their usual after-tax wages (particularly with some casual labor “off the books”). Moreover, cyclical layoffs account for most of the long-term unemployed, who, because of their seniority, have good reason to wait to be recalled.

Robert Topel of the University of Chicago figures that unemployment benefits could be extended to an entire year without spending another dime. How is that possible? Simply make people wait four weeks rather than three before they qualify for their first check. There are so many more people who collect benefits for a few weeks than for a few months that the savings from that one week would cover the costs.

Regardless of how extended benefits are financed, though, the unemployment rate would surely be significantly higher than otherwise, simply because more people would be subsidized to remain unemployed for longer periods. Studies in the Monthly Labor Review have shown that those who have supposedly been “unable to find a job” in 26 weeks miraculously find one within a few weeks after their benefits run out. They either quit waiting to be rehired in cyclical industries, or accepted second-best jobs that required, for example, moving to a new city.

Giving people almost a year to search for the “right” job could nonetheless be justified, in theory, because it is not in society’s interest to have many people working below their ability. But too long a period of subsidized job search is likely to reduce the intensity with which people look for work, and to delay economically desirable relocation of workers away from areas of high unemployment to areas where they are needed.

Another negative effect of prolonged benefits is that it would further subsidize employers that frequently lay off workers at the expense of those that do not. The tax employers pay for unemployment benefits is already too high, in an actuarial sense, on firms that provide stable employment, and too low on firms that do not. If layoff-prone employers had to bear more of the cost of the dole, they would adopt less volatile strategies of hiring and firing.

Over the longer haul, the more serious problem is not a shortage of jobs, but a shortage of people willing to work at the after-tax wages offered. From 1980 to 1989, the percentage of working-age people who were either working or looking for work rose from 63.7% to 66.5%, as marginal tax rates fell. But labor force participation rates began to dip at the start of 1990, and have now fallen back to 66.2%.

Many wives with working husbands, young people living with parents, and people of early retirement age have simply dropped out of the job market since the 1990–91 increases in Social Security taxes and in marginal federal and state income tax rates. They are indeed “discouraged workers,” but they are discouraged because their added work brings little added after-tax income, not because they couldn’t find jobs if they tried. Leaving the labor force means not trying.

Considering that the economy emerged from recession only a few months ago, the percentage of the unemployed who have quit their jobs is quite high — over 12%, compared with fewer than 8% in 1982–83. And new jobseekers (graduates) account for an unusually small share of the unemployed — 8.4% at mid-year, compared with 13% in 1984. Like the decline in labor force participation, this suggests the problem is not simply a shortage of jobs, but insufficient incentive, after taxes, to accept job offers and stay on the job. Congress should be less concerned about subsidizing lengthy periods between jobs, and far more concerned about tax policies that are shrinking the labor force and the tax base.

Better Late Than Never

I was getting a little concerned about the portentous silence from the administration in response to the U.S. sugar industry’s proposal to manage trade in sugar between the United States and Mexico (more here and here). Like toddlers in another room, silence often means trouble when it comes to the government: they must be up to something.

A swift, clear rejection of the proposal might have instilled more confidence, but today’s statement by Secretary of Agriculture Ed Schafer and United States Trade Representative Susan Schwab rejecting the proposal was welcome all the same. The positive part:

[T]he Administration cannot support recent sugar policy recommendations and will oppose efforts to implement them through legislation.

And the ominous:

We believe we have the tools and the cooperative relationships with the Government of Mexico to ensure the further smooth integration of our sweetener markets.

The use of the phrases “cooperative relationships” and “smooth integration” are not encouraging.

Mr. Regnery’s Advice to John McCain

In today’s Wall Street Journal (Feb 7), Alfred S. Regnery opines as follows (with my comments) on “How McCain Can Convince the Right”:

1. “Take a firm no-new-taxes pledge. Mr. McCain … needs to promise that he won’t increase Social Security taxes – especially by lifting the earnings cap – or increase hidden taxes in regulatory schemes, and that he will try to eliminate the death tax.”

That seems to be asking too much in some respects and too little in others. Regnery is suggesting that McCain do nothing to improve the tax system (as though it’s perfect as is) other than to try to do something he cannot possibly accomplish with this congress. The best defense is a good offense. That doesn’t mean taxing less, in terms of lost loot, but taxing smarter.

McCain’s top economist told me that McCain favors taxing estates (after a large exemption) at the same rate as long-term capital gains. If so, he should not be shy about that – it’s a great idea. That would be much more effective than tilting at windmills until 2011, when the estate tax comes back in full force.

Lifting the earnings cap is indeed a huge threat, adding about 10 percentage points to marginal rates for everyone earning more than $100,000. Expiration of the 2003 tax rates would add another 5 points to that. That would bring the top tax rate to 50%, not to mention state taxes and surtaxes Congressional Democrats have proposed to pay for more health insurance subsidies and easing the alternative minimum tax.

If Democrats want to raise the Social Security tax rate to pay for rising benefits, let them have the courage to propose that. In terms of potential damage to the economy, that would be better than tapping general revenues – which means switching from a flat-rate payroll tax that exempts income from savings to a progressive income tax that applies higher tax rates to both labor and capital.

2. “Get specific on spending. Mr. McCain talks a lot about pork barrel projects, earmarks and the need to get spending under control, but so does everybody. He needs to release a bold, Reaganesque proposal with specific reductions he would pursue as president, what programs he will try to eliminate, and how he will attempt to control a spendthrift Congress… .By getting specific, Mr. McCain would endear himself to a lot of fiscal conservatives.”

Absolutely right. And McCain would also endear himself to a lot of libertarians. It would be risky for Republicans to ignore how much money Ron Paul has pulled up from the grass roots, not to mention votes. That is not just because of Dr. Paul’s good looks and charming wit.

3. “Pick a fight with the press.” That’s bad advice. Let others start any fights. That rule also happens to be good foreign policy, as Ron Paul has observed.

4. “Pick a conservative running mate early. Mr. McCain needs a young vice president with stellar conservative credentials so that conservatives can know that an acceptable successor is being trained and waiting in the wings.”

The giant elephant in this room, the one polite people are not supposed to mention, is that McCain is a cancer survivor and no spring chicken. He is unlikely to serve a second term, and incumbent Vice Presidents have often won the next race. All voters will take his V.P. choice far more seriously than usual.

Regnery likes Gov. Mark Sanford of South Carolina, but national voters don’t know him and there is little time for an introduction. One name they are belatedly beginning to know very well is Mitt Romney. He came close enough in key places like California to have earned the V.P. nod if he’ll take it. In the campaign, I’d send Mitt on tour to focus on economics, where he’s more comfortable than McCain, but ask him to downplay that “competitiveness with China” stuff.

Romney has a few good ideas McCain could borrow, particularly exempting working seniors from the payroll tax. I have minimized the combined income and payroll tax by deliberately minimizing work and salary. But encouraging premature retirement ends up costing the Treasury a lot of income tax revenue, and deprives the economy of skilled labor.

5. “Conservatives … will never forgive him for what they perceive as his abuse of the First Amendment in McCain-Feingold, for his stand on immigration, and for his initial opposition to the Bush tax cuts.”

Regnery is right about McCain-Feingold, for reasons George Will explains better than anybody. But that fight can go on in the legislature and the courts, regardless of who is president. McCain’s positions on immigration and the 2001 tax law are not something that can so easily be dismissed by referring to some checklist of conservative orthodoxy (e.g., must we call a Catholic socialist a “conservative” if he or she wants to allow states to make abortion a crime?).

The American right is diverse, not monolithic or unchanging. In the 1970s I was on the masthead of the magazine Regnery now edits, The American Spectator, as well as those of National Review and Reason. Human Events ran my syndicated column in recent years. Yet that doesn’t mean I feel obligated to agree with Rush Limbaugh on every single topic, or that a Republican candidate has to measure up to some somewhat arbitrary standard of purity. If he’s good on A, B and C, but not so good on X, Y and Z, voters have to think clearly about how to set their own priorities among those issues. Since the president has no authority over “social issues,” and conservatives should fear granting such authority, such choices will often put more weight on good economics, without which costly military spending could soon prove highly problematic.

On complex topics like immigration and taxes, reasonable people can disagree and sometimes they should.

The U.S. labor force is getting old and growing slowly, which is just one reason I think McCain and George W. Bush were both right that we need many more temporary work visas to provide a legal alternative to illegal residence. Nearly half the illegal residents do not sneak across the southern border but arrive here legally by the millions as tourists, students and business travelers.

I was no enthusiast for the 2001 tax bill (although not because the measures threatened Iraq funding or were too kind to the rich). In a Wall Street Journal article on May 30, 2001 I wrote that “the primary objective of the $1.35 trillion cut … seems to have been to maximize revenue loss rather than to minimize tax distortions and disincentives.” I noted that only 31% of the estimated static revenue loss from original Bush tax bill was devoted to reducing the four highest marginal tax rates. Cutting all of the top four rates combined risked less revenue loss than the foolish gesture of reducing the lowest tax rate to 10% from 15% on the first few thousand. Not everything in that bill made sense, even after the worst glitches were fixed in 2003, and no tax law is ever perfect or permanent (least of all one that was designed to self-destruct in 2010).

Mr. Regnery ends by saying “John McCain needs conservatives more than conservatives need John McCain.” That sounds right.

Our Big, Fat Defense Budget

I suppose I should be happy to live in a country that can afford to spend nearly three quarters of a trillion dollars a year on defense even though we are relatively safe, historically speaking. But the defense spending that the President proposed to Congress Monday is so excessive that I can only manage outrage. Everyone complains about earmarks, but they cost $17 billion across the government last year. That’s just two months in Iraq; pocket change in the Pentagon.

Hawks, like Admiral Mike Mullen, the new Chairman of Joint Chiefs of Staff and Secretary of Defense Robert Gates, argue that, hey, it is only 4 percent of GDP. After all, they say, we used to spend far more of our wealth on the military, especially during wars – 35 percent of GDP in World War II and 9 percent in Korea.

That argument, popular as it is, baffles me. The US is about six and half times as rich it was in 1950, adjusting for inflation. Economic growth means that devoting a pegged portion of GDP to the Pentagon is to annually increase defense spending, whatever happens with foreign threats. That’s a silly way to spend tax dollars, to put it mildly. The sensible way to provide defense is look at your enemies’ capabilities and likely scenarios for defeating them and back spending out from that – whether that amounts to one percent of GDP or 30.

And it is not just the waste that offends. According to Steve Kosiak of the Center for Strategic and Budgetary Assessments, the budget will leave the Pentagon short – by $10 to 20 billion a year – of the cash it needs to meet its own requirements. That’s because the budget avoids choice, the essence of strategy. As Fred Kaplan noted the other day, instead of selecting a method of providing defense that would create winners and losers among military services and their platform communities, the non-war budget basically gives the services what they want under a topline. It also gives each service roughly the same relative share of the total as they received in each year since the Kennedy administration, with only a slight uptick this year for the ground forces. That tells you a great deal about George Bush’s claim to have transformed the military.

The worst thing about the budget is that it is bipartisan. No one influential complains. Congressional Republicans on the defense committees are either for it or want more. Democrats knock the Iraq funds, but accept the other $560 billion. History says that the defense budget – at least the non-war portion – that emerges as law next fall will deviate only slightly from what the President submitted.

Why is no one opposed? For one (and I could go on), both parties embrace brands of militaristic hegemony – the idea that that we are better off with massive military predominance over all other powers and that there is a military solution to most foreign policy concerns. Want a liberal world? Buy enough carriers and F-22s so that we can dominate it. China’s growing? Arm so heavily that they cannot compete. Pakistan troubles you? Draw up an invasion plan. Africa is disorderly? Create Africa Command.

But really you can’t blame politicians, who have to get elected. You have to blame the intellectuals who shape public opinion. Blame my field, political science, which has largely decided to avoid studying such unsophisticated questions as the requirements of our defense (and hiring those who do), leaving security debates short of truly independent experts. Blame the beltway pundits who avoid challenging the post September 11 explosion of militarism or lead the parade.

The good news is that bad things, the Iraq war and the growth of entitlements’ cost, are waking people up to the idea that maybe this isn’t the best use of tax dollars. DoD plans and insiders say FY 2009 will be a peak year for defense spending, and that we are about to hit a downward trend. Here’s hoping.