Topic: Tax and Budget Policy

Chocolate Chutzpah

Americans love their chocolate. So it’s no surprise that one of the most-read pages currently on the New York Times’ website is Monday’s op-ed decrying a proposal to change federal regulations on what can be legally labeled “chocolate.”

Under Food and Drug Administration regulations, “chocolate” must contain crushed cacao beans and may contain a short list of other ingredients, including spices, nuts, sweeteners, and dairy products. Confections that do not comply with those regulations cannot carry the “chocolate” label.

Some candymakers have petitioned the FDA to expand the list of allowable additives to include various fats. If that happens, chocolatiers could substitute cheaper vegetable oils for expensive cocoa butter — the fat in cacao beans that provides chocolate’s melt-in-your-mouth texture. By substituting away from cocoa butter, confectioners would lower their production costs,  which would lead to greater profit margins or, if the candymakers compete on price, lower chocolate’s price to consumers.

To be clear, chocolatiers can already make this substitution, but the resulting product cannot legally be called “chocolate.” A rose by any other name may smell as sweet, but “chocolate-like candy” apparently doesn’t sell as well as “chocolate.”

That brings us to the NYT op-ed, penned by Mort Rosenblum. He laments:

The proposal would widen the gap between good and awful. Industrial food companies could sell their waxy [confections] for less. But purveyors of the real thing have no corners to cut. While discerning chocoholics will fork over whatever it takes, those who can’t pay will never know chocolate.

As a chocophile, I sympathize with Rosenblum’s opinion of the would-be chocolates. But his lament is difficult to square with chocolate’s history, its current market trend, and basic economics.

When edible chocolate first appeared in the mid-19th century, the high price of cacao made it an endulgence for only the wealthy. Fortunately, the confection became more affordable a few decades later when chocolate makers started mixing in cheaper additives. The most important of those was milk, first popularized by the Swiss entrepreneur Daniel Peter (with help from a powdered milk maker named Henri Nestlé). In the United States, Milton Hershey experimented with the same idea, resulting in his affordable and popular ”great American chocolate bar.” Some Rosenblum predecessor likely complained that the added milk and sugar meant that consumers “will never know chocolate,” but it’s difficult to see Peter’s and Hershey’s creations as anything but a benefit to the consumer.

Nor did milk chocolate lead consumers to turn away from “real” chocolate. Until Monday’s NYT op-ed, recent news coverage on the chocolate industry has trumpeted the strong market trend toward premium chocolate. With plenty of Hershey’s, Whitman’s, and Russell Stover’s on the market, Americans nonetheless are buying more See’s, Godiva, and Lindt’s, and are searching for chocolate bars with higher and higher cacao content. And the large chocolate manufacturers are responding to the demand for premium chocolate.

From an economic perspective, this makes perfect sense. Consumers shift from a product to its substitute because they find the substitute preferable. In the case of the would-be chocolates, consumers would shift away from “real” chocolates because they prefer either the price or the taste of the new confections. Rosenblum makes clear his opinion that “real” chocolate is far better tasting, so only consumers with a strong concern about price would make the switch. Those consumers would not fail to “know chocolate” — they just would be unwilling to pay its price. Meanwhile, people who do prefer “real” chocolate — people who happily pay chocolate’s current price — will go on paying that price to enjoy the food of the gods.

A concern that Rosenblum’s op-ed could have raised is that consumers may be misled as to the nature of the candy bar they are purchasing if the “chocolate” regulation is amended as proposed. But even that concern seems hollow. As noted above, premium chocolates are currently en vogue, and the chocolate bars in the checkout lines at my Trader Joe’s boldly advertise their cacao content (some topping 85%). If the federal government were to change the chocolate regulations, quality chocolatiers would quickly respond with labels telling consumers that their chocolates contain no “foreign fats.”

Rosenblum’s op-ed is a fun and informative read, but the alarm it raises is, well, hard to swallow.

And now, I think I’ll head across the street to the CVS and grab a Ritter Sport bar.

Politics and Pricing

There are two ways to price products:

The market way, used for thousands of products for hundreds of years, and

the government way, used for certain politically favored products, such as milk, since the 1930s.

This is 2007. Don’t policymakers have enough experience yet to understand that one of these methods is simple, effective, and efficient, while the other is unfair, wasteful, and bureaucratic?

Mauritius Accelerates Move to Flat Tax

With the world’s list of flat tax nations growing every year, the pressure to adopt good tax policy is becoming more powerful. The latest example comes from the Indian Ocean. Mauritius already had adopted a flat tax, with the new system scheduled to go into effect in 2009. But tax competition is leading the government to implement the pro-growth system even sooner. Tax-news.com reports:

Deputy Prime Minister and Minister of Finance and Economic Development Rama Sithanen has announced the introduction of a flat corporate income tax, as the government strives to create conditions for “robust, sustained and inclusive growth” whilst opening the economy, facilitating business, and accelerating the transition to global competitiveness. …Central to attaining this goal is the reduction of corporate tax to a flat rate of 15%, a measure which has been brought forward by two years to July 1, 2007. This flat rate will also apply for personal income tax. Initially, the government had planned to reduce corporate tax in stages, starting with a cut in the top rate to 22.5% last year, to 20% this year and to 15% by 2009. …the Finance Minister stated….”We…have a system that is now geared towards rewarding effort and entrepreneurship.”

Justice Department’s Unethical Tax Evasion Case against KPMG Is Falling Apart

Thanks in large part to a punitive corporate tax rate and mind-numbing complexity in the tax code, a lot of accountants and lawyers get rich by figuring out ways to protect shareholder money. This irritates politicians and bureaucrats, who constantly tinker with the law in an attempt to grab more tax revenue (though this effort is offset by politicians looking for campaign cash, which leads to the endless creation of new loopholes). This is business-as-usual in Washington, but the Justice Department added a bizarre twist to the game by launching a legal attack on some partners from an accounting firm, even though the tax shelters they were peddling were not illegal. The Justice Department’s actions were reprehensible, rather akin to the totalitarian tactics of the tax authorities in Russia. If tax lawyers at the Department of Justice think that some people are taking advantage of tax loopholes, they certainly have every right to inform lawmakers and to ask them to change the law. In an ideal world, they would even recommend lower tax rates to remove the incentive to seek out new shelters. But they should never have the right or the ability to arbitrarily declare – by bureaucratic fiat – that tax planning is a criminal act. The Wall Street Journal condemns the Justice Department for its unethical behavior:

The Justice Department’s case against 16 former KPMG partners for tax evasion continues to unravel, with prosecutors themselves conceding late last week that federal Judge Lewis Kaplan has little choice but to dismiss the charges against most of the defendants. Judge Kaplan ruled last year that Justice had violated the defendants’ Constitutional rights by pressuring KPMG not to pay their legal fees. He is now considering a defense motion to dismiss. Prosecutors continue to protest the judge’s ruling but on Friday they admitted in a court filing that dismissal is the only remedy for the rights violations. The more honorable route would have been for prosecutors to acknowledge their mistakes and dismiss the charges themselves. The truth is that this tax shelter case should never have been brought. Both KPMG and its partners believed the shelters they marketed were legal, and no tax court had ruled against the shelters before Justice brought its criminal charges. Then prosecutors used the threat of criminal indictment against all of KPMG to extort an admission of guilt from the firm and force it to stop paying the legal bills of individual partners.

Americans Are Far More Generous than Europeans

USA Today reports on a new study showing that charitable contributions are at an all-time high in America. Most interesting, the report also revealed that Americans are far more generous than supposedly compassionate Europeans. Indeed, no nation gives even half as much (as a share of income) as the United States. The French are among the worst misers, giving less than one-twelfth of what Americans donate, though it is unclear whether this is because they are taxed so much that there is no money left in their wallets or whether they assume that it is now the role of government to solve every social problem:

Americans gave nearly $300 billion to charitable causes last year, setting a record and besting the 2005 total that had been boosted by a surge in aid to victims of hurricanes Katrina, Rita and Wilma and the Asian tsunami. …Individuals gave a combined 75.6% of the total. With bequests, that rises to 83.4%. …the willingness of Americans to give cuts across income levels, and their investments go to developing ideas, inventions and people to the benefit of the overall economy. Gaudiani said Americans give twice as much as the next most charitable country, according to a November 2006 comparison done by the Charities Aid Foundation. In philanthropic giving as a percentage of gross domestic product, the U.S. ranked first at 1.7%. No. 2 Britain gave 0.73%, while France, with a 0.14% rate, trailed such countries as South Africa, Singapore, Turkey and Germany.

An Almost-Ideal Plan to Fix the AMT

Kevin Hassett’s column proposes to solve the problem of the alternative minimum tax by dramatically lowering the top tax rate, a step that could be financed by eliminating the state and local tax deduction and ending the exclusion for municipal bond interest. While a very attractive proposal, the plan has a couple of less-than-perfect features, primarily the fact that it assumes the aggregate tax burden should rise. Admittedly, this already is going to happen if the AMT is allowed to fester (which will happen if current law is not changed), but acquiescing to a higher tax burden should never be an option. Moreover, his approach to municipal bond interest also is appealing since current law creates an advantage for debt-happy state and local governments over other interest-bearing investments, but eliminating the double tax on all forms of interest is the ideal way of fixing this inequity:

…the AMT problem is easy to fix in a way that should have bipartisan appeal. The key observation is this: most of the special items, such as the state and local tax deductions, that put taxpayers on the AMT mostly benefit wealthy people. After all, most ordinary folks don’t even itemize. Thus, if Congress is raising marginal tax rates to preserve the current system, they are effectively giving rich taxpayers money with one hand, when they allow them deductions, then taking the money back with the other, by raising marginal rates. Talk about needless complexity. It is a fool’s game, and it’s not all that hard to stop. Just eliminate or cap the deductions. To illustrate how beneficial that would be, the Tax Foundation recently estimated how big a revenue-neutral tax reduction you could fund by eliminating the big-ticket deductions and exclusions in the tax code. That is, they imagined a world with no state and local income deduction and no tax exclusion for municipal bond interest. They found that eliminating those items would allow a proportional tax-rate reduction of about 31 percent. That would take the top tax rate down from 35 percent to 24 percent. They also found that eliminating the deductions took just about everyone off the AMT. That was scored to raise the same revenue as the current code. In the real world, it would surely raise more as the low rates spurred economic activity. Such a reform is too bold to be considered bipartisan, but the key observation is this: It’s not difficult to conceive of a revenue-neutral reform that eliminates the AMT, drops tax rates by almost a third, and improves the overall efficiency of the economy. In that case, it is child’s play to conceive of half- measures necessary to eliminate the AMT and leave tax rates where they are today. Instead of eliminating the state and local tax deduction, for example, you could cap it at $10,000. The revenue gained from that could help you fix the AMT, without requiring marginal tax-rate increases.

Deja-vu All Over Again

The Wall Street Journal reports today (subscription barrier) that Philadelphia’s experiment with contracting out the operation of public schools to private providers is in jeopardy. Despite showing improvement since the contracting arrangement was introduced six years ago, a budget crunch is now being used as an excuse by district officials to demand that the program be shut down.

This is EXACTLY what happened to the school management firm Education Alternatives Inc. in Baltimore during the early 1990s. EAI was awarded a contract to run some of the city’s schools, the city subsequently spent itself into insolvency, refused to pay EAI what it was owed, and unilaterally cancelled its contract. I wrote about it all here.

For both practical and political reasons, contracting arrangements like these are dramatically inferior to real market reforms like universal education tax credits or school vouchers. Under these arrangements, schools are still bound by districts’ collective bargaining agreements, and sometimes even remain employees of their districts rather than of the private management firms. Students often continue to be assigned to schools based on their place of residence, rather than having a choice, so instead of creating an educational marketplace these programs simply subcontract the existing monopoly.

Politically, such programs are under constant threat of termination on the slightest pretext – usually budgetary as in the cases mentioned above. For any school choice program to create real, lasting market forces, funding has to be attached to the children and not pass through political or bureaucratic hands before making it to schools. The ideal such program is a tax credit (see link above) that avoids having education funds collected by the state in the first place, while still ensuring universal access to the marketplace.