Topic: Tax and Budget Policy

Ann Coulter of the Left: Jonathan Chait

For those who think that it’s just conservatives, such as Ann Coulter, who are mean-spirited, they should check out the new book by Jonathan Chait, a senior editor of the New Republic, entitled The Big Con: The True Story of How Washington Got Hoodwinked and Hijacked by Crackpot Economics.

I managed to get through the introduction and first chapter of Mr. Chait’s book. Alas, I could read no more. Here are some of Chait’s characterizations of supply-side economists and supply-side economics–from the 1970s to the present day–in those first 44 pages:

“Pseudo-economists”, “cult of fanatical tax-cutters”, “amateurs and cranks”, “patently ludicrous ideas”, “preposterous ideas”, “theological opposition to taxation”, “ideological fanatics”, “insane”, “detachment from reality”, “extremism of their agenda”, “triumph of the extreme”, “a cult”, “quasi-religious”, “totalistic ideology”, “crank doctrine”, “sheer monomania”, “plain loopy”, “magical”, “sheer loons”, “deranged”, “wingnuttery”, “utterly deluded”, “crackpot economic theories”, “lunacy”, “ludicrous,” etc.

You get the idea.

Interestingly, Chait ends the first chapter arguing that “Tax rates under 40 percent simply do not have much effect on economic behavior.” Thus, he seems to be admitting that all those crackpots back in the 1970s and 1980s who cut income tax rates from 70% to the pre-Bush 40% might have been right after all.

Of course it’s not correct that tax rates of less than 40% don’t affect behavior. The Wall Street Journal has a front-page story today on the big efforts of Wal-Mart to reduce its effective state income tax rate of just 3.5%.

Finally, note that for Chait’s supply-side conspiracy theory to work, the cult would have had to include governments of every major industrial nation, because they have all cut top marginal rates since the 1970s. The top individual income tax rate across the 30 OECD countries has plunged by 26 percentage points since 1980. If that’s wingnuttery, then I’m all for it.

Will Poland Become the Next Flat Tax Country?

Germany’s statist politicians must be a bit uneasy about the recent election results next door. While they are probably happy that the populist-oriented incumbent government - which periodically got into disputes with Germany - was defeated, they will be very dismayed if the victorious Civic Platform Party follows through on promises to implement a 15 percent flat tax. As the biggest “new” member of the European Union, Poland would add considerable fuel to the tax-competition fire if it adopted a simple and pro-growth tax system. The Financial Times reports on the election and the market-oriented reforms advocated by the nation’s new leaders:

Foreign leaders and Poland’s business community on Monday welcomed the victory of the liberal Civic Platform party in Sunday’s parliamentary elections, predicting the revival of contacts iced up under the previous government and the restart of much-delayed economic reforms. …With more than 99 per cent of ballots counted, Civic Platform had 41.4 per cent of the vote, translating into 209 seats in the 460-member parliament. …Civic Platform is likely to form a coalition with the smaller Peasants party, which will have 31 seats. …Some of the most specific comments, concerning the party’s economic policies, were made by Zbigniew Chlebowski, a potential economy minister. He talked of introducing a flat 15 per cent tax by 2009 and said the government would privatise more energetically than its predecessor.

European Politicians Seeking to Export Big Government

The ideal trade policy is unilateral openness, which hopefully would be copied by other nations. But some argue that trade negotiations are a wise strategy, since one nation’s liberalization can be a carrot to obtain liberalization in other nations. Unfortunately, European politicians want to turn this strategy upside down by using liberalization as a stick to encourage other nations to adopt onerous European-style regulatory burdens. The EU Observer reports on this statist French-led gambit:

According to the European Commission, the EU should…”shape” globalisation. …Speaking at the EU summit Friday (19 October), French president Nicolas Sarkozy proved to be the strongest advocate of such a principle. “Let’s not be naive, we must demand a reciprocity”, he said, complaining about the severe environmental and social requirements placed upon EU businesses, but not followed by their non-European competitors.

America’s Future Foundation Panel on Health Care

Last month, I spoke on an AFF panel on health care reform. Click here to listen to the podcast.

It was a good exploration of the health care debate taking place within the free-market movement, and a good companion to my recent National Review Online article where I offer friendly advice to conservatives wrestling with health care reform.

Local Laffer Curve

A recent newspaper item shows the Laffer curve at the local government level. The Laffer curve illustrates the idea that when tax rates go up, revenues might go down if the tax base shrinks enough.

From the Falls Church News-Press:

“With another big hike, 75 cents a pack, in its cigarette tax put into effect last July 1, the City of Falls Church City Council asked for a spot check on the impact from the City’s Chief Financial Officer John Tuohy after the first quarter of the fiscal year, and he reported this Monday that July-September net revenues were down from the previous three years. He attributed the drop to “the national trend of decreased smoking.” Annual revenues peaked at $520,000 in the 2005-6 fiscal year, dropping to $464,000 last year. Packs sold in the July-September time frame dropped from 69,000 in 2004 to 58,000 this year.”

Thus, the number of packs sold is down 16% in one year. The CFO says that the cause is a “national trend.” In fact, government data show that the smoking rate has been pretty flat in recent years.

The CFO is being disingenuous. He must know that local taxpayers are responding to the city’s sharp increases in the cigarette tax rate in recent years.

For cigarette tax background, see here.

EU Subsidies Were Not Key to Irish Economic Miracle

An article posted at AEI’s American.com discusses Ireland’s economic boom and explains that smaller government and lower tax rates are the key reasons the nation’s explosive growth. Bureaucrats in Brussels and opponents of limited government sometimes claim that subsidies from Brussels deserve the credit, but advocates of this position are unable to explain why Greece and Portugal (which received similar subsidies) have remained poor:

Some Europeans, particularly European Union officials in Brussels, praise significant EU structural subsidies—in the tens of billions—for planting the seeds of Irish prosperity. …But EU structural funds alone would not have helped Ireland escape its economic predicament. Many nations receive outside financial aid without any appreciable increase in their economic prosperity. The real credit belongs to Irish fiscal policy. Beginning in the late 1980s, successive Irish governments pursued vital spending cuts and tax relief. …Ireland has a 12.5 percent corporate tax rate, which has made it a magnet for powerhouse firms.

The Laffer Curve Straw Man

I’ve already addressed this issue, but here we go again. Commenting on the “totemic appeal” of the Laffer Curve for conservatives, Kevin Drum of Washington Monthly asserts that the concept is no longer relevant because:

…the current top marginal rate in the United States is 35%, and no one in their right mind thinks that’s anywhere near high enough to have a serious Laffer effect. When top rates are that low, lowering them further just reduces tax revenue.

Mr. Drum may know how (fairly) to mock politicians who exaggerate, but his critique of the Laffer Curve is based on the straw-man proposition that tax cuts are self-financing. Notwithstanding some of the political rhetoric, the Laffer Curve does not imply — and never has implied — that all “tax cuts pay for themselves.” That only happens if rates become sufficiently punitive to put the taxing jurisdiction on the downward-sloping portion of the curve.

The real issue is whether certain changes in tax policy will have some impact on economic activity. If an increase (decrease) in tax rates changes behavior and causes a reduction (increase) in taxable income, then revenues will not rise (fall) as much as “static” revenue-estimating models would predict. This is hardly a radical concept, and evidence of Laffer-Curve effects is very well established in the academic literature.

The reason there is a debate is that the government’s revenue-estimating bodies (the Joint Committee on Taxation on the Hill and the Office of Tax Analysis at Treasury) assume that tax policy changes have zero impact on economic performance. That’s right, zero.

For example, if the entire tax code was scrapped and replaced by a low-rate flat tax, JCT and OTA would assume no effect on macroeconomic aggregates. If tax rates were doubled, JCT and OTA would plug new numbers into their simplistic (yet totally nontransparent) models and estimate that tax revenues would double (to be fair, the government’s revenue estimators assume some microeconomic dynamic effects, such as higher tax rates causing people to shift the timing and/or composition of income, but this is akin to measuring the tail and ignoring the dog).

So what does all this mean? Two points are worth highlighting:

First, the current system is rigged against good tax policy by over-estimating the revenues that can be obtained by raising tax rates and exaggerating the revenues foregone when tax rates are reduced. This is why some of us advocate “dynamic scoring.”

Second, not all tax cuts (or tax increases) are created equal. An increase in the personal exemption or the child credit will have very little, if any, impact on incentives to work, save, and invest. As such, the “static” estimate of revenue losses will be reasonably accurate. A reduction in the tax rate on capital income, by contrast, will substantially alter incentives for taxpayers who have considerable ability to adjust their behavior. This will result in a Laffer-Curve response, though it is an empirical question whether the revenue feedback will offset 20 percent, 50 percent, or 75 percent of the static revenue loss (timing is also important since a tax rate reduction that yields a revenue feedback of 20 percent in the first year may generate a much larger revenue feedback five years in the future).

The left is very clever. Defenders of the status quo have created a straw man, and they find quotes from politicians and others with little knowledge to create the impression that advocates of lower tax rates believe in the fiscal version of a perpetual-motion machine. This tactic is then used to prop up the existing system of revenue estimating, which is based on assumptions that would earn an F if put forth by a student in an undergraduate public finance course.