Topic: Tax and Budget Policy

Washington’s Dishonest Budget Math

During fiscal debates in DC, politicians, the press, and interest groups all complain about supposed budget cuts. Yet every year, the budget gets bigger and more expensive. This seeming contradiction is due to the fact that Washington uses a strange form of math called “current services” budgeting. Under this system, a “cut” occurs anytime a budget doesn’t increase as fast as previously projected. This means that programs sometimes grow at more than twice the rate of inflation, but advocates of more spending get to complain that they are being subjected to “cruel” and “savage” reductions. While everyone inside the beltway understands how this game is played, ordinary Americans are completely deceived. They think that spending cuts are actually cuts - i.e., spending will be lower next year than it is this year. Defenders of the current system argue that “current services” budget is justified because it enables policy makers to know how much spending is “requried” because of inflation, demographic change, and previously-legislated program expansions. There is nothing wrong with having that information, of course, but that doesn’t justify dishonest presentation of budget numbers. If a politician or interest group wants to argue that a program should get a six percent increase because of various factors, that is a legitimate debate. But when a politician says that a program is getting a two percent cut because spending is climbing by four percent instead of six percent, that is deceptive. An article in the American Enterprise Institute’s magazine explores Washington’s dishonest budget math:
President Bush is not “cutting” Medicare spending—all the media hype notwithstanding… the President has not been suddenly seized by fiscal conservatism fever and did not, in fact, propose any spending cuts. Under the President’s proposal, federal spending on Medicare and Medicaid is set to increase by $84 billion from 2006 to 2008. That spending increase is certainly not a cut—even when including inflation, it represents a generous increase in entitlement spending. Newsweek confused cutting the rate of spending growth with cutting spending itself. The President’s proposals reveal an interesting picture: instead of growing at a 6.5% rate, the President would have Medicare grow at a 5.6% rate. Medicaid was set to grow at 7.3%; the President has proposed a 7.1% rate of growth. …It’s useful to place this spending restraint in perspective: entitlements face a looming $43 trillion shortage over the next 60 years, and unless entitlement spending is curbed, those programs are headed straight for bankruptcy. What’s fascinating is that if the President’s modest Medicare plans were realized, $8 trillion dollars would already be shaved off of Medicare’s future liability. It’s a hopeful reminder that moderate fiscal restraint can, over time, accomplish a great deal of good.

Some Good News on the Budget

Thanks in large part to the heroic efforts of Senators Jim DeMint and Tom Coburn, the corrupting culture of budget earmarks has hit a big bump in the road. Even more important, government spending is no longer climbing quite as fast. To be sure, it is hardly a victory to hold the growth of annual appropriations to the rate of inflation. After all, many of the programs being appropriated should be completely abolished. Moreover, annual appropriations does not include entitlement programs, many of which are growing at twice the rate of inflation. But in a town enriches itself by transferring income and wealth from the productive to the special interests, even a slowdown in the rate of spending growth is welcome news. The Wall Street Journal explains:

On Thursday, White House budget director Rob Portman issued little-noticed guidance to all federal departments and agencies that no Congressional requests for spending should be accommodated unless they are “specifically identified in statutory text” – which is to say, the law. This may sound like it ought to be regular practice, but it’s a revolution in the Beltway. That’s because, in order to dodge the legislative earmark limits that Mr. Byrd has been bragging about, Members have been speed-dialing executive branch officials and asking them to fund their specific earmark requests out of agency budgets even though they were purged from the larger budget bill. This Congressional lobbying can be hard for the average federal bureaucrat to refuse, since he doesn’t want to offend those on Capitol Hill who control his budget. …this means the Fiscal 2007 federal budget could have the fewest number of these pork-barrel projects in many a year. By the way, thanks to efforts late last year by GOP Senators Jim DeMint of South Carolina and Tom Coburn of Oklahoma to block a last-minute bipartisan spending splurge, the 2007 budget holds overall federal appropriated spending to the rate of inflation; recent years have often seen three times that.

Singapore Cuts Corporate Tax

If the average state levy is included, the U.S. corporate tax rate is about 40 percent, which is higher than the coporate rate in every European welfare state. American companies also must endure heavy regulatory burdens — especially in the aftermath of Sarbanes-Oxley.

Politicians fret that America is losing manufacturing jobs and they complain when American companies build plants overseas. Contrast the short-sighted behavior of U.S. lawmakers with those in Singapore. As noted by tax-news.com, the government of Singapore has just announced that the corporate tax rate is being reduced to 18 percent to boost international competition. The government also is boosting the value-added tax, so Singapore is not a perfect role model, but at least lawmakers understand the negative impact of high corporate tax rates:

In his Budget Statement for the Financial Year (FY) 2007, Second Minister for Finance, Tharman Shanmugaratnam announced a two percentage point reduction in the corporate income tax rate to 18% to sharpen Singapore’s competitive edge. However, the corporate tax cut will be balanced against a number of revenue raising provisions, such as…an increase in the GST rate from 5% to 7%.

OECD Says Sweden Should Consider Abolishing the State Income Tax

In a report on the Swedish economy, the Organization for Economic Cooperation and Development revealed more of its schizophrenic nature (see this article for more information on the OECD’s Jekyll and Hyde personality). While the Paris-based bureaucracy has become infamous for its so-called harmful tax competition project that seeks to penalize jurisdictions with pro-growth tax law, the economists at the OECD often write studies and reports that reflect a solid understanding of the negative impact of government intervention. The Policy Brief on the Swedish economy is a good example. As excerpted below, it notes the problems of high tax rates and excessively generous welfare benefits. It calls for the elimination of the wealth tax and reductions in punitive marginal tax rates. It even suggests that Sweden abolish the state income tax:

…the new government has renewed the commitment for sound macroeconomic framework conditions and will stick to the target for general government net lending of 2% of GDP over the cycle which is necessary to keep public finances on a sustainable path. Underlying this target is the assumption that taxes can be sustained at current levels which could be difficult in the future, not least due to mobile tax bases and international tax competition. …the share of 20 64 year olds who depend on public income transfers has declined to 20% in 2006, but it remains well above the 15-16% of 1990-91. …Sickness absence among those employed and the number entering disability pension increased rapidly from the late 1990s. The numbers are now falling, although the stock of disability pensioners remains among the highest in the OECD. …Letting people keep a bit more of the value they create is vital to encourage both labour supply and entrepreneurship. The plans to abolish the wealth tax should therefore be endorsed, as it sets in at a rate of 1½ per cent already from wealth slightly above the average price of a metropolitan-area one-family house. Abolition of the wealth tax might lead to repatriation of capital, possibly making more investment capital available for new small firms. Marginal income taxes are also important, though, because high rates kick in already from slightly above average full-time earnings. The combination of social contributions, income and consumption taxes drives the effective marginal tax rate above 70% for over a third of the full-time employed, helping to explain why working hours for those employed are below the OECD average. …Moving up the threshold by SEK 100 000 from 105% to 135% of average full-time earnings, for example, would halve the number of persons exposed to the above-70% combined marginal tax rate, which results when the state income tax sets in on top of social contributions, municipal income tax and consumption taxes. …In fact, completely abolishing the state income tax would cost just 1½ per cent of GDP.

French “Conservative” Candidate Calls for Hedge Fund Tax

While most nations are trying to liberalize their economies, both major candidates in France are competing to promise higher taxes and more spending. Sarkozy is supposed to be the market-oriented candidate, but he has endorsed higher taxes on financial services - and is suggesting sympathy for a higher VAT, according to MSNBC:

Nicolas Sarkozy will push for a European tax on “speculative movements” by financial groups, such as hedge funds, if he wins this year’s French presidential elections. …his plan to tax financial flows is likely to dismay US and UK financial groups, as well as parts of the French business community, which largely prefers him to Ms Royal. …His comments echo the traditional Gaullist suspicion of capitalism and financial investors, for which Mr Chirac has become well known. Mr Sarkozy’s attack on speculative finance mirrors the views of some business leaders. Claude Bébéar, chairman of insurer Axa, France’s biggest institutional investor, yesterday pilloried the “dictatorship of the market” and the “short-term interests” of hedge funds. …[Sarkozy’s] record as finance minister was notably dirigiste. He intervened to save Alstom, the engineering group, from bankruptcy and brokered an all-French merger of Aventis and Sanofi to avert a takeover by Switzerland’s Novartis. …Mr Sarkozy admitted he was watching Germany’s three percentage point increase in VAT with interest.

The story also notes that Sarkozy also was an interventionist finance minister. The net result is that France almost surely will continue to stagnate, regardless of who replaces Jacques Chirac.

Deferred Gratification and Income Inequality

The Economist reports on an interesting new study showing that members of a Bolivian tribe who understood the value of deferred gratification also experienced higher income gains:

One phenomenon that is almost unique to humans is deferred gratification—in other words, patient anticipation of a reward. Dr Reyes-Garcia and her colleagues therefore guessed that as the Tsimane’ became more enmeshed in modern society, the more patient of them would do better than the less. The Tsimane’s traditional subsistence economy depends on folk knowledge and learned skills that have quick pay-offs. Formal schooling does not pay off for years, but opens the door to bigger potential incomes. To test their idea, the researchers offered all 151 adults in two Tsimane’ villages a choice between receiving a small amount of money or food immediately, getting a larger amount if they were willing to wait a week, and getting a larger amount still in exchange for several months’ wait for payment. They found that the more education a villager had, the longer he was willing to delay gratification in return for a bigger reward. Five years later, Dr Reyes-Garcia and her colleagues came back again. They re-interviewed 100 of their volunteers (the other 51 were unavailable for one reason or another) and found that those who had shown most patience in the original experiment had also seen their incomes increase more than those of their less patient counterparts. The effect was relatively small—the incomes of the patient had grown 1% a year faster than those of the impatient. Over a lifetime, though, that adds up to a significant amount of inequality. The patient, then, could take their place alongside the lucky, the smart and the violent at the top of society’s heap.

These results are similar to research in advanced societies. All other things equal, successful people tend to recognize the value of sacrificing today in order to enjoy more income/consumption/wealth in the future. But consider what this research implies for the current political debate about income inequality. Leftists are beating the drums for higher tax rates and more income redistribution, in part because they insist that rich people are either lucky or that their wealth is earned at the expense of the less fortunate (the fixed-pie fallacy). But if income differences are the result of individual choices, these arguments are less persuasive. Rather than seeking to punish success, honest leftists should focus their energies on figuring out how to create a culture of deferred gratification in poor communities.