Topic: Tax and Budget Policy

New Tax Proposal Combines Social Engineering and Class Warfare

Congressional Democrats want to use the tax code to penalize large corporate severance packages. But this should be a matter for stockholders to decide, not headline-seeking politicians. The Wall Street Journal, meanwhile, explains that the middle class often feels the brunt of tax schemes designed to punish the so-called rich:

One of the ways the Senate bill does this is to place a cap on the amount of “deferred compensation” that a company can award its top executives in a given year. The cap is equal to $1 million or the executive’s average salary for the previous five years, whichever is lower. But rather than simply tax any deferred compensation above that threshold as income, it imposes an additional 20% penalty tax on deferred comp above the limit. The Joint Committee on Taxation predicts this provision will bring in $800 million over the next decade. We’ll go out on a limb and predict it brings in an amount closer to $0.

Senate leaders describe this cap on deferred compensation as closing a loophole in the 1993 law that barred companies from deducting from their taxes more than $1 million of salary paid to their CEO and other top execs. Never mind that employee salaries have always been a deductible business expense. This was the last time Democrats ran Congress, and thus the last time they could sock it to the successful.

That 1993 law has itself become a classic example of unintended consequences. The biggest “loophole” in that law was an exemption carved out for performance-based compensation, which was meant to alleviate concerns about Congress setting pay rates in the private sector. Back then, even tub-thumping Senator Carl Levin said “I don’t support the government setting CEO pay in the tax code.” Which he and his mates proceeded to do anyway. And businesses promptly responded by shifting CEO pay away from salary and toward stock options and bonuses to circumvent the cap.

[…]

[T]his time, a much larger pool of people than CEOs could be hit by the new deferred comp cap. People who make a lot less than $1 million have occasion to defer some of their salary, and at many companies even middle managers can do so. If this bill becomes law, those non-millionaires potentially face a 55% tax rate on the income they might otherwise have tried to defer. The tax code is riddled with provisions, such as the Alternative Minimum Tax, the estate tax and any number of phaseouts and caps, that were sold politically as targeting only the “super-rich” but now capture taxpayers of far more modest means.

Public Choice in Action

The Washington Post ran a story today that could be a case study in a Public Choice textbook, “Maverick Costco CEO Joins Push to Raise Minimum Wage.”

The chief executive of Costco Wholesale, the nation’s largest wholesale club, yesterday became the most prominent member of a new organization of business owners and executives pressing Congress to approve an increase in the federal minimum wage.

Wow, Costco’s Jim Sinegal must be a really moral and public-spirited CEO. Sinegal “said he signed onto the effort because he thinks a higher minimum wage would be good for the nation’s economy as well as its workers.” The CEO explained: “The more people make, the better lives they’re going to have and the better consumers they’re going to be… It’s going to provide better jobs and better wages.”

Who does Sinegal think he is fooling? His real aim is to use the government to squash any low-end competition. 

Costco, of Issaquah, Wash., would suffer no direct impact from a higher minimum wage because its lowest-paid employees now make about $11 an hour, Sinegal said, adding that the average worker in the company’s 504 stores in the United States makes $17 an hour.

Tax Reform Is the Right Way to Lower the So-Called Tax Gap

Many politicians in Washington think they could get a lot more money to redistribute if Americans could be compelled into being fully compliant with the internal revenue code. Yet the world’s leading expert on the underground economy estimates that the United States has less evasion than any other nation [.pdf]. Moreover, the Wall Street Journal notes that the vast majority of noncompliance is the result of tax code complexity, which is why the only pro-growth way to generate more revenue is lower tax rates and simplification:

The “tax gap” is the difference between what the Internal Revenue Service thinks taxpayers should be paying and what it collects. The IRS currently estimates this at about $290 billion a year. Ask any Congressional chairman how he intends to close the deficit, expand the Medicare drug benefit, reform the Alternative Minimum Tax or subsidize college education, and the answer is invariably “close the tax gap.” Last year the Senate held some half-dozen hearings in search of this pot of gold. …We suppose politicians are allowed to dream. But it’s worth recalling that Washington has searched for this revenue Atlantis for decades without success. …Nina Olson, the IRS’s taxpayer advocate, told Congress last year that IRS auditors have found that an estimated 94% of noncompliance is the result of honest mistakes by tax filers who simply don’t understand the 17,000-page beast of a tax code. One obvious answer would be to simplify the code (more on that later). But this requires political will, so Congress naturally prefers the easier route of ratcheting up taxpayer regulation and enforcement. …Our personal favorite would require that Americans withhold taxes from any cash payments they make to such individual contractors as babysitters, gardeners or plumbers. They’ll love that one in the suburbs. Implicit in all these new plans is a much bigger IRS staff to monitor and chase tax miscreants. Here’s another bad idea: Many doctors and lawyers who are incorporated under subchapter S will often pay themselves lower wages but higher dividends, in order to reduce self-employment taxes. The law is vague on the limits of this practice, and it is undoubtedly abused. But the Joint Tax Committee’s preferred solution is to make all professional income – even dividend payments – subject to self-employment taxes; this is nothing more than a backdoor tax hike. …There is a better way. The more complicated a tax system, the more likely taxpayers won’t understand, or will try to dodge, the rules. Simple tax regimes, such as a single flat rate, encourage compliance and efficiency, not to mention economic growth. This has been the experience of many Eastern European countries after they imposed a flat tax, and the U.S. had similar jumps in reported tax income from “the rich” following the 1986 tax reform that cut rates and closed loopholes.

Capitol Hill Briefing Re: Standard Health Insurance Deduction

At noon this Friday, the Cato Institute will host a Capitol Hill briefing on President Bush’s proposal to replace the tax exclusion for employer-sponsored coverage with a standard health insurance deduction.

Discussing the proposal will be: Katherine Baicker of the president’s Council of Economic Advisers, Leonard Burman, director of the Urban-Brookings Tax Policy Center, and me.

The room number and video of the event can be found where you preregister, here.

Friedman or Plato?

As noted earlier, today is Milton Friedman Day.  My modest contribution is this essay.

I call this the Fundamental Problem of Political Economy. How do we limit the power that idiots have over us?

One solution, that might be traced to the expression “philosopher-king” associated with Plato, is to hand the reins of government to the best and the brightest. Since the late 19th-century, the Progressive Movement in American politics has championed this approach…

The other way to avoid having our lives run by idiots is to limit the power that others have over us. This is the approach that was embedded in our Constitution, before it was eviscerated by the Progressives. It is the approach for which Milton Friedman was a passionate advocate.

Competition among Cantons Boosting Swiss Competitiveness

Federalism is a marvelous structure, both because it allows preferences for different policies to be satisfied and because it creates competition among units of government. While federalism has been somewhat eroded in the United States, it still exists and presumably is one of the reasons why America is relatively prosperous (thanks to a less oppressive level of government). Switzerland is an even bigger success story. The central government represents less than one-third of total government (as compared to two-thirds in the US), and the concomitant competition between cantons has helped control the size of government. And as a Swiss news report indicates, this has generated big benefits for the Swiss economy:

Zurich is poised for a further influx of foreign firms and workers after the relocation of Kraft Foods’ European headquarters and the expansion of Google this year. The moves earlier this month from the two United States giants offer further evidence that the region offers prime conditions for companies, according to the Greater Zurich Area relocation service. …”The relocation of headquarters and the nice growth of Google that we have seen in the last couple of months shows that we have very good basic conditions in the region,” commented Greater Zurich Area chief executive Willi Meier. …A more controversial lure for foreign companies is the low corporate tax rates offered by many cantons in Switzerland. …The competition among cantons to set the lowest business tax was intensified at the beginning of last year when Obwalden slashed its rates to a Swiss low of just 6.6 per cent. Obwalden attracted 376 new firms in the first 11 months of 2006, three times more than in the previous year. But Meier insists the Zurich region is not afraid of the increased competition. “The tax competition among Swiss cantons makes Switzerland as a whole more competitive on an international basis. Kraft has chosen Zurich despite the fact that we don’t have the lowest tax rate in Switzerland, but on an international scale its still a very competitive rate,” he said. 

Milton Friedman Day

Milton FriedmanDr. Milton Friedman, who passed away last November at the age of 94, was perhaps the most influential economist of the 20th Century and a champion of liberty. To honor Dr. Friedman, today has been declared Milton Friedman Day – “a celebration of the economist’s positive impact on American life and business, and the spread of the benefits of free markets to nations around the globe.” At 10pm EST tonight, PBS will premiere “The Power of Choice: The Life and Ideas of Milton Friedman,” an exclusive documentary on the remarkable life and free market vision of Milton Friedman. The special, produced for PBS by Free to Choose Media, gives viewers a new understanding of the magnitude of this legendary economist’s influence on the modern world.