201710

October 3, 2017 2:38PM

High Earners Pay Bulk of Income Taxes

President Trump and his advisors are stressing that they want tax cuts for the middle class, not high earners. Trump said, “the rich will not be gaining at all with this plan,” while Treasury Secretary Steve Munchin said, “Our objective is not to create tax cuts for the wealthy. Our objective is about creating middle-income tax cuts.”

The problem is that high earners, not those in the middle, pay the vast bulk of federal income taxes. As the chart below shows, the share of federal income taxes paid by the highest-earning 10 percent has steadily risen—from 49 percent in 1980 to 71 percent by 2014. Meanwhile, the share paid by everyone else has plunged. (Source: TF based on IRS).

The Trump team is painting itself into a corner with its “tax cuts for the middle-class only” rhetoric. I fear that to satisfy that promise in coming weeks, the administration will seek to expand further the most unproductive parts of the tax plan, such as child credits. In turn, that will reduce budget room for tax reforms that would promote growth and simplify the code.

Cutting the most damaging parts of the tax code—such as our high corporate income tax rate—would benefit all Americans by spurring growth and raising wages. That is what Trump and Republicans should be focusing on.

Media Name: income_tax_shares.png

October 3, 2017 9:24AM

The Strange Official Economics of Interest on Excess Reserves

In a note to my last post, I observed that Liberty Street Economics, the blog of Federal Reserve Bank of New York, promised a follow-up to its post addressing the advantages of the Fed's interest payments on required reserves. The follow up would address the benefits of paying interest on banks' excess reserves and of thereby establishing a "reserve-abundant regime."

That follow-up post has since appeared, under the title "Why Pay Interest on Excess Reserve Balances?" As I'd anticipated, it answers the question it poses by outlining some supposed benefits of having banks sit on immense piles of cash, without so much as hinting at the existence of any countervailing costs. As soon as those costs are considered, the supposed benefits turn out to be largely, if not entirely, fictitious.

Real and Pseudo Reserve Economies

According to the post's authors, Laura Lipscomb and Heather Wiggins (Board of Governors) and Antoine Martin (FRBNY), a major advantage of paying interest on excess reserves (IOER) is that, by ensuring that banks possess "a relatively abundant supply of [excess] reserves," it "makes the U.S. payment system more efficient." Besides no longer having to rely "on intraday and overnight credit from the Fed," the authors explain, banks made flush with reserves "are more willing to relinquish reserves early and are therefore engaging in less economizing and hoarding of reserves, making the payment system more efficient."

"Less economizing and [less] hoarding"? Usually, when we speak of someone "economizing" on X, we mean that he or she makes do with less of X. To do less economizing of X is therefore to require more of X. So how can banks do "less economizing and hoarding of reserves"? They can't. They can either economize less and hoard more, or they can economize more and hoard less.

Read the rest of this post »
October 3, 2017 9:20AM

Signs of Shifting Directions by the U.S. and China on Trade Policy

As the rankings in the recently‐​released Economic Freedom of the World: 2017 Annual Report make clear, the United States and China find themselves in very different places on the matter of trade policy. Occupying the somewhat middling overall position of number 63 (of the 159 jurisdictions ranked) in the “Freedom to Trade Internationally” category, the U.S. is nonetheless significantly ahead of China at number 108. 


Worth noting, however, are incipient signs that the two countries may be trending in different directions. Traditionally a relatively closed and protectionist economy, China through its words and even some of its actions has shown encouraging signs of moving towards greater openness (a topic I explore in a new policy analysis). In depressing contrast, trade policy under the Trump administration may be headed for a different track. A number of developments this year serve to illustrate this nascent divergence:


Rhetoric: Chinese President Xi Jinping offered a surprising but sorely‐​needed defense of free trade at the World Economic Forum in January. Likening the pursuit of protectionism to “locking oneself in a dark room” in his keynote address, Xi added that “While wind and rain may be kept outside, that dark room will also block light and air.” Similar sentiment has also been voiced in subsequent speeches by other senior leaders including Premier Li Keqiang and Vice Premier Zhang Gaoli.


President Donald Trump, meanwhile, said in his February speech to Congress that “I believe strongly in free trade but it also has to be fair trade” — language suggesting a less than full‐​throated embrace of the concept (Notably, in Premier’s Li’s own speech he reversed this formulation, stating that “In fact, free trade…is the prerequisite for fair trade.”). Privately, the President is reported to have told his chief of staff, “I want tariffs…bring me some tariffs.” 


New trade agreements: China continues to play a leading role in efforts to conclude the 16‐​member Regional Comprehensive Economic Partnership, a trade deal with a potential payoff estimated to be at least $260 billion over ten years. The country also has several other free trade agreements (FTAs) under negotiation, including a trilateral agreement with Japan and South Korea, and this year began exploring the possibility of a bilateral deal with Canada.


President Trump, in contrast, used his first week in office to withdraw from the 12‐​member Trans‐​Pacific Partnership, an agreement whose income gains were calculated at $131 billion through 2030 for the U.S. alone. While talk has been floated of a free trade agreement (FTA) with the United Kingdom, no formal efforts to begin negotiations have been undertaken with the U.K. or any other country.


Existing trade agreementsPresident Trump earlier this year expressed his desire to renegotiate the bilateral FTA with South Korea and more recently has threatened to withdraw from the agreement altogether. Negotiations have also begun on revising NAFTA — the subject of similar withdrawal threats by Trump — with early indications suggesting the Trump administration’s desire to take the deal in a more protectionist direction


China and New Zealand, meanwhile, announced in March their intention to further expand an existing FTA between the two countries.


The odds of China becoming a free trade paragon in the near future are admittedly remote. Even marginal progress in that direction, however, would be most welcome, delivering benefits to China such as greater economic efficiency and access by Chinese consumers to higher‐​quality imports. Gains would accrue outside of China as well, with its resulting growth contributing to higher living standards among its trading partners.


On the other side of the Pacific, the Trump administration’s flirtations with protectionism are an ongoing concern. Although thus far mostly constrained to rhetorical flourishes, the White House’s decision to withdraw from the TPP has inflicted a real opportunity cost on the US economy, and further protectionist backsliding must be avoided. As President Trump seeks to Make America Great Again, he should remember that openness to trade has been a key ingredient in making the country the superpower it is today.

October 2, 2017 2:52PM

The Jones Act: It’s Worse than You Think

Ike Brannon’s recent post on the Jones Act is excellent, and those who have not done so already should give it a read. He notes some of the many economic hardships imposed by the law, which are shielded from proper scrutiny because its large costs are spread across the population and benefits concentrated among a relatively limited number of entities such as shipbuilders. 

Brannon’s concluding sentences, however, may be too kind to the political process:

[P]laces like Puerto Rico, Hawaii and Alaska would benefit most of all [from getting rid of the Jones Act], since they are overly dependent upon shipping prices.

However, as those are only two low population states and a territory with no voting representation, their inconveniences won’t resonate much with Congress.

Such language implies that the elected representatives of Alaska and Hawaii are fully cognizant of the burdens imposed by the Jones Act, but are prevented from making headway toward its removal due to insufficient political sway. The truth is far worse. As I noted yesterday at USATo​day​.com, all four members of Hawaii’s congressional delegation—Sen. Brian Schatz, Sen. Mazie Hirono, Rep. Colleen Hanabusa, and Rep. Tulsi Gabbard—stand foursquare in support of the law. Among the three members of Alaska’s delegation, both Sen. Lisa Murkowski and Rep. Don Young have touted their backing of the Jones Act (I have been unable to determine the position of Sen. Dan Sullivan, who has only held his current position since 2015). 

Why is this? While the definitive motivations of these politicians are known only to themselves, a reasonable guess can nonetheless be hazarded.

We can first dispense with partisan explanations, as Hawaii’s congressional delegation is comprised entirely of Democrats while Murkowski and Young are both Republicans. More relevant is the fact that according to the American Maritime Partnership, Alaska is ranked #3 among the 50 states for maritime jobs per capita. Hawaii, being the lone U.S. state comprised of an island chain which imports as much as 90% of its food, presumably has a significant maritime sector as well. Those engaged in such employment, and who profit most from the Jones Act’s concentrated benefits, are much more invested in its future than the consumers forced to bear its significant but relatively small individual costs. Commensurate pressures from constituents then win out over economic sense when politicians set their positions.

Further food for thought is to be found in the fact that the Senate’s most committed Jones Act critic, Sen. John McCain, hails from the landlocked state of Arizona. McCain’s legislation to grant Puerto Rico a permanent exemption from the Jones Act enjoys co‐​sponsorships from Sen. Mike Lee of Utah and Sen. James Lankford of Oklahoma, also of landlocked states. As a result, these Senators are more likely attuned to the Jones Act’s net economic drag than benefits to maritime special interests. This may all be coincidence, but it fits perfectly with the public choice model of special interests

When it comes to protectionist U.S. policy, bitter experience has shown that the truth is often worse than we think. 

October 2, 2017 11:25AM

Overpromising “Middle‐​Class” Tax Cuts

As Republicans unveiled their tax reform plan last week, President Trump said, “We will cut taxes tremendously for the middle class.” Trump advisor Gary Cohn said, “We are giving tax cuts to middle- and lower-income Americans.” And House Speaker Paul Ryan said, “The entire purpose of this is to lower middle-class taxes.”

The problem is that “middle-class” Americans pay little in federal income taxes, while “lower-income” Americans pay virtually nothing. So Republican leaders are making promises that will be difficult to keep, and they are distracting themselves from the better message of growth and prosperity for all.

The chart below, based on CBO data for 2013, shows average federal income tax rates by income quintile. The highest-earning fifth of households paid 15.5 percent of their income to taxes, on average. The bottom two groups paid less than nothing, on average, because the refundable EITC and child credit wiped out their liabilities and gave them a subsidy. And the middle-income group that Trump, Cohn, and Ryan are talking about paid just 2.6 percent, on average.

The CBO uses a broad definition of “income” in these calculations, which inflates the denominators here and reduces the measured tax rates. Nonetheless, the data indicate who needs income-tax relief, and it is not the bottom three groups.

More important, dividing Americans into “classes” is the wrong way to go. Instead, Republicans should focus their tax reform talking points on economic expansion, business investment, entrepreneurship, job opportunities, wage growth, simplification, and international competitiveness. The Republican tax framework would advance all those goals, and thus benefit every American.

GOP leaders should leave the class struggle to the other party, and focus on how tax reform would support durable economic growth for the nation and broad-based prosperity.

Media Name: cbo_etrs.png

October 2, 2017 9:52AM

NAFTA Renegotiation Roundup

Round 3 of the NAFTA renegotiation wrapped up last Wednesday. Round 4 is scheduled for October 11 – 15 in the Washington, DC area. How have things been going so far? Here’s one assessment:

The United States, Canada and Mexico said at the end of a five‐​day session in Ottawa there had been progress made in the talks but acknowledged that much work remained to conclude the negotiations by the end of the year.

The next round might be a big one. Inside US Trade notes that “controversial ideas for investor‐​state dispute settlement and a sunset clause tied to the trade deficit” will be “finalized and proposed at the fourth round.”


The original plan was to do the renegotiation over 7 rounds in total, concluding this year. However, the idea of the three NAFTA countries reaching an agreement by the end of the year was always a bit unrealistic and now seems even more so. If all goes perfectly, perhaps they could do it by the spring or summer of next year, but it won’t be easy.


On October 26, we will have a full day conference here at Cato talking about a wide range of issues in the negotiations. You can register here. The full details are at the link, but here’s a brief rundown.


We’ll start with a panel made up of some of the original negotiators to explain why we had a NAFTA in the first place. What was the pre‐​NAFTA situation, and how did NAFTA improve things? We’ll then have a discussion panel that delves into the various criticisms of NAFTA over the years. Next, we’ll talk a bit of politics, focusing on the United States and Mexico, which are the places where the political process could present a hurdle to domestic ratification of a new NAFTA. We’ll then have a session on how to “modernize” NAFTA, that is, how to incorporate provisions that have been developed in other trade agreements over the 20+ years since NAFTA was signed (such as on e‑commerce and trade in services). Finally, we’ll have two breakout sessions, one on dispute settlement (a particularly contentious issue in the NAFTA renegotiation) and one on various product‐​specific issues that are being fought outside of NAFTA but could have an impact on the negotiations (trade in lumber, dairy, and aircraft).


We hope you can join us!