Tag: Double Taxation

Explaining the Perverse Impact of Double Taxation With a Chart

Whether I’m criticizing Warren Buffett’s innumeracy or explaining how to identify illegitimate loopholes, I frequently write about the perverse impact of double taxation.

By this, I mean the tendency of politicians to impose multiple layers of taxation on income that is saved and invested. Examples of this self-destructive practice include the death tax, the capital gains tax, and the second layer of tax of dividends.

Double taxation is particularly foolish since every economic theory—including socialism and Marxism—agrees that capital formation is necessary for long-run growth and higher living standards.

Yet even though this is a critically important issue, I’ve never been satisfied with the way I explain the topic. But perhaps this flowchart makes everything easier to understand.

There are a lot of boxes, so it’s not a simple flowchart, but the underlying message hopefully is very clear.

  1. We earn income.
  2. We then pay tax on that income.
  3. We then either consume our after-tax income, or we save and invest it.
  4. If we consume our after-tax income, the government largely leaves us alone.
  5. If we save and invest our after-tax income, a single dollar of income can be taxed as many as four different times.

You don’t have to be a wild-eyed supply-side economist to conclude that this heavy bias against saving and investment is not a good idea for America’s long-run prosperity.

There are various ways to protect yourself from double taxation, particularly by using IRAs and 401(k)s. You lock up your capital until retirement, but it is protected from double taxation.

Also, you cannot accumulate enough savings and investment to be subject to the death tax, though that’s not exactly aiming high.

But these strategies—and others—are not economically optimal. There should not be a tax bias against capital formation.

Too bad we can’t be more like Hong Kong, which has eliminated all extra layers of taxation.

That’s the benefit of real tax reform such as a flat tax. You get a low tax rate and you get rid of corrupt loopholes, but you also get rid of double taxation so that the IRS only gets one bite at the apple.

The Joint Committee on Taxation’s Voodoo Economics

The Wall Street Journal has an excellent editorial this morning on the obscure – but critically important – issue of measuring what happens to tax revenue in response to changes in tax policy. This is sometimes known as the dynamic scoring versus static scoring debate and sometimes referred to as the Laffer Curve controversy.

The key thing to understand is that the Joint Committee on Taxation (which produces revenue estimates) assumes that even big changes in tax policy have zero macroeconomic impact. Adopt a flat tax? The JCT assumes no effect on the economic performance. Double tax rates? The JCT assumes no impact on growth.

The JCT does include a few microeconomic effects into its revenue-estimating models (an increase in gas taxes, for instance, would reduce gasoline consumption), but it is quite likely that they underestimate the impact of high tax rates on incentives to work, save, and invest. We don’t know for sure, though, because the JCT refuses to make its methodology public. This raises a rather obvious question: Why is the JCT so afraid of transparency? Here’s some of what the WSJ had to say about the issue, including some comparisons of what the JCT predicted and what happened in the real world.

…it’s worth reviewing whether Joint Tax estimates are accurate. This is especially important now, because President Obama and Democrats in Congress want to allow the 2003 tax cuts to expire on January 1 for individuals earning more than $200,000. The JCT calculates that increasing the tax rates on capital gains, dividends and personal income will raise nearly $100 billion a year. …we are not saying that every tax cut “pays for itself.” Some tax cuts—such as temporary rebates—have little impact on growth and thus they may lose revenue more or less as Joint Tax predicts. Cuts in marginal rates, on the other hand, have substantial revenue effects, as economic studies have shown. …So how well did Joint Tax do when it predicted a giant revenue decline from the 2003 investment tax cuts? Not too well. We compared the combined Congressional Budget Office and Joint Tax estimate of revenues after the 2003 tax cuts were enacted with the actual revenues collected from 2003-2007. In each year total federal revenues came in substantially higher than Joint Tax predicted—$434 billion higher than forecast over the five years. …As for capital gains tax receipts, they nearly tripled from 2003 to 2007, even though the capital gains tax rate fell to 15% from 20%. Yet the behavioral models that Mr. Barthold celebrates predicted that the capital gains cuts would cost the government just under $10 billion from 2003-07 when the actual capital gains revenues over five years were $221 billion higher than JCT and CBO predicted. …Estimating future federal tax revenues is an inexact science to be sure. Our complaint is that Joint Tax typically overestimates the revenue gains from raising tax rates, while overestimating the revenue losses from tax rate cuts. This leads to a policy bias in favor of higher tax rates, which is precisely what liberal Democrats wanted when they created the Joint Tax Committee.

All of the revenue-estimating issues are explained in greater detail in my three-part video series on the Laffer Curve. Part I looks at the theory. Part II looks at the evidence. Part III, which can be watched below, analyzes the role of the Joint Committee on Taxation and speculates on why the JCT refuses to be transparent.