Tag: tax policy

A Rising Tide Is Lifting All Boats

President Trump delivers his State of the Union address tonight and will surely claim credit for the strong economy. He has taken actions that have both helped and hurt growth, and it is difficult to disentangle the net effects.

That said, it is impressive how today’s rising tide of economic growth is lifting boats across the American economy. The poverty rate is falling, wages are rising, labor market participation is rising, and employers are creating large numbers of jobs, as shown below.

Consider poverty and growth. In recent decades, poverty has fallen when the economy has expanded, as shown here. Also note that poverty plunged in two decades of strong growth prior to the federal government creating a big welfare state in the 1960s, as John Early shows in Figure 6. Strong economic growth improves lives.

Now consider the two ways that Washington policymakers try to help people and the economy. Under the misguided direct way, the government gives subsidies to particular groups and imposes regulations to “fix” particular markets—whether it is Democratic welfare programs or Republican trade restrictions. The direct way creates negative side effects and undermines the more powerful indirect way.  

Under the better indirect way, the government removes obstacles and allows entrepreneurs to produce better products at lower prices. That is the broad-based growth way. Trump’s corporate tax cut, for example, reduced tax obstacles to investment and hiring. Repealing regulations to cut costs for consumers is another good approach.

Let’s hope that Trump sticks to indirect-style proposals tonight so that America’s entrepreneurs can keep the private-sector growth machine humming.

Most Economists Know There’s No Free Lunch on High Marginal Tax Rates

When Alexandria Ocasio-Cortez suggested a 60-70 percent federal income tax rate on those earning over $10 million, prominent economists and economic commentators Matt YglesiasPaul Krugman and Noah Smith argued that her policy prescription was simply mainstream economics.

But a new Chicago Booth IGM Survey poll suggests economists are generally much more skeptical of the wisdom of jacking up top federal tax rates than these commentators suggest.

The economists were asked whether a top federal marginal income tax rate of 70 percent within the current code would raise substantially more revenue than today’s 37 percent without lowering economic activity. Just 18 percent of those surveyed agreed, against 49 percent who disagreed (21 percent vs. 63 percent when weighted by confidence.)[i]

Top MTRs

In other words, a clear majority of economists believe there’s no free lunch from higher marginal rates on the top income bracket. Either it will raise revenue but with economic distortions, or it won’t raise revenue, or it will both fail to raise revenue and be detrimental to broader economic health.

It’s worth noting the wording of the question does not leave much room for nuance. Richard Thaler asked why it deviated from Ocasio-Cortez’s actual proposal. Kicking in at a much higher income level, and so on a group likely to be more responsive in terms of tax planning, her policy would certainly raise less revenue than the policy asked about in the question.

Several other economists said they would have changed the way they voted if a word like “substantially” was inserted in front of economic activity too. But overall, a host of the economists commented to the effect that such high marginal rates within the current code would lead to a whole host of new avoidance activity, on the one hand, and reduced labor supply on the other.

Given the particular wording of the question, the most interesting vote cast was that of Emmanuel Saez, who has been responsible for much research in this area. Intriguingly, he was in the minority in voting that he agreed a 70 percent top marginal rate would raise revenue without lowering economic activity.

On one level, that’s not surprising. His work with Peter Diamond concluded that a total combined 73 percent top marginal tax rate would be revenue maximizing and “optimal” if we put zero weight on the welfare of the rich. They believe too that the real economic responses to higher top tax rates would be small. As such, their research is the academic go-to for those arguing for much higher top marginal tax rates.

But when you read the details of how they got to that result, it’s difficult to see how Saez answered this IGM question in the affirmative. The Diamond-Saez paper makes clear their 73 percent result only holds if you presume policymakers could redesign the tax code to eliminate deductions, exemptions and other possibilities for tax planning or avoidance.

If not, then presuming people in the top tax bracket are as responsive today to tax changes as in the 1980s, the revenue maximizing total combined marginal tax rate would be much lower at 54 percent – equating to around a 48 percent marginal federal income tax rate. This, incidentally, is very similar to the revenue-maximizing income tax rate calculated by the UK government.

According to Saez’s own work then, raising the 37 percent top marginal income tax rate to 70 percent within the current code (as the question clearly sets out), would take us far beyond the revenue maximizing top marginal tax rate. It would be self-defeating in terms of revenue raising. We would be far on the wrong side of the Laffer curve.

It seems extraordinarily unlikely, in a world where 48 percent is the revenue maximizing rate, that a 70 percent rate would raise “substantially more revenue” than a 37 percent rate, as Saez’s answer implies.


 


[i]  In 2019, the 37 percent rate will apply to all single filers with more than $510,300 of taxable income.

Leon Trotsky on the Weapon of Taxation

“You ought not to forget that the credit system and the tax apparatus remain in the hands of the workers’ state and that this is a very important weapon in the struggle between state industry and private industry….

The pruning knife of taxation is a very important instrument.  With it the workers’ state will be able to clip the young plant of capitalism, lest it thrive too luxuriously.”

–Leon Trotsky, The First 5 Years of the Comintern, Vol 2 (London, New Park, 1945) p. 341

Washington’s Disdain for Wealth Creators Is a Big Part of the Problem

Like too many other long-reigning fixtures on Capitol Hill, Senator Carl Levin (D-MI) doesn’t appreciate the magnitude of the challenge to the authority he presumes to hold over America’s job and wealth creators. Or maybe he does, and frustration over that fact explains why he besmirches companies like Apple, Google, Microsoft, and Hewlett-Packard.

Levin presided over a Senate hearing last week devoted to examining the “loopholes and gimmicks” used by these multinational companies to avoid paying taxes – and to branding them dirty tax scofflaws. Well here’s a news flash for the senator: incentives matter.

The byzantine U.S. tax code, which Senator Levin – over his 33-year tenure in the U.S. Senate (one-third of a century!) – no doubt had a hand or two in shaping, includes the highest corporate income tax rate among all of the world’s industrialized countries and the unusual requirement that profits earned abroad by U.S. multinationals are subject to U.S. taxation upon repatriation. No other major economy does that. Who in their right minds would not expect those incentives to encourage moving production off shore and keeping profits there?

Minimizing exposure to taxes – like avoiding an oncoming truck – is a natural reaction to tax policy. Entire software and accounting industries exist to serve that specific objective. Unless they are illegal (and that is not what Levin asserts directly), the tax minimization programs employed at Apple, Google, Microsoft, and Hewlett-Packard are legitimate responses to the tax policies implemented and foreshadowed by this and previous congresses. If Levin is concerned about diminishing federal tax collections from corporations (which, of course, reduces his power), the solution is to change the incentives – to change the convoluted artifice of backroom politics that is our present tax code.

Combine the current tax incentive structure with stifling, redundant environmental, financial, and health and safety regulations, an out-of-control tort system that often starts with a presumption of corporate malfeasance, exploding health care costs, and costly worker’s compensation rules, and it becomes apparent why more and more businesses would consider moving operations abroad – permanently. Thanks to the progressive trends of globalization, liberalization, transportation, and communication, societies’ producers are no longer quite as captive to confiscatory or otherwise suffocating domestic policies. They have choices.

Of course many choose to stay, and for good reason. We are fortunate to have the institutions, the rule of law, deep and diversified capital markets, excellent research universities, a highly-skilled workforce, cultural diversity, and a society that not only tolerates but encourages dissent, and the world’s largest consumer market – still. Success is more likely to be achieved in an environment with those advantages. They are the ingredients of our ingenuity, our innovativeness, our willingness to take risks as entrepreneurs, and our economic success. This is why companies like Microsoft, Apple, Google, and Hewlett-Packard are born in the United States.

But those advantages are eroding.

While U.S. policymakers browbeat U.S. companies and threaten them with sanctions for “shipping jobs overseas” or “hiding profits abroad” or some other manifestation of what politicians like to call corporate greed, characterizing them as a scourge to be contained and controlled, other governments are hungry for the benefits those companies can provide their people. Some of those governments seem to recognize that the world’s wealth and jobs creators have choices about where they produce, sell, and conduct research and development. And some are acting to attract U.S. businesses with incentives that become less necessary every time a politician vents his spleen about evil corporations. Not only should our wealth creators be treated with greater respect from Washington, but we are kidding ourselves if we think our policies don’t need to keep up. As I wrote in a December 2009 Cato paper:

Governments are competing for investment and talent, which both tend to flow to jurisdictions where the rule of law is clear and abided; where there is greater certainty to the business and political climate; where the specter of asset expropriation is negligible; where physical and administrative infrastructure is in good shape; where the local work force is productive; where there are limited physical, political, and administrative friction.

This global competition in policy is a positive development. But U.S. policymakers cannot take for granted that traditional U.S. strengths will be enough.  We have to compete and earn our share with good policies. The decisions made now with respect to policies on immigration, education, energy, trade, entitlements, taxes, and the role of government in managing the economy will determine the health, competitiveness, and relative significance of the U.S. economy in the decades ahead.

Since another hearing devoted to thanking these companies for their contriubtions to the U.S. economy is unlikely, perhaps Senator Levin should at least consider the perils of chasing away these golden geese.

IRS Can’t Manipulate Tax Code to Generate More Revenue for Itself

This blogpost was co-authored by Cato legal associate Matt Gilliam.

An American energy company called PPL bought one of many state-owned British utilities privatized in the 1980s. In 1997, PPL thus became subject to the UK’s new “windfall tax,” which was based in part on “profit-making value”—the utility’s average annual profit multiplied by an imputed price-to-earnings ratio.

Various American energy companies subject to this tax filed claims with the IRS for a “foreign income tax” credit, which the IRS denied in 2007, asserting that the British tax was not a creditable one under the “foreign income tax” provision of the Internal Revenue Code (Section 901). The IRS claimed that the windfall tax did not satisfy the “predominant character” standard (was not predominantly an income tax) because the British statute used the term “profit-making value” instead of “net income” and “gross receipts,” and the tax rate was defined “as a percentage of an imputed value … rather than directly as a percentage of net income.”

After the federal tax court held that PPL was entitled to the foreign tax credit, the U.S. Court of Appeals for the Third Circuit reversed. Explaining that a tax exemption is a privilege extended by legislative grace, the appellate court held the tax not to be creditable because it reached beyond realized profit and did not tax actual gross revenue. In a different case last year, however, the U.S. Court of Appeals for the Fifth Circuit held that the British windfall tax was indeed creditable because (1) it reached realized income and (2) gross revenue was an inherent part of the calculation. The Fifth Circuit explained that the form and label of the foreign tax are not determinative and that the predominant character standard requires the IRS to analyze the history and intent of a tax to assess whether it tries to reach some net gain.

Cato now joins Southeastern Legal Foundation and Goldwater Institute on an amicus brief in urging the Supreme Court to take PPL’s case because it implicates fundamental issues of property rights, free markets, and the arbitrary exercise of government power—and the circuit split creates uncertainty for American businesses overseas. We argue that taxpayers have the right to be free from double taxation and that here the IRS and Third Circuit improperly disregarded the substance of the windfall tax and applied an overly rigid construction of its terms.

Ultimately, a foreign tax’s form or label cannot mask its substantive character and intent for legal purposes. American businesses operating overseas should be able to rely on a stable, substantive application of U.S. tax law instead of arbitrary interpretations and constructions manipulated to generate payments to the IRS.

The Supreme Court will decide this fall whether to hear PPL Corp. v. Commissioner of Internal Revenue.

Democratic Tax Policy, Then and Now

My new piece at Daily Caller looks at how the Democratic Party’s approach to tax policy has changed over the decades.

The piece was prompted by a recent article from Norm Ornstein and Tom Mann claiming that needed bipartisan reforms are being blocked by the new “ideologically extreme” Republican Party.

Baloney. It’s the Democrats who have changed. The party’s leaders have moved far to the left on economic issues.

As evidence, I point to this Cato Journal article from 1985 by Democrat Richard Gephardt, who was a leader on tax reform. As a free-market guy, I agree with the great majority of what Gephardt said, yet I agree with virtually nothing that modern Democratic leaders say about tax policy.

Regarding ridding the tax code of special breaks, Gephardt says, “I confess that I am not qualified to act as a central planner and I do not know anybody on either committee who is.” Amen!

And Gephardt says, “We in Congress take pride in the free market system.” When was the last time you heard a Democratic leader say something like that?

Bush Was a Statist, Not a Conservative

A former White House speechwriter, Mark Thiessen, has jumped to the defense of his former boss, writing for the Washington Post that George W. Bush “established a conservative record without parallel.” Even by the loose standards of Washington, that is a jaw-dropping assertion. I’ve been explaining for years that Bush was a big-government advocate, even writing a column back in 2007 for the Washington Examiner pointing out that Clinton had a much better economic record from a free-market perspective. I also groused to the Wall Street Journal the following year about Bush’s dismal performance.

“Bush doesn’t have a conservative legacy” on the economy, said Dan Mitchell, a senior fellow at the libertarian Cato Institute. “Tax-rate reductions are the only positive achievement, and those are temporary … Everything else that has happened has been permanent, and a step toward more statism.” He cited big increases in the federal budget, along with continuing subsidies in agriculture and transportation, new Medicare drug benefits, and increased federal intervention in education and housing.

Let’s review the economic claims in Mr. Thiessen’s column. He writes:

The thrust of their argument is that Bush expanded the size of government dramatically – and they are absolutely right. Federal spending grew significantly on Bush’s watch, and this is without question a black mark on his record. (Federal spending also grew dramatically under Ronald Reagan, though he was dealt a Democratic Congress, whereas Bush had six years of Republican leadership on Capitol Hill.)

Since federal spending almost doubled in Bush’s eight years, it’s tempting to summarily dismiss this assertion, but let’s cite a few additional facts just in case someone is under the illusion that Bush was on the side of taxpayers. And let’s specifically compare Bush to Reagan since Mr. Thiessen seems to think they belong in the same ball park. This article by Veronique de Rugy is probably a good place to begin since it compares all Presidents and shows that Bush was a big spender compared to Reagan…and to Clinton. Chris Edwards has similar data, capturing all eight years of Bush’s tenure. But the most damning evidence comes from the OMB’s Historical Tables, which show that Reagan reduced both entitlements and domestic discretionary spending as a share of GDP during his two terms.  Bush (and I hope nobody is surprised) increased the burden of spending in both of these categories.That’s the spending side of the ledger. Let’s now turn to tax policy, where Thiessen writes:

Bush enacted the largest tax cuts in history – and unlike my personal hero, Ronald Reagan, he never signed a major tax increase into law.

Using the most relevant measures, such as changes in marginal tax rates or comparing the impact of each President’s tax changes on revenues as a share of GDP, Bush’s tax cuts are far less significant than the Reagan tax cuts. But there presumably is some measure, perhaps nominal revenues over some period of years, showing the Bush tax cuts are larger, so we’ll let that claim slide. The more relevant issue to address is the legacy of each President. Reagan did sign several tax increases after his 1981 Economic Recovery Tax Act, but the cumulative effect of those unfortunate compromises was relatively modest compared to the positive changes in his first year. When he left office, he bequeathed to the nation a tax code with meaningful and permanent tax rate reductions. The Bush tax cuts, by contrast, expire at the end of this year, and virtually all of the pro-growth provisions will disappear. This doesn’t mean Bush’s record on taxes was bad, but it certainly does not compare to the Gipper’s. But what about other issue, such as trade? Thiessen writes:

Bush enacted free-trade agreements with 17 nations, more than any president in history.

Those are some positive steps, to be sure, but they are offset by the protectionist moves on steel and lumber. I’m not a trade expert, so I don’t know if Bush was a net negative or a net positive, but at best it’s a muddled picture and Thiessen certainly did not present the full story. And speaking of sins of omission, his section on health care notes:

Bush created Health Savings Accounts – the most important free-market health-care reform in a generation. And he courageously stood up to Congressional Democrats when they sought to use the State Children’s Health Insurance Program (SCHIP) to nationalize health care – and defeated their efforts.

Conveniently missing from this analysis, though, is any mention of the utterly irresponsible prescription drug entitlement. There is no doubt that Bush’s net impact on health care was to saddle America with more statism. Indeed, I’d be curious to see some long-run numbers on the impact of Bush’s prescription drug entitlement and the terrible plan Obama just imposed on America. I wouldn’t be surprised to find out that the negative fiscal impact of both plans was comparable. Shifting gears, let’s now turn to education policy, where Thiessen writes:

Bush won a Supreme Court ruling declaring school vouchers constitutional and enacted the nation’s first school-choice program in the District of Columbia.

Bush deserves some credit on school choice, but his overall education record is characterized by more spending and centralization. Thanks in part to his no-bureaucrat-left-behind plan, the budget for the Department of Education grew significantly and federal spending on elementary, secondary, and vocational education more than doubled. Equally worrisome, federal bureaucrats gained more control over education policy. Finally, Thiessen brags about Bush’s record on Social Security reform:

Bush fought valiantly for a conservative priority no American president had ever dared to touch: Social Security reform, with private accounts that would have given millions of our citizens a stake in the free market system. His effort failed, but he deserves credit from conservatives for staking his second term in office on this effort.

This is an area where the former President does deserve some credit. So even though the White House’s failure to ever put forth a specific proposal was rather frustrating, at least Bush did talk about real reform and the country would be better off today if something had been enacted.

This addresses all the economic claims in Thiessen’s article, but we can’t give Bush a complete grade until we examine some of the other issues that were missing from the column. On regulatory issues, the biggest change implemented during the Bush year was probably Sarbanes-Oxley – a clear example of regulatory overkill. Another regulatory change, which turned out to be a ticking time bomb, was the expansion of the “affordable-lending” requirements for Fannie Mae and Freddie Mac.

And speaking of Fannie and Freddie, no analysis of Bush’s record would be complete without a discussion of bailouts. Without getting too deep in the issue, the most galling part of what Bush did was not necessarily recapitalizing the banking system (a good chunk of which was required by government deposit insurance anyhow), but rather the way it happened. During the savings & loan bailout 20 years ago, at least incompetent executives and negligent shareholders were wiped out. Government money was used, but only to pay off depositors and/or to pay healthy firms to absorb bankrupt institutions. Bush and Paulson, by contrast, exacerbated all the moral hazard issues by rescuing the executives and shareholders who helped create the mess. Last but not least, let’s not forget that Bush got the ball rolling on auto-industry bailouts.

If all of this means Bush is a “conservative record without parallel,” then Barack Obama must be the second coming of Ronald Reagan.