Topic: Tax and Budget Policy

Winner and Loser States from Centralized Government

Ninety years ago, two-thirds of government spending in America was state-local and one-third was federal. Today, it is the reverse with about two-thirds federal and one-third state-local. American government has become larger and much more centralized. That centralization has made winners and losers among the states as vast flows of taxpayer cash pour into Washington and are then dispersed through more than 2,200 federal spending programs.

In 2019, the federal government will vacuum $3.5 trillion from taxpayer pockets in the 50 states, borrow $1 trillion from global capital markets, and then turn on the leaf blower to scatter $4.5 trillion back out across the 50 states. Many billions of dollars will stay in and around Washington to pay for the leaf-blowing operations.

The Rockefeller Institute of Government has released a very useful report detailing these cash flows. The report calculates a “balance of payments” for each state in 2017, which is federal spending in each state less taxes paid to the federal government by individuals and businesses in each state. The winner states have a positive balance and the loser states a negative one. Federal spending includes four items: benefits (such as Social Security), state-local grants (such as Medicaid), procurement (such as fighter jets), and compensation paid to federal workers.

On a per capita basis, the biggest winner states are Virginia, Kentucky, and New Mexico. Virginia has a lot of federal employees, contractors, and the world’s largest naval base. Kentucky receives a lot in benefits, contracts, and grants, and has Senator Mitch McConnell. New Mexico has a lot of federal employees, contractors, and Los Alamos.

The biggest loser states are Connecticut, New Jersey, and Massachusetts. Those states have a large number of high-earning individuals who get hit hard under the “progressive” federal income tax.

Figure 1 below shows data from the Institute’s report. Taxes per capita are on the horizontal axis and spending per capita on the vertical axis. Each dot is a state. The totals allocated for 2017 were $3.1 trillion in taxes and $3.8 trillion in spending, leaving out five percent of taxing and spending that could not be allocated by state.

Generally, states on the bottom right are the losers and those on the top left are winners.

Connecticut is on the far right paying $15,462 in federal taxes per capita but receiving only $11,462 in federal spending. Connecticut would be better off in a decentralized United States with citizens paying most of their taxes to state and local governments rather than the federal government.

Every state is actually worse off than indicated in Figure 1 because federal borrowing in 2017 allowed spending to be 20 percent larger than taxes. But borrowing is not a free lunch. It creates a cost that will hit residents of every state down the road—borrowing is just deferred taxes.

For Figure 2 below, I scaled up federal taxes to include both current and deferred. That is, I scaled up taxes for each state the same percent so that total federal taxes for the nation equals total federal spending. With that adjustment, Connecticut residents paid $18,586 in current and deferred taxes per capita and received only $11,462 in spending. Connecticut residents are only getting back 62 cents for every dollar owed to Washington.

The patterns exhibited in the figures have persisted for decades. High-income states such as Connecticut have been penalized by the overly progressive federal income tax for a very long time. The interesting political question is why do they stand for it? Why do members of Congress from high-income states support a highly progressive federal income tax that particularly harms their own states?

The Case for Economics When Considering Alcohol Tax Levels

“It’s time to raise the alcohol tax,” declared Vox author German Lopez back in December.

Now let me state upfront that I am not confident I know what the correct tax rate on alcohol should be. Lopez may well be right about their being a rational case on economic grounds for an increase based on high-quality, robust analysis. But his article does not make a reasoned case satisfactorily, nor does it link to such analysis.

In fact, it came to my attention as I was finalizing my new paper “How Market Failure Arguments Lead to Misguided Policy” (released today). And I’m convinced his piece is a classic of the genre. This article aims to highlight some of the key objections I have to his approach, which is increasingly common in public debate.

The traditional economic case for alcohol taxation

Libertarian theory aside, the classic case for taxing alcohol will be familiar to those with basic economic knowledge. Alcohol consumption is believed to impose, on net, external costs on people other than drinkers themselves.

When deciding whether to drink, individuals are thought to only consider the balance of private costs (the money it costs to drink, the hangover, the risk of disease or accidents for them etc) and the private benefits of consumption (the confidence, the enjoyment of the taste, the benefits to them of socializing etc).

But clearly, alcohol consumption can have external effects. The costs of alcohol-related crime and driving under the influence are borne by others. There may be net external costs relating to health care, too, given alcohol-related diseases and incidents could necessitate higher taxpayer subsidies or insurance premiums (though, applying such logic consistently, one would have to net off any “savings” that alcohol consumption might deliver in terms of lower Social Security and Medicare payments from reduced longevity).

The economic case for a tax then is this: if we observe net external costs associated with alcohol consumption, then allowing a free market would lead to higher levels of consumption than optimal. If a tax can be imposed that equates roughly to the marginal external costs of consumption, then drinkers are faced with a price reflective of the true costs of their actions.

Due to the “Law of Demand,” the amount of alcohol consumption will fall to the level at which marginal social costs equate to marginal benefits as this tax is imposed. Some of the negative external costs will occur less often, as will some of the private costs. Society as a whole will be better off because the tax means prices now reflect the true cost to society of the product’s consumption.

In order to make the case for a hike in alcohol taxes then, Lopez simply needed to present clear evidence that current tax rates on alcohol are too low to account fully for the external costs of consumption we see. His line of reasoning does not make this case.

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.

All Your Money Are Belong to Us

In his State of the City Address, New York mayor Bill de Blasio laid out his governing philosophy succinctly:

Here’s the truth, brothers and sisters, there’s plenty of money in the world. Plenty of money in this city. It’s just in the wrong hands!

The money, of course, is in the hands of those who earned it. In de Blasio’s view, people who earn too much are “the wrong hands.”

In the speech itself and in an interview with Jake Tapper on CNN’s “State of the Union,” he elaborated: the wealthy have too much money because they aren’t taxed enough.

There are whole books on the correct theory of taxation. De Blasio, like many politicians, seems operate on the theory most clearly enunciated in 1990 by Sen. Barbara Mikulski (D, Md.):

Let’s go and get it from those who’ve got it.

There are many theories of taxation, such as Haig-Simons, the Tiebout model, and the Ramsay Principle. But I’d bet that the Mikulski Principle explains actual taxation best. And as “progressives” are feeling their oats, we can expect more politicians and pundits to be asking, “Who’s got the money? Let’s go get it.”

California’s 6-Month Paid Leave Program Is Not as Popular as You Think

At a press conference earlier this month, California Governor Gavin Newsom announced a new plan to offer 6-months of paid family leave in the Golden State. Despite it being the most generous in the nation, CNN parenting contributor Elissa Strauss felt it’s not enough, saying it’s “so much better than nothing, but leaves room for improvement.” Yet, the Cato 2018 Paid Leave Survey finds that at the national level, Americans are not supportive of establishing a 6-month paid leave program. 

The survey found that less than half (48%) support “establishing a new government program to provide 6-months of paid, job-protected, leave to workers after the birth or adoption of a child or to deal with their own or a family members serious illness.” Fifty-percent (50%) oppose establishing a 6-month paid leave program. 

Find full survey results here 

Notably, support is low despite the question not mentioning anything about tax increases or other trade-offs that are required when establishing a new government program. As the New York Times rightfully points out, it remains unclear how California will pay for 6-months of paid family leave benefits.

Fortunately, the Cato 2018 Paid Leave Survey asked Americans how much they’d be willing to pay in higher taxes each year to establish a 6-month paid leave program. The survey finds that 66% of Americans would oppose establishing a 6-month paid leave program if it cost them $525 per year in higher taxes, 68% would oppose if it cost $750 a year, and 69% would oppose if it cost $2,100 in higher taxes.[1] These costs are based on using certain program assumptions from the Family Medical Insurance Leave (FAMILY) Act sponsored by Sen. Kirsten Gillibrand (D-NY) and Rep. Rosa DeLauro (D-CT). (See here for more information).

Without mentioning tax increases, majorities of women (54%), mothers of children under 3 (59%), and African Americans (59%) favor creating a 6-month leave program, while majorities of men (58%) and whites (54%) would oppose. Latinos are evenly divided with 49% in support and 45% opposed. But, each of these groups opposes a 6-month program once taxes are mentioned. Majorities oppose among women (64%), men (67%), mothers of children under 3 (54%), whites (71%), Latinos (58%), and African Americans (51%) if a 6-month paid leave program cost $525 a year in higher taxes. 

Some could reasonably point out that California is more liberal than the rest of the country, with California voting Democratic in 7 of the past 10 presidential elections. To consider how Democratic-leaning Californians might feel about increasing their taxes to pay for a 6-month paid leave program, we can examine what Democrats nationally think about it:

When no taxes are mentioned 61% of Democrats support establishing a 6-month paid leave program and 38% are opposed. This includes 67% of Democratic women and 55% of Democratic men. (In contrast, 70% of Republicans oppose, including 64% of Republican women and 76% of Republican men). However, Democratic support flips as soon as tax increases are mentioned. If the 6-month program cost people $525 a year in higher taxes, 55% of Democrats would oppose the program and 44% would favor. If costs turned out to be higher, 67% of Democrats would oppose if the program cost them $750 a year in higher taxes and 71% would oppose if it cost them $2,100 a year in higher taxes. Furthermore, majorities of both Democratic women and men oppose a 6-month paid leave program once costs are considered.

These results suggest that if California voters more closely resemble national Democratic voters rather than the nation as a whole, they would like the program in theory but not in practice. While they may desire to offer a 6-month paid family leave benefit to people, they would not tolerate the higher taxes likely required to properly fund the program. 

California already has the highest income tax rates in the country, reaching up to 13.30%, with the average family paying 9.30%, and a statewide sales tax rate of 7.25% percent in addition to local sales tax rates. Especially given these conditions, it remains uncertain voters would be willing to tolerate another tax increase. One option to keep costs low could be to means-test the program so that only the needy would receive benefits. Otherwise, the program may be too expensive for voters to accept. Another option is to promote tax-advantaged savings accounts. Eighty-two percent (82%) of Democrats, as well as 78% of all Americans, would support creating tax-advantaged family leave savings accounts that could be used if people needed to take family or medical leave.

Altogether, these results indicate that while Californians may be excited about the benefits that this new program would offer, they are likely to resist the higher taxes likely required to make the program possible.

Read about the full survey results and analysis here.

For public opinion analysis sign up here to receive Cato’s upcoming digest of Public Opinion Insights and public opinion studies.

The Cato Institute 2018 Paid Leave survey was designed and conducted by the Cato Institute in collaboration with YouGov. YouGov collected responses online during October 1-4, 2018 from a national sample of 1,700 Americans 18 years of age and older. Restrictions are put in place to ensure that only the people selected and contacted by YouGov are allowed to participate. The margin of error for the survey is +/- 2.4 percentage points at the 95% level of confidence. 

      

 


[1]Public support doesn’t change much after taxes reach $525 a year perhaps because Americans aren’t supportive of the program to begin with. After taxes are mentioned there may be a threshold after which cost-conscious people will be opposed. Those who remain in support even if the costs rose to $2,100 a year may be very ideologically committed to establishing a program, they think someone else will foot the bill, or they may not believe taxes would actually be raised that much.

Welfare Cowboy

A reporter called the other day to ask what I thought about the National Endowment for the Arts (NEA) giving subsidies to the National Cowboy Poetry Gathering in Elko, Nevada. The government appears to have given the cowboy poets hundreds of thousands of taxpayer dollars over the years.

As the symbol of rugged individualism in the American West, I’m surprised cowboys aren’t embarrassed to take government hand-outs. The amount of money is not large, but when private groups get hooked on subsidies they become tools of the state. They lose their independence and may self-censor.

From the government’s perspective, subsidies placate dissent and encourage subservience. I’m not just talking about cowboys, but recipients of all the federal government’s more than 2,000 subsidy programs.

The NEA launched the poetry subsidies in 1985 to fix the negative image of cowboys as “strong, silent types.” Bikers and gun owners also have image problems, so we might expect the NEA to next sponsor poetry at the Sturgis Motorcycle Rally and the Crossroads of the West Gun Show.

I’m not receiving any NEA subsidies, but I nonetheless crafted a song sung to the tune of Rhinestone Cowboy:

“Welfare Cowboy”

 

I’ve been studyin’ the budget so long

Complainin’ about the wasteful mor-ons

I know every hand-out in the dirty hallways of Congress

Where money’s the name of the game

And our taxes get washed down the pork-barrel drain

 

There’s one program so surprisin’

On the road Elko, Nevada

That’s where NEA shines a light on its inanity

 

Like a welfare cowboy

Writing poetry for a subsidized gathering

Like a welfare cowboy

Getting hand-outs from people they don’t even know

And offers gained from a lobbying lasso

Note: the cowboy poets appear to have received about $35,000 every year or two from the NEA since the 1980s. They also receive support from the Nevada government and City of Elko.

Government Octopus Threatens Economy

As the government shutdown drags on, it is starting to damage activities across the economy because federal tentacles are in everything. But we better get used to it because with rising deficits and growing partisan discord such disruptions will probably become more frequent and damaging.

Sadly, the expansion and centralization of government power in recent decades has made our $20 trillion economy dependent on a small group of self-interested and often ill-informed politicians. Centralization and dysfunction at the core is a toxic mix.

The shutdown is affecting activities that the government needlessly monopolizes—such as air traffic control. It is affecting activities that the government needlessly regulates and subsidizes—from Smuttynose’s beer labels in New Hampshire to Betty Gay’s home repairs in Kentucky.

And it is needlessly harming a large group of people that it has micromanaged for far too long—American Indians. “The shutdown has hit Native American tribes especially hard because so many of their basic services depend on federal funding,” notes the Washington Post. Education, health care, road maintenance, and other services on reservations are often run by the federal government or run by tribal employees paid by the federal government.

That dependency has long resulted in mismanaged and low-quality services for the million people who live on reservations. In the New York Times, one tribal leader spoke of federal support, “The federal government owes us this: We prepaid with millions of acres of land,” while another said the shutdown “adversely affects a population that is already adversely affected by the United States government.”

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