Topic: Tax and Budget Policy

Apollo 11: A Rare Federal Success

NASA’s Apollo 11 blasted off 50 years ago today sending astronauts to land on the moon and return safely to earth. The mission was planned rapidly and executed almost flawlessly. The Saturn V rocket was the most powerful engine ever built. The computers available at the time were primitive, yet everything about the timing of burns and entry angles had to be precise. Neil Armstrong, Buzz Aldrin, and Michael Collins were unbelievably brave. It was a stunning achievement. An American triumph.

If the mission were pursued today, the president would be tweeting undignified comments and hogging the spotlight. The launch would be years behind schedule and the computers would jam like during the Obamacare launch. Environmental lawsuits would shut down the launchpad. Labor regulations would slow astronaut training. NASA executives would be indicted for graft. Federal budget squabbling would close the federal government and mission control, leaving the astronauts to find their own way home from the moon. It would be a mess.

Policymakers these days keep on dreaming of big spending projects for the government. But Washington is running trillion-dollar deficits and is far more dysfunctional than in 1969. I discuss the structural reasons why the government fails so much in this study.

The federal government has suffered from corruption, cost overruns, pork barrel spending, and nasty partisan battles since the beginning. But the problems have grown worse because the government has grown far too huge to manage and oversee properly. The federal government’s budget is 100 times larger than the budget of the average state government. As Milton Friedman said, “because government is doing so many things it ought not to be doing, it performs the functions it ought to be performing badly.”

The 1969 moonshot remains awe-inspiring, as the new Apollo 11 movie captures. But looking ahead, we would get more out of the government if it did less. We would be better off letting entrepreneurs take the lead both in space exploration and in the many challenges we face here on earth.

Washington Post: Illogic on Gas Taxes

A recent Washington Post editorial addressed highway funding and gas taxes. The piece noted that gas taxes went up in 13 states in July and that “31 of the 50 states have raised or reformed their motor fuel taxes during the past decade.”

From these state policy actions, the Post deduced that the federal government should raise its own gas tax. But that makes no sense. The recent gas tax increases show that the states are already addressing their highway funding needs. The chart below, based on API data, shows that while the federal gas tax rate has been stable in recent years the average state rate has risen substantially.

The states have powerful revenue sources to fund their highways and other infrastructure, including gas taxes, income taxes, sales taxes, and borrowing. They can pursue privatization and public-private partnerships to draw private funds into infrastructure. And they can re-direct gas tax revenues currently used for other purposes back to highway use.

State governments own the nation’s highways, including the entire Interstate system, and they can best judge how much money is needed for construction and maintenance. The federal government is a bureaucratic and pork-barrel middleman that has no magic source of free funds. We should let the states fill up their own highway funding tanks.

Marching to a Federal Debt Crisis

My new op-ed at The Hill discusses the disastrous rise in federal government debt as profligacy dominates both parties in Washington. With the far-left lurch of the Democrats and the complete abdication of responsible budgeting by Republicans, I don’t see how the nation escapes from a damaging and protracted economic crisis down the road.

It does not have to be this way, as my article discusses. Canada escaped a similar debt spiral in the 1990s as a left-of-center government imposed and sustained sharp spending cuts. We can and should do that here, now, yet virtually all members of Congress appear uninterested in reform.  

An excerpt from The Hill:

So while debt projections already look scary, we’ll probably be hit by surprises that make the outlook even worse, such as recessions, wars, higher interest rates or a new president in 2021 who wants spending on a Green New Deal or Medicare for All.

We are on a budget death spiral similar to what Canada faced in the 1990s. As deficits soared, interest costs began devouring their federal budget—rising from 10 percent of total spending in the mid-1970s to 30 percent by the mid-1990s. The high debt scared away investors and the economy struggled. Canada’s federal debt was downgraded by the ratings agencies, and a Wall Street Journal editorial called the country a “basket case” and “an honorary member of the Third World” for its bleak outlook.

The Canadian story has a happy ending because leaders were jolted to their senses and made gutsy decisions to slash spending. They cut defense, business subsidies, farm aid, welfare, grants to lower governments, federal jobs and much else. Federal debt plunged from 67 percent of GDP in 1996 to 34 percent by 2006. Defying Keynesian predictions, the large spending cuts revived the economy and launched the nation on a long boom.

American leaders used to know how to reduce debt. Debt spiked during every war over the past 230 years but was always paid down afterwards. After the Civil War, for example, the government ran surpluses 28 years in a row, causing debt to plunge from 31 percent of GDP down to just 7 percent.

Today we are at peace yet the debt is soaring. The profligacy is so scary because our leaders don’t seem to have the guts to make tough spending decisions like Canada did. We’re marching into a fiscal crisis and few of our leaders seem to care about debt or know how to tackle it.

This study puts government debt in historical perspective and explains why it is so harmful.

This chart shows the history of federal debt and CBO’s baseline projection, which is an “optimistic” forecast if Congress does not make spending reforms.

Image Credit: Congressional Budget Office 

Boston’s Rail System: Another Government Failure

The federal government spends $14 billion a year on subsidies for local rail and bus transit. This spending should be zeroed out in the next federal transportation bill because it induces cities to own and run monopoly transit systems that are unionized and mismanaged.

Federal transit aid has mainly covered capital costs, not operations and maintenance. That has encouraged cities to purchase rail systems with big up-front costs, rather than cheaper, safer, and more flexible bus systems.

One consequence of the bias toward rail is that cities get stung by huge maintenance costs down the road. Rail systems across the nation are suffering from breakdowns, delays, and safety hazards. Subway systems in New York City, Washington D.C., and Boston are in poor shape, yet those cities are induced by federal aid to keep expanding them.

A New York Times investigation of that city’s subway system found lavish spending on new projects at the same time as a shocking neglect of maintenance. Meanwhile, Washington’s Metro is building a boondoggle $5.8 billion rail line to Dulles airport, even though the system suffers from maintenance and safety failures, smoke in tunnels, crashes, and declining ridership.

It is a similar story with Boston’s rail system, as discussed in the Wall Street Journal today:

Bostonians are losing patience with their transit system.

In June, a 50-year-old subway car left its track and smashed signaling equipment, just days after a trolley derailed underground. The resulting commuting chaos, along with a July 1 fare increase and a plan to limit summer service for repairs, combined to overshadow the aging system’s slow-moving rehabilitation.

The Massachusetts Bay Transportation Authority, a state agency that runs the system, estimates it will take about $10.1 billion and 13 more years to modernize it, with costs expected to rise as equipment ages. 

… Nationwide, it would cost at least $100 billion to address the backlog of transit-system upgrades, said Paul Skoutelas, chief executive of the American Public Transportation Association, which represents transit agencies. “It’s difficult, once you go any number of years—and in some cases it’s decades of that underinvestment—it’s very difficult to dig your way out of that hole,” he said.

… The MBTA suffered widespread failures during a brutal winter in 2015, just as Mr. Baker, a Republican, took office. He found a system beset by neglect and financial problems, including an inability to spend available resources quickly enough. The Baker administration says the extended timeline for MBTA upgrades reflects the challenges in addressing long-running problems.

… “Digging out from decades of neglect doesn’t happen overnight, not on a system that must continue to operate every single day,” [Baker] said.

Why has there been “decades of neglect?” Why is there a $100 billion “backlog?” Why is the Boston system “beset by neglect and financial problems?” Why are all these transit systems so shoddy? Because they are unionized monopolies owned by governments, and there is little incentive for efficiency, innovation, and improvement. Federal subsidies encourage bad behavior and bad choices by states and cities.

The federal government should end subsidies and the states should privatize. Before the 1960s, most U.S. urban transit systems were private, and they should be private once again. Hong Kong privatized its metro system in 2000, and the reform has been a big success. Government transit has been a failure, so it is time to give entrepreneurs and markets a chance.

More on these issues here, here, and here.

 

Why French and British Digital Sales Taxes Are “Marxist”

Back in 2017, tax expert Professor Michael Devereux claimed that digital services taxes being proffered in Europe were “Marxist.” Not because they were socialist or communist ideas. No, he didn’t have good old Karl Marx’s theories in mind. A limited tax on certain firms’ sales, with those burdened being determined by arbitrary thresholds and industry definitions, instead echoed the spirit of Groucho Marx. He who famously said: “those are my principles, and if you don’t like them, well I have others.”

European countries have long adopted the principle that profits should be the basis for corporate taxation. Those corporate profit taxes are supposedly levied in the country where the profit making takes place. Yet with murkiness about where true profit-making activity occurs for digital firms, given intellectual property and firms’ ability to shift headquarters between countries, the European polities looked willing to throw out their principles altogether upon disliking its results. Their aim instead was higher government revenue from certain firms, and if new, highly targeted secondary tax bases were needed to achieve it, so be it.

That, sadly, is the new reality in France and soon the UK too. The French this week passed a law such that any digital company with worldwide revenue of more than $844 million (and at least $28 million from France) will face a new 3 percent tax on sales generated in France. The UK tax is likewise introducing a 2 percent tax on revenues from intermediate (not retail) sales for “search engines, social media platform or online marketplaces” for those with worldwide revenue exceeding $628 million, and at least $31 million from UK activity.

If this seems arbitrary and highly targeted at companies such as Google, Facebook, and Amazon, that’s because it is. There are big, evident challenges for the current corporate tax system. But rather than debate wholesale change, such as whether a destination-based tax system might be preferable to the status quo (explicitly changing the central principle from taxing where profits are made to where sales occur), the UK and France are instead undergirding their existing approach with a new revenue stream explicitly directed at large, American businesses.

Implementation is almost certain to lead to a reaction from President Donald Trump. Since Europe isn’t blessed with many home-grown tech giants, these digital services taxes are a bit like tariffs. The odds of a tit-for-tat reaction from a US President who self-identifies as “Tariff Man” must therefore be very short. But in truth, these measures won’t just hit existing firms and their consumers. They could have chilling effects on tech innovation too, especially in Europe.

It will be future digital giants – those fast growing, initially low profit-margin (or even loss-making) digital businesses – who will suffer most from a revenue tax. Think Amazon a decade ago. Businesses in those positions may find they have to raise funds just to pay their tax bills. That’s why the UK is already thinking about an exemption for very low profit companies, making the policy even messier. On the margin, still, such taxes could deter firms scaling up or serving new markets due to the compliance cliff-edges. This problem will be much worse if there are very different taxes operating across different countries. It’s almost a fatalistic admission that Europe is completely giving up on ever becoming a breeding ground for successful digital giants.

Sadly, as I’ve written before, new taxes for digital companies are politically popular, and supported by bricks and mortar retail competitors to Amazon, especially in the UK. These firms and prominent politicians have effectively popularized the line that it’s unfair that businesses such as Amazon are not burdened by local business property taxes, unlike “High Street” stores. The result, it is said, is “unfair competition” caused by an “uneven playing field.”

This, of course, completely misunderstands the nature of the competitive process. Companies such as Amazon have developed business models that explicitly avoid the need for high-cost, inner-city premises. That’s one reason why they can offer consumers low prices. To punish them for that with a new revenue tax would be a bit like imposing extra revenue taxes on companies that found ways to automate certain activities to save on labor costs.

That is the key point. The French and UK governments are not thinking through their tax codes from first principles, or trying to develop a neutral framework updated for modern challenges. They are, Groucho Marx-like, trying to justify the revenue grab from large foreign firms by adding new principles to their already hideously complex tax laws.

State and Local Tax Differences

Americans are moving from higher-tax states to lower-tax states.

As I discuss in this study, 578,269 people moved from the highest-tax states to the lower-tax states in 2016, on net. Of the 25 highest-tax states, 24 of them had net out-migration. Of the 25 lowest-tax states, 17 had net in-migration.

The pattern seems clear to me, but the degree to which moves are driven by taxes versus other factors is subject to debate. An annual Census Bureau survey asks Americans who move the reasons for their decision out of 19 choices, but the choices do not include taxes.

Many of the largest migration flows are between states with the highest and lowest taxes. State-local taxes are 14.7 percent of personal income in the largest outflow state, New York, but they are just 7.5 percent in the largest inflow state, Florida. Florida’s government costs half as much as New York’s, yet the services are probably just as good.

There are large tax differences between cities. The District of Columbia government produces an annual study comparing state-local taxes on hypothetical families at various income levels in the largest city in each state. The study includes sales, property, individual income, and automobile taxes.

The table shows results for 2017. Families earning $75,000 a year could save about $5,000 a year moving from a high-tax city to a low-tax city. Families earning $150,000 could save about $10,000 with such a move. Bridgeport and Newark have very high property taxes. Other high-tax cities, such as Detroit and Philadelphia, impose city income taxes on top of state income taxes.

People move because of weather, housing costs, and job opportunities. But these sorts of large tax differences are likely driving migration patterns as well.

Household taxes for largest city in each state

 

Opportunity Zones: Big Win for Landowners

The Republican Tax Cuts and Jobs Act of 2017 created 8,700 “opportunity zones” across the country, which receive special capital gains tax breaks. O Zones have divided our cities and towns into winner and loser zones, while encouraging political corruption.

O Zones are supposed to alleviate poverty, but the main beneficiaries are likely to be certain landowners within the politically chosen zones. When governments alter the profitability of parcels of land through taxes and regulations, changes in expected future returns are capitalized into current land prices. Markets are forward looking.

News articles have highlighted the windfalls that O Zones have bestowed on some lucky landowners, as I noted here and here. Now a statistical study has confirmed the basic economic logic. A study by Alan Sage, Mike Langen, and Alex Van de Minne found that O Zone designation has:

resulted in a 14% price increase for “redevelopment” properties and a 20% price increase for vacant development sites … Our findings suggest that the OZ program has thus far primarily passed through the statutory tax benefits to existing land owners, with limited evidence of additional value creation.

The authors investigated whether there is evidence of increased productivity within O-Zones and spillover benefits to other properties. They find no such effect:

If the tax benefit would spur the local economy, one would expect price increases for all properties [in the zones], not just the ones getting the actual tax benefit. Instead, we find that only properties that benefit from the tax break—redevelopment properties and vacant land—see their prices increase. The tax break is essentially factored into the land price.

The study concludes,

Our findings cast doubt on the capacity of the OZ program to achieve its ostensible goal of creating value in low-income communities … Whereas an increase in land productivity could produce benefits for residents of OZs, a pass-through of tax benefit will likely benefit only existing owners of commercial real estate in target neighborhoods.

The problems with O Zones are discussed further hereherehereherehere, and here.

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