Topic: Tax and Budget Policy

‘The Amazing Hillary’

Hurry, hurry, hurry! Step right up, ladies and gentlemen, and see the Diva of Deception, the Impresario of Illusion — THE AMAZING HILLARY!! Watch her make the federal gas tax SEEM TO DISAPPEAR!! But in fact, you’ll still be paying the same price for gas! Even the media can’t figure out this trick!! She’s remarkable! She’s astounding! So hurry right in and see the First Lady of Legerdemain, the Mistress of Magic!

That’s what Hillary Clinton’s campaign managers should be barking about her joining John McCain in proposing to suspend the federal gasoline tax for the 2008 summer driving season. Says Candidate Clinton, the move would “immediately lower gas prices.”

What makes her proposal a true work of wizardry is that, she claims, it would not reduce government tax revenues. Whereas McCain says he would reduce government spending to make up for the lost tax money (an example of magical thinking?), Clinton would implement “a windfall profits tax on the big oil companies” to close the revenue gap.

Did you catch The Amazing Hillary’s trick? Did you see why consumers would still pay the same price for gasoline? No? OK, let’s watch the sleight of hand in slow motion:

The price of any good is ultimately set by just one factor: the equilibrium of supply and demand. If demand for a good increases, consumers will bid against each other to obtain it, driving up the price. The higher price encourages producers to supply more of the good and allows them to use costlier means of production. The higher price also incentivizes consumers to moderate their demand. This dynamic operates until a new equilibrium price is reached. Similar dynamics occur if demand falls, or if supply increases or falls.

Taxes affect prices by reducing the supply of a good. Most goods (including gasoline) can be furnished in a variety of ways from a variety of inputs. Some of those supply lines are more expensive than others, and producers will only operate lines that are profitable. If a tax takes away some of the revenue that producers receive for their goods, the producers will idle the lines that are unprofitable given the post-tax revenues. The decrease in supply will push up the price until it reaches a new equilibrium between supply and demand.

Let’s apply this specifically to gasoline. Gas can be produced from many different supplies of oil, ranging from cheap-to-extract-and-refine Saudi light crude to more-expensive Texas crude and oil pumped from shallow-water wells in the Gulf of Mexico, to even-more-expensive oil from deep-water wells, or from the frozen ground of Prudhoe Bay, or from the oil sands of Canada. That oil can then be transported by a variety of methods to different refineries with different operating costs. The resulting gasoline is then transported to consumers through countless routes in the global supply chain.

Gasoline suppliers, like all other suppliers, will use only the lines that are profitable and idle lines that are not. A tax on gasoline — assessed either as a sales tax or as a corporate excise tax — will reduce the profits of different supply lines. Some of those lines will become unprofitable and be idled by suppliers, reducing overall supply. The result is that consumers pay a higher price that should produce more supply, but suppliers receive lower revenue that prompts them to decrease supply. (The difference between what should be supplied at a given price and what actually is supplied underlies what economists refer to as a “deadweight loss.”)

Deadweight losses from taxation are undesirable, but they are tolerated because government provides important services. One of the virtues of the gas tax, specifically, is that it acts (ostensibly) as a user fee for roads and other services that motorists need. Now, there certainly are more efficient ways to finance roads, but the fuel tax isn’t half bad.

However, there is something wrong with assessing a tax but claiming that it’s not there. Candidate Clinton’s “trick” is to swap the gas tax for a special tax on oil companies. Because she intends for the windfall profits tax to generate the same revenue as the gas tax, the windfall profits tax will have the same effect on gasoline supply, demand, and price as the current gas tax. The only difference is that the gas tax is transparent to consumers while the windfall profits tax is not. Voilà — the gas tax seems to disappear, but gas prices stay the same and the government still gets its money.

Theoretically, there are ways to construct a windfall profits tax so that it doesn’t suffer this problem. One way would be to levy a one-time lump sum tax — that is, to pass legislation mandating that, in 2008, the oil companies will hand over a specific amount of dollars to the federal government regardless of profit or production levels. Another theoretical windfall profits tax would apply only to lines of supply that are low-cost and would remain profitable and continue to operate despite the tax. If either of those taxes were substituted for the current gas tax, it would lower gas prices and increase supplies by getting rid of the gas tax’s deadweight loss.

However, windfall profits taxes are much easier to construct in theory than in reality. The United States tried the “low-cost supply” tax in the 1980s and found that it produced little revenue but it had some unpleasant unintended consequences. Conversely, the lump sum tax would set off one amazing (and costly) legal and political battle.

So far, I can find no information on the design for Clinton’s windfall profits tax. Perhaps The Amazing Hillary has figured a way to make the tax work. More likely, it’s just hocus-pocus.

So, in the battle of presidential rivals, give McCain a little credit for having a less illusory gas tax proposal. But the real credit should go to Sen. Barack Obama, who has dismissed the idea entirely as a “short-term, quick-fix” proposal. What Obama said last week about the very small monetary gain of McCain’s call for suspending the tax also covers Clinton’s nicely: “A half a tank of gas — that’s [their] big idea.”

Anonymous Earmark Manifesto

Appropriations lobbyists have weathered a rough few years of media scrutiny, and a series of earmarking outrages has put pressure on Congress to pass minor reforms. Luckily there may be fewer vehicles for earmarks this year as Congress will probably pass only one or two appropriations bills for Fiscal Year 2009 and leave the budget mess for a new president to sort out.

Congressional appropriators have well-rehearsed defenses of the earmarking process, and an anonymous appropriations lobbyist has joined the fray to strike back at earmark critics. I obtained a copy of a six-page document defending the earmark system called “Fairness of Congressional Earmarking Report,” which is circulating around Capitol Hill.

Earmark enthusiasts argue that the Congressional system of doling out money to local governments, businesses and special interest groups is better than giving “faceless bureaucrats” the ability to allocate federal funds. The anonymous white paper expands on this argument and tries to make the case that earmarking is a much fairer process than letting federal agencies allocate the money.

The author of the paper is a member of an exclusive clique of former appropriations staffers called the 302(b) Group, according to Washington Post lobbying columnist Jeffrey Birnbaum.

Whether earmarks are useful depends on one’s perspective. To appropriations lobbyists and groups that have difficulty obtaining federal funding through merit-based, competitive grants, earmarks are a welcome bonanza. To taxpayers and advocates of spending restraint, transparent government and federalism, they’re woefully inefficient and pit parochial interests against the national interest.

Let’s look at the debate from the perspective of an appropriations lobbyist, to whom all federal spending is good federal spending:

The most democratic way to distribute these federal dollars is to spread funding across to numerous, meritorious local government projects rather than to concentrate resources to a select few.

Ah, democracy. The implication is that if someone is against earmarking, they must be some sort of dictator-loving democracy hater. The Chronicle of Higher Education published an investigative piece in March showing that the top recipient of educational earmarks for research in FY 2008 was Mississippi State University (Number two? The University of Mississippi). The Bulldogs are not known for a world-class research program, but they happen to have influential representatives and senators on the appropriations committees to steer funds their way. Never mind that educational earmarks receive little to no scrutiny to determine merit by scientists or that millions of dollars winds up at universities with no graduate or research programs in the research areas for which they receive funds. That’s earmark “democracy” in action.

The paper also analyzes the appropriations process during FY 2006 (when Congress used earmarks) and FY 2007 (when Congress did not use earmarks because the appropriations process fell apart and Congress fell back on a series of continuing resolutions that just increased spending across the board).

Generally speaking, federal agencies awarded substantially fewer grants when compared to when Congress earmarked these funds. A few local governments did better; the vast majority did not.

There’s a debate over whether earmarks increase overall spending or if they only divert it. Assuming that overall spending doesn’t change in a given year, earmarks just redirect spending to narrow interests; removing earmarks does not decrease spending. However, the paper seems to argue spending was reduced without considering the money was likely spent on other priorities.

In the bizarro lobbying world, the federal government spending less money on special interest projects is automatically a bad thing. To taxpayers, the notion that the government isn’t indiscriminately spending money because a representative or senator inserts an earmark in an appropriations bill is usually a good thing.

Communities across the nationwide are faced with increased traffic congestion and transportation needs. These local governments must address broken sidewalks, antiquated infrastructure, congested roads, and inadequate bicycle and pedestrian trails.

Setting aside this excerpt’s grammar issues, it’s comically ludicrous to suggest that the federal government needs to bail out local governments so that they can fix broken sidewalks and bike trails. Local governments are more accountable to residents’ spending wants and needs. It’s also more efficient to tax local and state residents to provide local and state infrastructure and services instead of routing the money through the maze of federal bureaucracy.

Reasonable people can disagree about the solution to the earmark problem. An effective argument for appropriators is that until the system is reformed, it’s their duty to get as much money for their district as possible — even if it’s wasteful and inefficient. This anonymous paper, though, is a silly defense of the system. It’s understandable why the author wants to remain anonymous.

Don’t Shoot the Messenger

I’m sorry to bring bad tidings so close to the weekend, but apparently House and Senate conferees have reached agreement [$] on the broad outlines of a Farm Bill.

We will have to wait until Monday to get the full, disgusting details but broadly, we know this about the proposed bill:

  • it will raise the target prices and loan rates for northern crops (i.e., wheat, soybeans, other feedgrains) beginning in 2010
  • raise the sugar loan rate three-quarters of a cent
  • include a sugar-to-ethanol program (whereby the USDA would buy sugar that would otherwise threaten the domestic minimum price and sell it, presumably at a loss, to ethanol plants)
  • an additional $4 billion for conservation programs
  • $10.361 billion extra for domestic and international food aid programs
  • The bill also includes the new “permanent” disaster program (some thoughts on that here), albeit at $250 million less than the original $4 billion request

To pay for this, your representatives in Congress cut the $5.2 billion per year direct payments program (that is the program that pays farmers on the basis of past production and yields, regardless of what they produce now) by 2 percent per year for four years. Recall that the direct payments program, while an offence to taxpayers everywhere, is at least less trade distorting than the price-linked subsidies that the conferees have agreed to increase. And in the final year, when it really counts for purposes of planning future spending levels (i.e., the baseline), the direct payments will go back up again.

The one possible bright light at the end of this sewer-pipe: a presidential veto. No word from the administration on this latest deal, but it does not fit their past definition of an acceptable amount of reform and thus, assuming intestinal fortitude on the part of President Bush (I know, I know), would likely elicit a veto threat.

Happy weekend, everybody.

A “Crisis” of Their Own Making

A National Conference of State Legislatures report released today is sparking gloom-and-doom headlines about states in fiscal crises. Conspicuously absent from the news stories is any mention of the root cause of the “shortfalls” supposedly wrecking havoc in state capitols.  Over the last few years, state lawmakers forgot the lessons of the 1990s, and decided to add new programs and significantly expand general fund spending on existing programs.

Now, according to NCSL:

Current state fiscal conditions are being driven by weak revenue performance. State officials expected revenue growth to slow in FY 2008, but not as dramatically as it has. […] Because most FY 2008 budgets were built on revenue forecasts that are not materializing as expected, budget gaps have grown.

This reminds me of a short story by J.D. Salinger in which the main character describes the tragic lives of “bananafish:”

Well, they swim into a hole where there’s a lot of bananas. They’re very ordinary-looking fish when they swim in. But once they get in, they behave like pigs. […]  Naturally, after that they’re so fat they can’t get out of the hole again. Can’t fit through the door.

In FY 2007 alone, states raised general fund spending by 9.3 percent, well above the 30-year average of 6.4 percent.  18 states saw spending rise by at least 10 percent.  The only real news here is that state governments are finding themselves in a fiscal “hole” because they gorged on revenues when times were good, and now they have been fat so long they forgot how to go on a diet.

Yon Goicoechea Named Recipient of the 2008 Milton Friedman Prize for Advancing Liberty

Yon Goicoechea, leader of the pro-democracy student movement in Venezuela, has been awarded the 2008 Milton Friedman Prize for Advancing Liberty. Under Goicoechea’s leadership, the student movement organized mass opposition to the erosion of human and civil rights in Venezuela and played the key role in defeating Hugo Chávez’s bid for a constitutional reform that would have turned the country into a dictatorship. Goicoechea’s vision of optimism, tolerance, and modernity has breathed new life into efforts to defend basic freedoms in Venezuela and elsewhere in Latin America where freedom is threatened.

Full Details

Happy Tax Freedom Day!

Taxpayers can breathe a sign of relief. According to the Tax Foundation, April 23 is Tax Freedom Day. That means that the average American has finally earned enough to pay estimated federal, state, and local taxes for 2008. One of the most depressing finding in the Tax Foundation’s report is that Americans pay more in tax than they do for food, clothing, and shelter combined. To compensate for being the bearer of bad fiscal news, the Tax Foundation released an amusing video. It doesn’t quite equal this classic tax video, but it’s worth watching.

Money Meddling

Are you an entrepreneur who deposits a regular amount of your business revenues in the bank? Watch out, the government might come after you for illegal “structuring.”

Are you a high earner who regularly pulls out a substantial amount of cash from your bank account? Watch out, your bank could be sending ”suspicious activity reports” about you to the government, as former senator Bob Dole’s bank did.

Have you ever deposited or withdrawn more than $10,000 from your bank? Watch out, because your activities were recorded on a government database of “currency transaction reports,” which is growing by 16 million new reports each year.

Did you overstate your income on a loan form when you bought your house? Watch out, the government could nail you for both ”bank fraud” and “money laundering.”

Forbes focuses on government encroachments on our civil liberties in a series of articles this month. See here, here and here

As a tax wonk, the IRS angle in these articles caught my eye. But like many people, I find it very disturbing that continual expansions in federal power are shrinking the realm of privacy and individual automony in modern society.