Topic: Tax and Budget Policy

OECD Tax Bureaucrat Admits Tax Competition Leads to Better Tax Policy

The Organization for Economic Cooperation and Development is infamous for its anti-tax competition campaign. Acting on behalf of uncompetitive nations such as France and Germany, the Paris-based bureaucracy even has a blacklist of low-tax jurisdictions and wants those “tax havens” to be subjected to financial protectionism. Yet a top OECD tax official just confessed that tax competition is driving tax policy in the right direction by pressuring governments to lower tax rates, as noted in this Thomson Financial News report on the Forbes website:

Chistopher Heady, head of the OECD’s centre for tax policy and administration said…whilst corporate tax rates have fallen in Europe, revenues have not. ‘It is likely that corporate tax revenue will eventually start falling,’ he said at the Brussels Tax Forum. He said that combined with decreasing tax income from high earners…this could lead to a combination of taxes which would be more beneficial for GDP growth. ‘The pressures of tax competition may lead to a tax mix that is better for growth,’ he said.

The OECD logic is remarkable. The bureaucrats admit that tax competition is producing positive results. Heck, an earlier OECD report admitted that “the ability to choose the location of economic activity offsets shortcomings in government budgeting processes, limiting a tendency to spend and tax excessively.” Yet rather than celebrate tax competition as a liberalizing force, the bureaucracy wants to sanction and penalize jurisdictions with pro-growth tax systems.

More on the Value of Preventive Medicine

David Brown has an excellent article in the Health section of today’s Washington Post:

Most of us naturally assume that preventing a disease is cheaper than waiting for the disease to appear and then treating it. That belief is especially dear to politicians, who often view prevention as an underused weapon in the battle against health-care costs.

The campaign Web site for Sen. Hillary Clinton (D-N.Y.) notes that her health-care plan is “targeting the drivers of health-care costs, including our back-ended coverage of health care that gives short shrift to prevention.” Rival Sen. Barack Obama (D-Ill.) asserts that American families can save up to $2,500 a year each if five cost-containing strategies are implemented, one of which is “improving prevention and management of chronic conditions.”…

Even when prevention greatly reduces future cases of a particular illness, overall cost to the health-care system typically goes up when lots of disease-preventing strategies are put into practice. This is usually true whether treating the preventable diseases is cheap or expensive.

I raise similar points here and here.

Two points bear clarification, however. First, just because preventive medicine often increases medical spending, that does not necessarily mean (in the words of the article’s headline) that it is “Cheaper To Let People Get Sick.” Illness imposes its own costs, and so it may be cheaper to spend money on preventive care even when doing so increases overall medical spending because the benefits of avoiding illness outweigh the additional spending. But we should not think that spending additional money on preventive medicine would reduce medical spending. Second, contrary to what Brown claims in his first sentence, there very likely was a period in health economics when an ounce of prevention was worth a pound of cure. During the period when public health measures first began to control contagious diseases and foodborne illnesses, prevention probably did deliver health improvements 16 or more times greater than those delivered by treatments for existing conditions.

The article also contains this priceless comment from Louise B. Russell of Rutgers University:

“The point of the medical-care system is to serve people. It is not the point of people to serve the medical-care system.”

Let’s hope that one gets a lot of play in the near future.

Will Hungary Finally Join the Flat Tax Club?

Unlike most of its neighbors, Hungary is still saddled with a discriminatory tax regime, leading to high tax rates on productive behavior and a big underground economy. Fortunately, the collapse of the current Hungarian government may pave the way for a flat tax:

Small Hungarian opposition party the Hungarian Democratic Forum Thursday said it would attempt to force the introduction of a flat tax after a coalition split this week raised the prospect of a minority government. “The withdrawal of the (junior coalition) Alliance of Free Democrats has opened up the possibility of introducing a flat tax from 2009, since this gives the parliamentary majority for the decision,” the party said in a statement. Free Democrat leader Ibolya David called for opposition parties to attend talks on April 15 to work out details of a bill to submit to parliament by May. The party wants to emulate regional peers such as Slovakia and Romania by introducing a flat 18-per-cent personal income tax to reduce a tax burden it called “unfairly high.” The Free Democrats and main opposition party Fidesz - along with its allies the Christian Democrats - have said in the past that they would favour a flat tax. …The Socialist Party has only 190 seats in the 386-seat parliament, meaning that the opposition parties could force through a flat tax bill by banding together. Hungary is ranked as having the second-highest tax burden for single people, behind Belgium, amongst the members of the Organization for Economic Cooperation and Development (OECD). Many feel the high burden - made worse in 2006 when the government hiked taxes as part of its economic reforms - hits Hungary’s regional competitiveness. …The tax burden also credited with maintaining the huge black economy. Estimates of the size of the black economy vary from the official figure of 18 per cent of gross domestic product to as high as 50 per cent among some analysts.

Illinois Politicians Hatch Scheme to Kill State’s Flat Tax

There’s good news and bad news in the Land of Lincoln. Starting with the bad news, a handful of state politicians want to impose a so-called progressive tax scheme that will double the tax burden for productive citizens. The good news is that this requires an amendment to the Illinois Constitution, which requires both three-fifths support from the legislature and - more important - three-fifths support from state voters:

A group of House Democratic lawmakers announced Thursday they want to ask voters to amend the state constitution to double the income tax burden on Illinoisans who earn more than $250,000 a year. …”I believe a flat rate income tax is a regressive tax, it’s an unfair tax and by moving to a progressive tax - one that taxes those who earn more at a higher rate - we can accomplish some of these goals that have eluded the state for a number of years,” Smith said at a press conference at the capitol. Smith said about 107,000 of the more than 5 million taxpayers in Illinois would be affected by the proposed increase. In order for the Illinois Constitution to be amended, both chambers of the General Assembly must approve the proposal by a three-fifths majority. Afterward, 60 percent of voters must vote in favor of the amendment on a referendum that will appear on the ballot in the next election.

How States Use Medicaid to Bilk Taxpayers in Other States

Today, the Government Accountability Office (GAO) testified before Congress on the many ways that states use the Medicaid program to defraud (my word) taxpayers in other states.  The following is an excerpt from GAO’s prepared testimony:

GAO has reported for more than a decade on varied financing arrangements that inappropriately increase federal Medicaid matching payments. In reports issued from 1994 through 2005, GAO found that some states had received federal matching funds by paying certain government providers, such as county-operated nursing homes, amounts that greatly exceeded established Medicaid rates. States would then bill CMS for the federal share of the payment. However, these large payments were often temporary, since some states required the providers to return most or all of the amount. States used the federal matching funds obtained in making these payments as they wished…[Such] financing arrangements effectively increase the federal Medicaid share above what is established by law…

Supplemental payments involving government providers have resulted in billions of excess federal dollars for states, yet accountability for these payments—assurances that they are retained by providers of Medicaid services to Medicaid beneficiaries—has been lacking. CMS has taken important steps in recent years to improve its financial management of Medicaid, yet more can be done.

Yes, more should be done.  Congress should reform Medicaid and the State Children’s Health Insurance Program the same way it reformed welfare: eliminate the federal entitlement to benefits, and replace those programs’ matching grants with lump-sum block grants.  That would eliminate many perverse incentives created by those programs, including the incentive to cheat taxpayers in other states.

Those reforms would also be a nice stepping stone toward giving the states full responsibility for maintaining those programs, and getting the federal government out of the business of providing medical care to the poor entirely.

Oil Subsidies in the Dock

Yesterday, Congress summoned the heads of BP, Shell, Chevron, ConocoPhilips, and ExxonMobil to defend the prices they’re charging at the pump and the subsidies they are receiving from the federal government. The former issue is of less interest to me than the latter.

The main issue is the so-called Section 199 tax credit passed in 2005. The credit is available to all domestic manufacturers - not just to oil and gas companies - and it allows the oil industry to write-off $13.6 billion over ten years that might otherwise be sent to the federal treasury. While a good case could be made to get rid of Section 199 in toto – the feds shouldn’t be in the business of artificially making some business activities more economically attractive than others – limiting that deduction for oil and gas companies and oil and gas companies only will compound the underlying economic distortion and encourage investors to put relatively less money in oil and gas production and more money in other industrial sectors. How is that a good thing with oil prices topping $100 a barrel?

Oil companies are already paying a staggering tax bill. In 2006, for instance, big-bad ExxonMobil faced an effective tax rate of 44 percent on a profit margin of around 11 percent, a figure that actually understates things because corporate revenues sooner or later find their way to oil company employees, contractors, shareholders, and those who do business with the same, and that revenue is taxed again via the personal income tax.

“So what?” you ask? Well, the more you tax “Big Oil,” the less return investors will get on money plowed into oil production. The less return on investment, the less investment there will be. Less investment equals less production, and less production equals higher prices. This is fact, not theory. Analysts at the Congressional Research Service report that the 1980 Crude Oil Windfall Profits tax reduced domestic oil production by 3-6 percent and increased oil imports by 8-16 percent for exactly that reason.

If the Congress were really interested in ending oil and gas subsidies, it could eliminate preferential tax treatment afforded intangible domestic drilling expenses, increase the amortization period for geological and geophysical expenditures from five years to seven, end preferential expensing for equipment used to refine liquid fuels, close the exemption from passive loss limitations for owners of working interests in oil and gas properties, and eliminate accelerated depreciation allowances for small oil producers, natural-gas distribution pipeline investments, and expenditures on dry holes. Such a plan would reduce – rather than compound – economic distortions produced by the tax code and deliver about $8.3 billion for the Treasury over 10 years. Congress is presumably less inclined to offer such a plan because those subsidies are far more important to “Little Oil” than they are to their “Big” brethren, and it’s the former – not the latter – that has most of the political clout in Washington.

Regardless, if getting rid of subsidies is such a good thing, then why does Congress propose to take those subsidies away with one hand but to reallocate them to the renewable energy business with the other? If renewable energy is economically competitive, it doesn’t need the subsidy, and if it’s not economically competitive now – with energy prices setting records across the board – then what makes anyone think that federal subsidies will make any difference? After all, they never have in the past. Ethanol has been lavished with government subsidy for 30 years, yet ethanol is still about $1.20 per gallon more expensive than conventional gasoline on wholesale markets last week after we adjust for the differential in energy content between the two. Nuclear energy has lived off a plethora of federal subsidies for five decades now, yet rather than being “too cheap to meter,” it’s still more expensive than any other conventional source of electricity once we account for the cost associated with building the reactor. Examples of similar subsidy boondoggles are legion.

Getting rid of energy subsidies is a fine thing, and Democrats are right to argue that those subsidies are even less warranted at a time when energy prices – and thus, energy profits – are relatively high. Too bad they aren’t serious about translating their rhetoric into legislative reality.

Don’t Do Something, Just Stand There

In the Washington Post Shankar Vedantam discusses “the action bias, or the desire to do something rather than nothing when you have just been through a terrible experience.” He cites evidence that both individuals and politicians often prefer to do something rather than nothing, even if “nothing” would be the wiser course.

When people suffer losses and confront the possibility of even greater reverses – it doesn’t matter if you are talking about a terrorist attack or a meltdown in retirement savings – it is psychologically difficult to do nothing, to hold course. This is true even when the action you contemplate produces an outcome that leaves you demonstrably worse than you were in the first place….

Economist Ofer Azar recently came up with a novel way to study the insidious nature of the action bias. He examined whether soccer goalies were more likely to stop penalty kicks when they dived to the left, dived to the right or stayed in the center of the goal. In a study of 286 penalty kicks faced by elite Israeli goalkeepers, Azar found that goalies had the best chance of stopping a kick when they remained in the center – partly because when they dived to one side, they left themselves with no chance of stopping a kick aimed at the other side or a kick aimed dead center. And even when they correctly guessed the direction of the kick, they still had only a 1-in-4 chance of stopping a goal.

Despite the clarity of the evidence, Azar found that goalies dived to one side or the other 93 percent of the time.

And of course it’s not just goalies. Vedantam suggests that “the Iraq war might be Exhibit A for the action bias”–noting Hillary Clinton’s statement in 2002: “In balancing the risks of action versus inaction, I think New Yorkers who have gone through the fires of hell may be more attuned to the risk of not acting. I know that I am.”

Good point. And he might go on to discuss the current rush to regulation in the wake of the subprime crisis and the Bear Stearns collapse. Voters expect politicians to “do something!” Regulators don’t want to look unresponsive. So everybody has a plan for more money, more regulation, or some sort of action. And of course it’s a recurring problem. Enron failed, and politicians panicked right into the Sarbanes-Oxley Act, whose costs will be with us long after we’ve forgotten what Enron was.

The bias toward action is one good reason for constitutional and procedural constraints on government actions. Constitutional limits on what government can legislate, bicameral legislatures, supermajorities, the filibuster, the presidential veto–all are designed to prevent hasty action, whether from popular delusions, demagogic campaigns, or the simple desire to be seen doing something rather than prudently refraining from misguided actions.