Topic: Tax and Budget Policy

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.

Dropouts. Starving for a Good Education

“Secretary of Education Margaret Spellings will require all states to use one federal formula to calculate graduation and dropout rates,” reports the New York Times, as part of a campaign to keep more kids in school.

The idea that we can reduce the public school dropout rate simply by measuring it better is misguided. It’s like believing that the North Koreans could improve their economy by more accurately measuring the number of people who are starving. As with the North Korean economy, the problem with U.S. public schooling is that it is a monopoly that takes choice away from families, takes professional autonomy away from educators, and takes normal economic incentives away from everyone.

Meanwhile, there is evidence from a sophisticated nationwide study that inner city minority kids – those most at risk of dropping out – are more likely to graduate, more likely to get into college, and more likely to graduate from college if they attend private instead of public schools – and that’s true after controlling for differences in student and family background. Other small scale studies of the Milwaukee school voucher program show similar results.

We already know how to reduce the dropout rate: ensure that all families can easily afford to choose the public or private schools best suited to their children. Until that happens, expect to see millions of American kids continuing to starve for a real education.

New Zealand Cuts Corporate Tax Rate

The 39.3 percent corporate tax rate in the United States is very high by world standards, exceeded only by Japan. This is very damaging for job creation and prosperity – and it becomes an even bigger problem every time another nation lowers its corporate rate. The latest nation to move in the right direction is
New Zealand, which is dropping its rate to 30 percent, according to Tax-news.com:

An important initiative in the government’s ongoing programme to strengthen the economy takes effect on April 1st, 2008, when the company tax rate drops to 30%, Finance Minister Michael Cullen and Revenue Minister Peter Dunne announced on Monday. “Reducing the company tax rate will allow successful businesses to re-invest a greater share of their profits in new technologies and in further building-up the skill base of employees,” Dr Cullen stated. “We expect that lowering of the company tax rate will serve to strengthen the competitiveness of New Zealand-based companies, and that is good for the long-term interests of all New Zealanders,” Dunne added. The cut to the company tax rate to 30% (from 33% previously) represents the first time the company tax rate has been reduced in New Zealand since 1988.

Will Switzerland Defend Financial Privacy?

The New York Times reports that high-tax nations such as France and Germany are badgering Switzerland to weaken its privacy laws so that flight capital can be tracked – and taxed. Germany’s former finance minister even argues that this would be akin to Switzerland helping to return a stolen car. But this argument is morally and legally wrong. On a moral basis, the German government is the one guilty of taking something it shouldn’t have. Over-taxed Germans are putting their money in Swiss banks because they don’t want the German government to confiscate too much of their money – especially since Germany is guilty of both high tax rates and pervasive double taxation of income that is saved and invested. If Germany wants to reduce tax evasion, it should reform its tax code rather than harrass peaceful neighbors. On a legal basis, nations help each other enforce laws using the principle of “dual criminality,” which means that an action has to be against the law in both nations. Stealing cars is illegal in both Swtizerland and Germany, so cooperation in the battle against car theft is appropriate. Confidential bank accounts, by contrast, are not against the law in Switzerland, so there is no reason for Switzerland the violate its human rights policiy on privacy just to help Germany enforce bad tax law. This upsets the Germans, yet they do the same thing when refusing the extradite suspects who might face the death penalty to America. It’s not their job to enforce American criminal law, so they have every right to say no. But it does indicate that German priorities are a bit strange. They defend the principle of dual criminality when they want to provide refuge to American murderers, but they think the principle should be discarded when politicians think they can grab some money from Swiss banks:

This land of stunning Alpine vistas, which has chosen to remain outside the European Union, has always loomed large in the global imagination as the place where the wealthy stash their money beyond the tax man’s reach. The best estimates suggest that image is true, to the tune of $1 trillion to $2 trillion. The scandal that threatens that lucrative business began when German authorities obtained secret financial data from Liechtenstein, Switzerland’s tiny neighbor with similar banking laws. The information in hand, investigators fanned out across Germany to seize documents thought to be related to tax evasion by hundreds of wealthy Germans. Cases are now being prepared based on the information, a process likely to take years. The fallout has claimed the job of one top executive, Klaus Zumwinkel, who had headed the German postal service, and has given the German left a political boost. But Switzerland is the bigger prize. And its continuing refusal to help other countries catch tax cheats hiding their money there appears to have hardened Europe’s resolve to force change. “If a car is stolen in Germany and taken to Switzerland, the Swiss help find it,” said Hans Eichel, a member of the German Parliament and a former finance minister. “But when it’s about tax evasion — and much larger sums — they do nothing. No one outside Switzerland understands that.” …European officials believe they can seize this moment to rally public opinion against the Swiss, German officials said. France, which will take over the rotating presidency of the European Union in the second half of this year, has agreed to take up the issue. …The concept of bank secrecy is deeply rooted in Switzerland, akin to the confidentiality rules governing doctors and lawyers in other countries, and a 1934 law makes it a crime for bankers to disclose client information. For foreigners, this combination is an effective shield against authorities at home. …Hans-Rudolf Merz, the Swiss finance minister, has brushed aside notions that Switzerland will water down banking confidentiality, a cornerstone of the financial system. Jean-Michel Treyvaud, a spokesman for Mr. Merz, called the debate “a media phenomenon” and declined an interview request.