Topic: Tax and Budget Policy

Local Laffer Curve

A recent newspaper item shows the Laffer curve at the local government level. The Laffer curve illustrates the idea that when tax rates go up, revenues might go down if the tax base shrinks enough.

From the Falls Church News-Press:

“With another big hike, 75 cents a pack, in its cigarette tax put into effect last July 1, the City of Falls Church City Council asked for a spot check on the impact from the City’s Chief Financial Officer John Tuohy after the first quarter of the fiscal year, and he reported this Monday that July-September net revenues were down from the previous three years. He attributed the drop to “the national trend of decreased smoking.” Annual revenues peaked at $520,000 in the 2005-6 fiscal year, dropping to $464,000 last year. Packs sold in the July-September time frame dropped from 69,000 in 2004 to 58,000 this year.”

Thus, the number of packs sold is down 16% in one year. The CFO says that the cause is a “national trend.” In fact, government data show that the smoking rate has been pretty flat in recent years.

The CFO is being disingenuous. He must know that local taxpayers are responding to the city’s sharp increases in the cigarette tax rate in recent years.

For cigarette tax background, see here.

EU Subsidies Were Not Key to Irish Economic Miracle

An article posted at AEI’s discusses Ireland’s economic boom and explains that smaller government and lower tax rates are the key reasons the nation’s explosive growth. Bureaucrats in Brussels and opponents of limited government sometimes claim that subsidies from Brussels deserve the credit, but advocates of this position are unable to explain why Greece and Portugal (which received similar subsidies) have remained poor:

Some Europeans, particularly European Union officials in Brussels, praise significant EU structural subsidies—in the tens of billions—for planting the seeds of Irish prosperity. …But EU structural funds alone would not have helped Ireland escape its economic predicament. Many nations receive outside financial aid without any appreciable increase in their economic prosperity. The real credit belongs to Irish fiscal policy. Beginning in the late 1980s, successive Irish governments pursued vital spending cuts and tax relief. …Ireland has a 12.5 percent corporate tax rate, which has made it a magnet for powerhouse firms.

The Laffer Curve Straw Man

I’ve already addressed this issue, but here we go again. Commenting on the “totemic appeal” of the Laffer Curve for conservatives, Kevin Drum of Washington Monthly asserts that the concept is no longer relevant because:

…the current top marginal rate in the United States is 35%, and no one in their right mind thinks that’s anywhere near high enough to have a serious Laffer effect. When top rates are that low, lowering them further just reduces tax revenue.

Mr. Drum may know how (fairly) to mock politicians who exaggerate, but his critique of the Laffer Curve is based on the straw-man proposition that tax cuts are self-financing. Notwithstanding some of the political rhetoric, the Laffer Curve does not imply — and never has implied — that all “tax cuts pay for themselves.” That only happens if rates become sufficiently punitive to put the taxing jurisdiction on the downward-sloping portion of the curve.

The real issue is whether certain changes in tax policy will have some impact on economic activity. If an increase (decrease) in tax rates changes behavior and causes a reduction (increase) in taxable income, then revenues will not rise (fall) as much as “static” revenue-estimating models would predict. This is hardly a radical concept, and evidence of Laffer-Curve effects is very well established in the academic literature.

The reason there is a debate is that the government’s revenue-estimating bodies (the Joint Committee on Taxation on the Hill and the Office of Tax Analysis at Treasury) assume that tax policy changes have zero impact on economic performance. That’s right, zero.

For example, if the entire tax code was scrapped and replaced by a low-rate flat tax, JCT and OTA would assume no effect on macroeconomic aggregates. If tax rates were doubled, JCT and OTA would plug new numbers into their simplistic (yet totally nontransparent) models and estimate that tax revenues would double (to be fair, the government’s revenue estimators assume some microeconomic dynamic effects, such as higher tax rates causing people to shift the timing and/or composition of income, but this is akin to measuring the tail and ignoring the dog).

So what does all this mean? Two points are worth highlighting:

First, the current system is rigged against good tax policy by over-estimating the revenues that can be obtained by raising tax rates and exaggerating the revenues foregone when tax rates are reduced. This is why some of us advocate “dynamic scoring.”

Second, not all tax cuts (or tax increases) are created equal. An increase in the personal exemption or the child credit will have very little, if any, impact on incentives to work, save, and invest. As such, the “static” estimate of revenue losses will be reasonably accurate. A reduction in the tax rate on capital income, by contrast, will substantially alter incentives for taxpayers who have considerable ability to adjust their behavior. This will result in a Laffer-Curve response, though it is an empirical question whether the revenue feedback will offset 20 percent, 50 percent, or 75 percent of the static revenue loss (timing is also important since a tax rate reduction that yields a revenue feedback of 20 percent in the first year may generate a much larger revenue feedback five years in the future).

The left is very clever. Defenders of the status quo have created a straw man, and they find quotes from politicians and others with little knowledge to create the impression that advocates of lower tax rates believe in the fiscal version of a perpetual-motion machine. This tactic is then used to prop up the existing system of revenue estimating, which is based on assumptions that would earn an F if put forth by a student in an undergraduate public finance course.

Eminent Domain Abuse Still Rampant in Missouri

I’ve written a new study for the Show-Me Institute examining the problem of eminent domain abuse in Missouri. In the wake of the 2005 Kelo decision, a few state legislatures took decisive action to protect property rights, but many failed to enact comprehensive reforms. Unfortunately, Missouri was in the latter category. The legislature here passed a very timid eminent domain bill in 2006 that made some minor procedural changes and increased compensation for some property owners. But as I document in the study, the legislation has had little or no impact on the frequency of eminent domain projects that primarily benefit politically-connected private developers.

I make two major points in the study that are relevant across the country. First, the moment cities start to threaten the use of eminent domain by designating an area “blighted,” it casts a shadow over the affected area that retards economic development. After all, what home or business owner is going to invest in property that is likely to be demolished in a few years? As a result, “blight” often becomes a self-fulfilling prophesy; properties deteriorate as politicians draw up a new “master plan” for the area.

Second, I point out that eminent domain is most harmful to small business owners and low-income residents who lack the political clout or the deep pockets required to fight the seizure of their properties. As I argue in a new article in The American, “redevelopment” projects punish small business owners who choose to open up shop in struggling neighborhoods. And in McRee Town, the redevelopment project I studied in the most detail, the city demolished apartments that had rents between $275 and $550/month, and replaced them with single-family homes costing more than $200,000. Obviously, the previous occupants were forced to move to other parts of the city, presumably into neighborhoods that are just as slum-like.

Romania Joins the 31-Nation Private Retirement Account Revolution

An English-language story from the European press discusses the privatization of the retirement system in Romania. The system eventually will permit workers to put six percent of their income in personal accounts. This is good news, but there is a dark lining to this silver cloud. I challenged my colleague Jose Pinera earlier this year that the number of flat-tax nations would soon exceed the number of private-account nations. Unfortunately, Jose works too hard, and he keeps adding new nations to his list. Since there are now 21 jurisdictions with flat tax systems, this means I still have a long way to go:

Under a new system launched last month, more than 3 million Romanian workers under 35-years-old must opt for one of 14 competing private pension funds before January 17th, 2008. Those ages 35 to 45 can also decide to join one of the private funds. Starting in 2008, 2% of every worker’s general income will be redirected from the state budget to the chosen private fund. This contribution will gradually increase to 6% by 2015, and the current 9.5% social security contribution to the state system will diminish accordingly. “Several million Romanians will become investors, and the private pension system will educate them in the spirit of a free market economy,” says Romanian President Traian Basescu. …Romania cautiously now joins a club formed by 31 countries – Bulgaria, Macedonia and Croatia among them that have decided to address the demographic pressure on state budgets through privatisation.

Disaster Collectivism

Naomi Klein, darling of the loonie left, has a new book out called The Shock Doctrine: The Rise of Disaster Capitalism. The basic idea is that the insidious forces of neoliberalism take advantage of wars, economic crises, and natural disasters to impose their evil schemes on disoriented and distracted publics. The career of Milton Friedman, the occupation of Iraq, and the bungled response to Katrina are all supposedly cases in point.

Klein is not a serious person, and in this book she does not mount a serious argument. But she does raise an interesting issue: the political implications of crises. It is certainly true that the waves of liberal reform (political as well as economic) that swept the world in the ’80s and ’90s were often triggered by economic crises. Indeed, I wrote a book on the subject in which I interpreted the current episode of globalization as a response to the often cataclysmic breakdown of various state-dominated models of economic development.

There’s nothing terribly surprising about this. Inertia is a powerful force in politics: every status quo has vested interests that benefit from it, while advocates of change push in all different directions and frequently cancel each other out. A crisis, though, can discredit the status quo and demoralize its supporters, while galvanizing particular pro-reform camps and boosting their credibility. Politics suddenly becomes more fluid; rapid and sweeping changes that had no chance of being enacted beforehand now occur in rapid succession.

But it’s ridiculous to portray this dynamic as somehow uniquely favoring one side of the political spectrum. Recall the great triumphs historically associated with the left: the French Revolution was made possible by the financial distress of the ancien regime; the Paris Commune was founded after defeat at the hands of the Prussians; the Russian Revolution was catalyzed by military failures in World War I.

In our own country, it was a one-two punch of cataclysms – the Great Depression, followed by World War II — that brought Big Government to the United States and then consolidated its hold. The unprecedented economic collapse made traditional American attitudes of laissez faire and individual responsibility seem hopelessly outdated; by contrast, the frenetic activity of the New Deal, regardless of the decidedly mixed results, projected boldness and vigor and hope. The subsequent mass mobilization for total war reinforced the shift in political culture. If you watched any of the wonderful new Ken Burns documentary on “The War,” you saw that the “home front” wasn’t just an expression: the diversion of the country’s industrial might to war production, price controls and rationing, extremely high tax rates, war bond drives, and incessant propaganda combined to thoroughly collectivize American society. And it worked: the economy boomed, people reaped the psychological satisfactions of banding together against a common and abominably evil enemy, and in the end America triumphed.

Today people on the left are filled with nostalgia for the political economy of the early postwar decades. I don’t think many of them recognize, though, how heavily their Golden Age depended on the lingering economic and cultural effects of destruction on a mind-boggling scale. They call themselves progressives, yet they pine for the good old days of disaster collectivism.

[cross-posted from]

Catholics against SCHIP

The Rev. Robert A. Sirico is a Catholic priest, as well as president and co-founder of the Acton Institute for the Study of Religion and Liberty.  In today’s Detroit News, he weighs in on the debate over the State Children’s Health Insurance Program:

The Catholic Health Association has blasted President Bush for vetoing a program called SCHIP, the State Children’s Health Insurance Program. How can anyone be against the health of children?

Well, public policy is more complicated than that. When the state gets involved in public health, there are unintended consequences. In fact, there is enough wrong with this program to make it possible to oppose SCHIP in good conscience…

There is not a living soul who would not wish that every person, especially every child, would have access to perfect medical care. But the essential condition for universal coverage is universal prosperity, and the only means available to create that is a flourishing and free economy – a condition that programs like SCHIP help to undermine…

It is folly to seek short-term gains at the expense of long-term economic development. Eliminating taxes and regulations that hinder private industry will make greater strides toward universal coverage than any state program can or will…

What I fear most is that politicians use legitimate issues to gather more power unto themselves and their friends in government. The population becomes more dependent on the public sector and less reliant on the sectors over which they exercise real control.

Amen to that.  Now how do we get the Catholic hospitals to stop taking Caesar’s coin?