The stimulus tax cuts

Every now and again the claim is made that roughly 35 percent of the stimulus package ($300 billion out of $862 billion) consisted of tax cuts. This is a nice trick on the part of the left, as it both demonstrates alleged bipartisan outreach efforts ("We tried to meet Republicans halfway with tax cuts)" and helps insulate the stimulus against charges it didn't work (tax cuts failed).

The problem with this narrative, however, is that confuses permanent tax rate cuts -- which were completely absent -- with tax credits and deductions best understood as tax expenditures and government spending by another means. To understand this, take a look at the various tax provisions of the stimulus package helpfully detailed by the Wall Street Journal (click to enlarge):

A quick reading of these provisions reveals it to be in large part a grab bag of tax favors for various favored constituencies. Among these include special bonds for high-speed rail, special provisions for steel and lumber companies, tax credits for plug-in vehicles and various forms of renewable energy.

Such tax measures are properly understood as a further distortion of the tax code which confuses economic decision making. Rather than promote growth and prosperity, such tax credits encourage the misallocation of resources away from more productive ends to less productive ones (after all, if the area receiving the tax credit would receive resources anyway the tax credit is superfluous, as people don't need to be incentivized to seek high returns on their investments).

Equating such measures with permanent reductions in marginal rates is a perversion of pro-growth tax policy. Growth does not result merely from depriving the government of revenue, but minimizing the distortions that factor into economic decision making. Tax credits, such as those in the stimulus package, and genuine tax cuts are two very different animals.

Geneva's alleged growth problem

Today's New York Times features that rarest of commodities -- a story acknowledging the virtues of low taxes:

The financial crisis may have crimped corporate investment across the West, but companies still appear willing to spend in one corner of Europe — the Lake Geneva region — for a simple reason: It saves them money on taxes.

Companies from Europe and the United States, and more recently, Asia, are being drawn to the area by low taxes, generous write-offs and labor laws that are more flexible than much of the rest of Continental Europe. Then there’s the central location and, of course, all that fresh air.

...Andrio Orler, a partner at the law firm Tavernier Tschanz, said the fiscal structure remained crucial. Outwardly, the tax structure appears complex, given the need to pay communal, cantonal and federal taxes. But companies end up saving money.

Geneva’s corporate tax rate has edged up to about 24 percent, Mr. Orler said, but that is a “starting rate.” Companies can negotiate with the canton to be excused from paying all or part of their tax bills for up to 10 years if they fulfill certain conditions, including creating jobs. That can reduce the applicable tax rate to as low as 7.8 percent.

The effective corporate tax rate, incorporating allowances, last year was 9.7 percent in Hong Kong, 27.7 percent in London and 34.1 percent in nearby Lyon, according to BAK Basel, a consulting firm.

This being the Times, however, the narrative presented is that all of this growth has come at a steep cost, pushing up housing prices and contributing to a surging cost of living:

The influx has brought this placid region revenue, jobs and other benefits. But the growth has not come without a price, pushing up the cost of living and, some say, detracting from the quality of life for local residents and expatriates alike.

In October, a leading Geneva politician broke a taboo by suggesting the city had reached its limits in its ability to absorb large foreign companies.

“We would hesitate to welcome a company with more than 5,000 employees because we would not know where to house the employees and their families,” Pierre-François Unger, the city’s economy and health minister, said during a news conference.

A senior official at an international organization, who spoke on the condition of anonymity out of fear of offending the authorities in Geneva, used to work in the United States for a nongovernmental organization. In Geneva, she said, she earns twice as much, “but now I’m clearing much less.”

“Most other cities have a range of price points,” she added. “Here, it’s all expensive.”

Basic economic theory teaches us to be suspicious of such explanations. After all, if prices go up, this serves as a signal for more housing to be built, thus increasing supply and bringing prices back down. Furthermore, a quick look at Geneva reveals that the storyline advanced by a "leading Geneva politician" of a city has simply reached its physical limits to be false:

Plainly there is plenty of green space, including farmland (which makes little sense given the country's topography and is best explained by lavish farm subsidies), which can be developed. This suggests one obvious culprit: government policy. Indeed, a bit of research indicates that this appears to be the case:

As [Philippe Brun, who teaches city planning at the University of Geneva] sees it, “There is no will to extend and develop. There is a fear to extend.”

He says this mentality penetrates circles of politicians, so even as everyone is saying ‘there is a problem, we must develop,’ that underlying fear keeps them from having the courage and force to impose the changes needed to actually get enough housing built.

“The building zones are full today, and Geneva is so built that we have the center and around the center we have the agriculture zone,” Brun illustrates, “like a greenbelt, and after you have the border. And so you have to change the use of the agriculture zones to make building zones but this attitude makes it very, very difficult to change even small plots.”

Low taxes aren't the problem, it's government meddling. Meanwhile, it's worth pondering that Switzerland's low corporate tax rate has produced an abundance of jobs while the unemployment rates hovers near 10 percent in the US, which has one of the highest corporate income taxes in the developed world.

Tax cuts as stimulus

Greg Mankiw:

One piece of evidence comes from Christina D. Romer, the chairwoman of the president’s Council of Economic Advisers. In work with her husband, David H. Romer, written at the University of California, Berkeley, just months before she took her current job, Ms. Romer found that tax policy has a powerful influence on economic activity.

According to the Romers, each dollar of tax cuts has historically raised G.D.P. by about $3 — three times the figure used in the administration report. That is also far greater than most estimates of the effects of government spending.

Other recent work supports the Romers’ findings. In a December 2008 working paper, Andrew Mountford of the University of London and Harald Uhlig of the University of Chicago apply state-of-the-art statistical tools to United States data to compare the effects of deficit-financed spending, deficit-financed tax cuts and tax-financed spending. They report that “deficit-financed tax cuts work best among these three scenarios to improve G.D.P.”

My Harvard colleagues Alberto Alesina and Silvia Ardagna have recently conducted a comprehensive analysis of the issue. In an October study, they looked at large changes in fiscal policy in 21 nations in the Organization for Economic Cooperation and Development. They identified 91 episodes since 1970 in which policy moved to stimulate the economy. They then compared the policy interventions that succeeded — that is, those that were actually followed by robust growth — with those that failed.

The results are striking. Successful stimulus relies almost entirely on cuts in business and income taxes. Failed stimulus relies mostly on increases in government spending.

All these findings suggest that conventional models leave something out. A clue as to what that might be can be found in a 2002 study by Olivier Blanchard and Roberto Perotti. (Mr. Perotti is a professor at Boccini University in Milano, Italy; Mr. Blanchard is now chief economist at the International Monetary Fund.) They report that “both increases in taxes and increases in government spending have a strong negative effect on private investment spending. This effect is difficult to reconcile with Keynesian theory.”

Tax cuts, outside of a proposed one year suspension of capital gains for small businesses, have not been part of the Obama Administration's economic recovery agenda. (Don't fool yourself about tax cuts in the original stimulus, there wasn't a single marginal rate reduction in there) It seems increasingly clear that, despite rhetoric about a new kind of politics and odes to pragmatism, domestic policy formulated within the Obama Administration is based almost exclusively on left-wing ideology.

No matter the topic, be it the economy, health care or financial regulation, the solution is always more government rules and spending without regard for past experience as to whether such measures actually work or not. The primary objective appears to be expanded government, with actual success in the form of achieving stated goals (e.g. "bending the cost curve" in health care) a more distant consideration.

Chart of the day

Houston, we have a problem.

Read the accompanying blog post here.

Chart of the day (year?)

Copies of this should be distributed to every member of Congress:

Reagan entered office, cut taxes -- and the number of rich people and tax revenue collected both surged! Does this mean that all tax cuts pay for themselves? No, but plainly they provide an economic boost. Hmm, seems like the economy could use a shot in the arm right about now -- tax cuts anyone?

Update: Percentages:

Total people making over $200K: +520 percent
Income tax paid: +425 percent

Paying the corporate tax

The U.S. has the second highest corporate tax rate in the world, pushing nearly 40 percent. My hypothesis is that this occurs because taxing corporations is preferable to taxing individuals. Corporations, after all, do not vote and I imagine plenty of people see it as a great way to stick someone else with the bill.

But who really pays corporate taxes? Certainly it does not come out of some giant mattress corporations keep their money under. A dollar taxed away from a corporation is a dollar less which is available to pay employees, reward investors or develop new products. In other words, we still end up paying. Rather than writing a check directly to the government, however, we simply pay in the form of raises we don't get, less money earned on our investments (which affects a lot of people given the widespread nature of 401k accounts) and reduced competitiveness (with less money for research and development) which could result in layoffs.

Even in tax policy, there is no such thing as a free lunch.

The supply side caricature

What a nightmare

Bruce Bartlett:

During the George W. Bush years, however, I think SSE became distorted into something that is, frankly, nuts--the ideas that there is no economic problem that cannot be cured with more and bigger tax cuts, that all tax cuts are equally beneficial, and that all tax cuts raise revenue.

These incorrect ideas led to the enactment of many tax cuts that had no meaningful effect on economic performance. Many were just giveaways to favored Republican constituencies, little different, substantively, from government spending. What, after all, is the difference between a direct spending program and a refundable tax credit? Nothing, really, except that Republicans oppose the first because it represents Big Government while they support the latter because it is a "tax cut."

I think these sorts of semantic differences cloud economic decision making rather than contributing to it. As a consequence, we now have a tax code riddled with tax credits and other tax schemes of dubious merit, expiring provisions that never expire, and an income tax that fully exempts almost on half of tax filers from paying even a penny to support the general operations of the federal government.

I think this is at least broadly correct. Republican thinking on taxes has too often become lazy and simplistic with intellectual rigor sorely absent. Tax cuts have become defined as any act which deprives the government of revenue. Tax credits, however, are as much the enemy as government spending as they distort economic decision making, reward the politically connected and make the tax code even more incomprehensible.

Marginal rate reductions are great, but they also need to be linked with spending cuts. While many Republicans love to talk about cutting taxes it seems few are willing to lead the charge on slashing government programs. We want the ice cream but refuse to eat our broccoli.

Instead of tax cuts -- laughable in an era of massive deficits -- what Republicans should instead emphasize is tax reform. The U.S. has a tax code that is any abomination by any measure. It is lengthy, complex and its numerous loopholes a tribute to the power wielded by lobbyists. Why not scrap all loopholes and tax credits and in exchange for marginal rate reductions? After all, this was done before -- on a bipartisan basis -- with the 1986 Tax Reform Act.

The other aspect of U.S. taxation I find near scandalous is how many people don't participate in it. An astounding 47 percent of households pay zero income tax. Yes, many in that number pay payroll taxes which fund Social Security and Medicare, but they get that money back in benefits later on in life. Even if only $50, everyone should pay something.

Chart of the day

The TaxProf blog recently noted that 47 percent of all households do not pay income tax. Earlier this week he looked at who those 47 percent voted for in last year's presidential election:

Those who pay taxes are fairly divided. Those who stand to collect the benefits while not bearing the costs, not so much.

Quote of the day II

James Madison on tax policy:

The apportionment of taxes on the various descriptions of property is an act which seems to require the most exact impartiality; yet there is, perhaps, no legislative act in which greater opportunity and temptation are given to a predominant party to trample on the rules of justice. Every shilling with which they overburden the inferior number, is a shilling saved to their own pockets.

He was ahead of his time.

Marginal tax rates

Sometimes you will see people who dismiss tax hikes on the wealthy by noting that high marginal rates of taxation are nothing new and have been implemented in the past without major repercussions for the economy. That's true. You can look back over history and find several instances in which the top rates were in excess of 70 percent. The problem with this line of thinking, however, is that those high rates tended to kick in at much higher income levels and only affected a relatively small number of people.

As the Economix blog points out the highest marginal tax rate in 1960, adjusted for inflation, kicked in at around $3 million. Today? $360,000.

Taxes and international soccer

Arguably the biggest sports story yesterday -- it even made the Drudge Report -- was the transfer of Cristiano Ronaldo (whose second name of Ronaldo is in honor of Ronald Reagan) from England's Manchester United to Real Madrid of Spain. Unlike U.S. sports, where players switch clubs in trades, most soccer teams simply pay cash for the player that they want, provided he is still under contract. The fee paid by Madrid to Manchester? 80 million pounds, or about $130 million.

Brandon Arnold of the Cato Institute, meanwhile, notes that taxes likely played a role in Ronaldo's decision to switch teams:

There are a number of reasons why Kaka and Ronaldo are moving to Spain, but it’s pretty clear that taxes played a significant role. That’s because in 2005, Spain passed a tax break for foreign workers, including soccer players. This gives Spanish teams a huge advantage in bidding wars with teams from higher-tax countries like Italy and England. To make matters worse, England recently raised its top income tax rate.

“The new tax rate in England is going to make things much harder for English clubs,” noted Jonathan Barnett, a leading sports agent whose clients include Glen Johnson, Ashley Cole and Peter Crouch. “It will hinder the [English] Premier League and help the Spanish league because Spain has big tax discounts for footballers, so there’s an enormous advantage to go there. Someone like Ronaldo could be offered the same money at Real Madrid but be 25% better off.”

A friend of mine is actually an agent for professional soccer players and he frequently sends his players to Denmark's professional ranks. One reason is that Denmark has a tax provision for foreigners that are deemed "experts" in their field. Provided they make at least $125,000 they are subject to a 20 percent income tax rather than the 60 percent most Danes pay. I imagine that this also helps other Danish industries attract high-level talent and stay competitive. In addition it is worth noting that many Danish clubs provide items such as housing and cars as part of contracts for their players, which are not subject to income tax.

Another tax stat

Well that's an awful lot of unpatriotic Americans:

An astonishing 43.4 percent of Americans now pay zero or negative federal income taxes. The number of single or jointly-filing "taxpayers" - the word must be applied sparingly - who pay no taxes or receive government handouts has reached 65.6 million, out of a total of 151 million.

Those numbers come from an analysis published yesterday by the Tax Policy Center, a joint project of the Urban Institute and Brookings Institution. Neither is a low-tax or conservative advocacy group; the Urban Institute was created under the Johnson administration during the Great Society era, and it receives most of its funding from the federal government.

Taxes: too high, too complicated, unfair and not enough participation.

The tax debate

Ezra Klein of The American Prospect attempts to address accusations that the current tax code unfairly punishes the rich. The problem, however, is that you simply can't defend the indefensible. As Klein states:

People hear that the top 20 percent pay almost 70 percent of the country's income taxes and nod their head. That's unfair! But it mainly seems unfair because people don't know the top 20 percent accounts for almost 60 percent of the national income.

Well, sorry, that still strikes me as unfair. Even here, however, Klein isn't being totally forthcoming. The spread between what the rich make and their percentage of the tax burden isn't 10 percent, but 13.6 percent, as the top 20 percent earned 55.7% of pretax income and paid 69.3% of federal taxes. Now, maybe Klein just wanted to work with nice even numbers but then it would have made more sense to round down to 55 and up to 70, making the spread 15 percent.

The top 1 percent, unmentioned by Klein, earned 18.8% of income and paid 28.3% of taxes.

Fairness at its most Orwellian.

Update: More on Klein's apparent difficulty wtih math here. 

More tax facts

Things ain't what they used to be. Via the Carpe Diem blog a tax form from 1913:

The post also notes that the maximum tax rate at the time was 6 percent. By the time President Kennedy took office less than 50 years later the maximum rate was 91 percent. Such is the greed of politicians. Also be sure to check out this post on tax fairness, which we currently have only in the most Orwellian sense.

Update: More here.

Tax fairness

Those greedy rich people:

In 2006, the highest quintile earned 55.7% of pretax income and paid 69.3% of federal taxes, while the top 1% of households earned 18.8% of income and paid 28.3% of taxes. In all other quintiles, the share of federal taxes was less than the income share. The bottom quintile earned 3.9% of income and paid 0.8% of taxes, while the middle quintile earned 13.2% of income and paid 9.1% of taxes.

And remember, President Obama has vowed to "rebalance" the tax code, which in the DC parallel universe means raising taxes on the rich. Government sure is a lot easier to stomach when someone else is footing the bill.

Chart of the day

Keep this in mind next time you hear a politician talk about tax fairness and the need for the rich to pay more:

via Calafia Beach Pundit

Eat the rich

The left-wing Institute for Policy Studies gives their take on tax fairness:

The good news: Under Mr. Obama's new plan to cut the deficit in half, the very richest Americans will start paying something closer to their fair tax share.

It's been a while since they've done that. As recent IRS data show, these elites are paying less in taxes – much less – than their deep-pocket counterparts used to pay. In 2006, the 400 highest-income Americans together reported $105 billion in income, an average of $263 million each.

...The current top tax rate on "ordinary" work income sits at 35 percent. But dividends and capital gains from the buying and selling of most assets face only a 15 percent top rate. That's why in 2006, America's top 400 paid just 17.2 percent of their $263 million average incomes in federal tax.

Millions of middle-class American families, once you tally income and payroll taxes, pay far more of their incomes in tax. One particularly striking example from billionaire investor Warren Buffett: In 2006, he paid 17.7 percent of his income in total taxes. His secretary, who made $60,000, paid 30 percent of hers.

This is simply staggering. Let's do the math here: at an effective 17.2 percent tax rate those richest 400 Americans paid an average of $45,236,000 each. That's over $18 billion for all 400 of them. And yet that's not enough in their eyes!

It really and truly helps to think of the left as using government as legalized robbery after reading such nonsense. Basically, people engage in various enterprices and earn this money -- typically by having a product or service that improves people's lives and employing lots of other people to produce it -- and then the government forces tens of millions of dollars to be handed over. If you resist you are thrown in jail.

Adding insult to injury, the money is then handed over to politicians to play with, so that these non-contributing members of society can implement their utopian schemes that typically backfire.

It would be a lot easier to stomach this if we were actually all in this together, but that is a complete illusion. As of 2006 about one-third of all tax filers didn't pay any income tax after they took their credits and deductions. That means that these people contribute little to nothing in taxes -- aside from payroll taxes that fund medicare and social security -- while voting in politicians that extract huge amounts of money from a tiny percentage of the electorate to pay for programs that the rest of the people desire.

It's simply immoral.

The only argument I have any sympathy for is that some Americans pay a higher percentage of their income in tax than Warren Buffet. However, I have a solution. We simply implement a flat tax of 25 percent on all types of income. Eliminate all deductions and allow for a standard deduction of $5,000 and it becomes regressive. Yes, this would mean higher taxes for a lot of people, but if you want lots of government you have to pay for it. We should also implement a balanced budget amendment that would require a 2/3 vote of Congress to pass a budget with a deficit.

Then we do slash and burn on the federal budget, eliminating programs and cutting benefits until the deficit is eliminated. What's left over is a budget which is quite literally fair and balanced.

Progressive Taxation: Europe Vs. U.S.

Wow! (via Club for Growth)

Taxman

"Taxman was when I first realized that even though we had started earning money, we were actually giving most of it away in taxes."
-- George Harrison

I'll tell you who can probably sympathize with this -- Peter Eastgate. Never heard of him? He's a 22 year old Dane that recently won the World Series of Poker title along with a cool $9.2 million in prize money. Mark Perry points out, however, that after taxes Mr. Eastgate will actually take home less money than the second place finisher. Denmark (one of the famous Scandinavian social welfare models that the American left would love to import), you see, will force Eastgate to pay an effective tax rate of 72.77 percent while the second place finisher, a Russian, will pay the country's 13 percent flat rate.

Now economists love to argue about the efficiency of various tax schemes and what the optimal rate should be, but often times lost in the debate is the philosophical aspect. The taxation that Eastgate is being forced to pay is simply immoral. He earned it, it's his, and the fact that he will only be able to keep a minority of his earnings after the government gets its take is simply disgusting.

Ask a left-winger why the rich should be forced to pay higher tax rates than everyone else and as likely as not they will respond that it is fair. Similarly, ask them why cutting taxes for the rich is wrong and they will respond that it is unfair.

Excuse me?

Let's talk about what is fair. Fair is treating everyone the same. Deviate from that simple rule and you get into some murky territory. If you believe that the rich should pay more, well how much more? During the Clinton Administration the top marginal tax rate was 39.6 percent. I love that last .6 percent. Would 39 percent be too little? It was similarly amusing to witness the kicking and screaming when Bush proposed reducing the rate to 33 percent -- an even one-third. That, liberals explained, was too little. But how do you justify that? It's completely arbitrary.

Beyond how ridiculous the notion is that treating people differently is fair, what I also find disturbing is the impingement on people's freedom from high taxation. Money is freedom. The more you have the more stuff you can do. This is so obvious that it doesn't require any further elaboration. We all know this. Take away people's money and you take away their freedom. You reduce their options and the choices available to them.

Any defense of the rich, meanwhile, immediately prompts responses along the lines of "Oh, like Bill Gates would really miss that extra $10 million? That's what you're likely to find in the cushions of his couch." Whether Bill Gates would miss it or what he would otherwise do with the money is irrelevant. It's his, he should be able to make a bonfire with it and dance around the flames naked if he wants to.

But since the point has been raised, who would really make better use of the money, Bill Gates or the government? Warren Buffet or the government? Hell, Paris Hilton or the government? After all, the rich tend to get that way by either providing products or services that people like. Let an investor keep more of his money and you are likely to get more investment. Let the government take that money and you are likely to get a bridge to nowhere.

In these economic times I know which scenario I prefer.

Update: More on fairness here.

Tax the poor

Now here's a tax idea I can get on board with:

...I'll add another improbable idea for Democrats: It is time to begin taxing –- if only by a few dollars -- the millions of lower earners who pay no tax or get money back. This largely symbolic step would allow citizens to reestablish their connection with the federal government.

Obama has a far better chance of pulling this off than any Republican would. He might package such a tax into a larger work program of community service.

As I've said before we really need to consider raising income taxes on people in lower tax brackets to make sure they actually pay something. Just as only Nixon could have gone to China, can Obama be the one who pulls such a move? I have my doubts given his endless talk about 95 percent of us getting a cut, but then again Bill Clinton talked about a middle class tax on the campaign trail and ended up doing the opposite.