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Archive for the ‘Joint Committee on Taxation’ Category

Because I’ve been sharing good news recently – which definitely is not my normal style, I joked the other day I must be on coke, in love, or rolling in money. For example:

Well, the drugs, love, and money must still be in my system because I’m going to share some more good news. Our lords and masters in Washington have taken a small step in the direction of recognizing the Laffer Curve.

Here are some details from a Politico report.

Here’s one Republican victory that went virtually unnoticed in the slew of budget votes last week: The Senate told the Congressional Budget Office it should give more credit to the economic power of tax cuts. It won’t have the force of law, but it was a big symbolic win for conservatives — because it gave them badly needed moral support in an ongoing war to get Washington’s establishment number crunchers to take their economic ideas more seriously. The amendment endorsed a model called “dynamic scoring,” which assumes that tax cuts will pay for at least part of their cost by generating more economic activity. The measure by Sen. Rob Portman (R-Ohio) called on CBO and the Joint Committee on Taxation to include “macroeconomic feedback scoring” in all future estimates of tax legislation. …Portman eked out a narrow 51-48 victory in the final series of budget votes that started around 3 a.m. on Saturday.

Just in case you missed it, this modest victory for common sense took place in the Senate. You know, the place controlled by Harry Reid of Cowboy Poetry fame.Laffer Curve

To be sure, it’s not quite time to pop open the champagne.

The vote was a symbolic victory for the think tanks and lawmakers on the right who have been fighting for years to force CBO and JCT to officially endorse the idea that people spend more and invest more when they owe the government less. …Conservatives’ ideas, including revenue-generating tax cuts and a more market-oriented health care system, can only work if tax policy changes people’s behavior — and that’s just not how CBO views the world.

I’ve been very critical of both CBO and JCT, so I’m one of the people in “think tanks” the article is talking about.

P.S. Chuck Asay has a good cartoon mocking the CBO.

P.P.S. I’ll repeat, for the umpteenth time, that we want to recognize the insights of the Laffer Curve in order to facilitate lower tax rates, not because we want to maximize revenue for the government.

P.P.P.S. Dynamic scoring is a double-edged sword. If the statists control everything, they’ll use the process to justify more spending using discredited Keynesian economics.

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I’m a big believer in the Laffer Curve, which is the common-sense proposition that changes in tax rates don’t automatically mean proportional changes in tax revenue. This is because you also have to think about what happens to taxable income, which can move up or down in response to changes in tax policy.

The key thing to understand is that incentives matter. If you raise tax rates and therefore increase the cost the engaging in productive behavior, people will be less likely to work, save, invest, and be entrepreneurial. And they’ll figure out ways to engage in tax avoidance and tax evasion to protect the interests of their families. In other words, taxable income will be lower because of higher tax rates.

Likewise, people will be more willing to earn – and report – taxable income if tax rates are reduced.

If you don’t believe me, look at this incredible data showing how the rich paid for more money after Reagan slashed their tax rates.

This doesn’t mean that “tax cuts pay for themselves.” That may happen in rare circumstances, but the real issue is the degree of “revenue feedback.”

For some types of tax changes, such as lowering tax rates on the “rich,” the revenue feedback may be very large because they have considerable control over the timing, level, and composition of their income.

In other cases, such as providing a child tax credit, the feedback may be very small because there’s not much of an impact on incentives to engage in productive behavior.

This doesn’t necessarily mean one type of tax cut is good and the other bad. It just means that some changes in tax policy produce revenue feedback and others don’t.

Even leftists recognize there is a Laffer Curve. They may argue that the “revenue-maximizing rate” is very high, with some claiming the government can impose tax rates of more than 70 percent and still collect additional revenue. But they all recognize that there’s a point where revenue-feedback effects are so strong that higher rates will lose revenue.

Actually, let me rephrase that assertion. There is a small group of people in the nation who claim that there’s no Laffer Curve. But that’s no surprise, the world is filled with weird people. Some genuinely think the world is flat. Some think the moon landings were faked. You can probably find some people who actually think the sun is a giant candle in the sky.

But what is surprising is that this small cadre of anti-Laffer Curve fanatics are at the Joint Committee on Taxation, which is the group on Capitol Hill in charge of providing revenue estimates on tax legislation.

They aren’t completely oblivious to the real world. They do acknowledge some “micro” effects of changes in tax rates, such as people shifting between taxable and non-taxable forms of compensation. But they completely reject “macro” changes such as changes in economic growth and employment.

So if we replaced the nightmarish income tax with a simple and fair flat tax, the JCT would assume no impact of GDP or jobs. If we went the other direction and doubled all tax rates, the JCT would blithely assume no change to the economy.

To give you an idea of why this is an extreme view, I want to share some polling data. Last week, I spoke at the national conference of the American Institute of Certified Public Accountants.  As you can imagine, this is a crowd that is very familiar with the internal revenue code. They know the nooks and crannies of the tax code and they have a good sense of how clients respond when tax policy changes.

Prior to my remarks, the audience was polled on certain tax issues.

Some of the answers disappointed me. By a narrow margin, the crowd thought it would be a good idea if the overall tax burden increased. But here’s the response that fascinated me the most. The audience was asked what could be described as a Laffer Curve question. Specifically, they were asked, “Do you believe the growth potential of marginal tax rate cuts could lead to some degree of revenue feedback, even if not enough to be self-financing?”

They had four possible responses. Here’s the breakdown of their answers.

These are remarkable results. A plurality (more than 36 percent) think the Laffer Curve is so strong that lower tax rates are self-financing. Even I don’t think that’s the case. Another 23.5 percent of respondents think there are very significant feedback effects, meaning that lower tax rates don’t lose much money.

There were also 18.6 percent who thought there were some Laffer Curve effects, though they thought the revenue feedback wasn’t very significant.

Less than 15 percent of the crowd, however, agreed with the Joint Committee on Taxation and said that lower tax rates have no measurable revenue feedback.

Why am I sharing this information? Well, we’re going to have a big debate in the next month or two about President Obama’s proposed class-warfare tax hike on investors, entrepreneurs, small business owners, and other rich people.

Supporters of that approach will cite Joint Committee on Taxation numbers to claim that the tax hike will generate a big pile of money.

That number will be based on nonsensical and biased methodology. In an ideal world, opponents will mock that number and expose the JCT’s primitive approach.

For additional information, here’s Part III of my video series on the Laffer Curve, exposing the role of the Joint Committee on Taxation.

If you want to see Parts I and II, click here.

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About this time last year, with the White House about to release a new budget, the press was filled with stories about President Obama being a tough-minded budget cutter.

Once the budget was released, I looked at the real numbers and explained how the burden of government spending would jump by $2 trillion in just 10 years if the President’s plan was enacted.

So why is there such a disconnect? Why does the establishment media report about “cuts” that would “slash” the budget, when actual spending is rising?

I explain this scam to John Stossel.

I made similar points last year in this interview with Judge Napolitano.

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One of my frustrating missions in life is to educate policy makers on the Laffer Curve.

This means teaching folks on the left that tax policy affects incentives to earn and report taxable income. As such, I try to explain, this means it is wrong to assume a simplistic linear relationship between tax rates and tax revenue. If you double tax rates, for instance, you won’t double tax revenue.

But it also means teaching folks on the right that it is wildly wrong to claim that “all tax cuts pay for themselves” or that “tax increases always mean less revenue.” Those results occur in rare circumstances, but the real lesson of the Laffer Curve is that some types of tax policy changes will result in changes to taxable income, and those shifts in taxable income will partially offset the impact of changes in tax rates.

However, even though both sides may need some education, it seems that the folks on the left are harder to teach – probably because the Laffer Curve is more of a threat to their core beliefs.

If you explain to a conservative politician that a goofy tax cut (such as a new loophole to help housing) won’t boost the economy and that the static revenue estimate from the bureaucrats at the Joint Committee on Taxation is probably right, they usually understand.

But liberal politicians get very agitated if you tell them that higher marginal tax rates on investors, entrepreneurs, and small business owners probably won’t generate much tax revenue because of incentives (and ability) to reduce taxable income.

To be fair, though, some folks on the left are open to real-world evidence. And this IRS data from the 1980s is particularly effective at helping them understand the high cost of class-warfare taxation.

There’s lots of data here, but pay close attention to the columns on the right and see how much income tax was collected from the rich in 1980, when the top tax rate was 70 percent, and how much was collected from the rich in 1988, when the top tax rate was 28 percent.

The key takeaway is that the IRS collected fives times as much income tax from the rich when the tax rate was far lower. This isn’t just an example of the Laffer Curve. It’s the Laffer Curve on steroids and it’s one of those rare examples of a tax cut paying for itself.

Folks on the right, however, should be careful about over-interpreting this data. There were lots of factors that presumably helped generate these results, including inflation, population growth, and some of Reagan’s other policies. So we don’t know whether the lower tax rates on the rich caused revenues to double, triple, or quadruple. Ask five economists and you’ll get nine answers.

But we do know that the rich paid much more when the tax rate was much lower.

This is an important lesson because Obama wants to run this experiment in reverse. He hasn’t proposed to push the top tax rate up to 70 percent, thank goodness, but the combined effect of his class-warfare policies would mean a substantial increase in marginal tax rates.

We don’t know the revenue-maximizing point of the Laffer Curve, but Obama seems determined to push tax rates so high that the government collects less revenue. Not that we should be surprised. During the 2008 campaign, he actually said he would like higher tax rates even if the government collected less revenue.

That’s class warfare on steroids, and it definitely belong on the list of the worst things Obama has ever said.

But I don’t care about the revenue-maximizing point of the Laffer Curve. Policy makers should set tax rates so we’re at the growth-maximizing level instead.

To broaden the understanding of the Laffer Curve, share these three videos with your friends and colleagues.

This first video explains the theory of the Laffer Curve.

This second video reviews some of the real-world evidence.

And this video exposes the biased an inaccurate “static scoring” of the Joint Committee on Taxation.

And once we educate everybody about the Laffer Curve, we can then concentrate on teaching them about the equivalent relationship on the spending side of the fiscal ledger, the Rahn Curve.

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I testified earlier today before the Joint Economic Committee about budget process reform. As part of the Q&A session after the testimony, one of the Democratic members made a big deal about the fact that federal tax revenues today are “only” consuming about 15 percent of GDP. And since the long-run average is about 18 percent of GDP, we are all supposed to conclude that a substantial tax hike is needed as part of what President Obama calls a “balanced approach” to red ink.

But it’s not just statist politicians making this argument. After making fun of his assertion that Obama is a conservative, I was hoping to ignore Bruce Bartlett for a while, but I noticed that he has a piece on the New York Times website also implying that America’s fiscal problems are the result of federal tax revenues dropping far below the long-run average of 18 percent of GDP.

In a previous post, I noted that federal taxes as a share of gross domestic product were at their lowest level in generations. The Congressional Budget Office expects revenue to be just 14.8 percent of G.D.P. this year; the last year it was lower was 1950, when revenue amounted to 14.4 percent of G.D.P. But revenue has been below 15 percent of G.D.P. since 2009, and the last time we had three years in a row when revenue as a share of G.D.P. was that low was 1941 to 1943. Revenue has averaged 18 percent of G.D.P. since 1970 and a little more than that in the postwar era.

To be fair, both the politician at the JEC hearing and Bruce are correct in claiming that tax revenues this year are considerably below the historical average.

But they are both being a bit deceptive, either deliberately or accidentally, in that they fail to show the CBO forecast for the rest of the decade. But I understand why they cherry-picked data. The chart below shows, rather remarkably, that tax revenues (the fuschia line) are expected to be back at the long-run average (the blue line) in just three years. And that’s even if the Bush tax cuts are made permanent and the alternative minimum tax is frozen.

It’s also worth noting the black line, which shows how the tax burden will climb if the Bush tax cuts expire (and also if millions of new taxpayers are swept into the AMT). In that “current law” scenario, the tax burden jumps considerably above the long-run average in just two years. Keep in mind, though, that government forecasters assume that higher tax rates have no adverse impact on economic performance, so it’s quite likely that neither tax revenues nor GDP would match the forecast.

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For both political and policy reasons, the left is desperately trying to maneuver Republicans into going along with a tax increase. And they are smart to make this their top goal. After all, it will be very difficult – if not impossible – to increase the burden of government spending without more revenue coming to Washington.

But how to make this happen? President Obama is mostly arguing in favor of class-warfare tax increases, but that’s a non-serious gambit driven by 2012 political considerations. Moreover, there’s presumably zero chance that Republicans would surrender to higher tax rates on work, saving, and investment.

The real threat is back-door hikes resulting from the elimination and/or reduction of so-called tax breaks. The big spenders on the left are being very clever about this effort, appealing to anti-spending and pro-tax reform sentiments by arguing that it is important to get rid of “tax expenditures” and “spending in the tax code.”

I recently warned, however, that GOPers shouldn’t fall for this sophistry, noting that “If legislation is enacted that results in more money coming into Washington, that is a tax increase.” I also explained that tax breaks are not spending, stating that “When politicians tax (or borrow) money from one person and give it to another, that’s government spending. But if politicians allow a person keep more of their own money, that’s a tax cut.”

To be sure, the tax code is riddled with inefficient and corrupt loopholes. But those provisions should be eliminated as part of fundamental tax reform, such as a flat tax. More specifically, every penny of revenue generated by shutting down tax preferences should be used to lower tax rates. This is a win-win situation that would make America more prosperous and competitive.

It’s also important to understand what’s a loophole and what isn’t. Ideally, you determine special tax breaks by first deciding on the right benchmark and then measuring how the current tax system deviates from that ideal. That presumably means all income should be taxed, but only one time.

So what can we say about the internal revenue code using this neutral benchmark? Well, there are lots of genuine loopholes. The government completely exempts compensation in the form of employer-provided health insurance, for instance, and everyone agrees that’s a special tax break. There’s also the standard deduction and personal exemptions, but most people think it’s appropriate to protect poor people from the income tax (though perhaps we’ve gone too far in that direction since only 49 percent of households now pay income tax).

Sometimes the tax code goes overboard in the other direction, however, subjecting some income to double taxation. Indeed, because of the capital gains tax, corporate income tax, personal income tax, and death tax, it’s possible for some types of income to be taxed as many of three or four times.

Double taxation is a special tax penalty, which is the opposite of a special tax break. The good news is that there are some provisions in the tax code, such as IRAs and 401(k)s, that reduce these tax penalties.

The bad news is that these provisions get added to “tax expenditure” lists, and therefore get mixed up with the provisions that provide special tax breaks. This may sound too strange to be true, but here’s a list of the biggest so-called tax expenditures from the Tax Policy Center (which is a left-leaning organization, but their numbers are basically the same as the ones found at the Joint Committee on Taxation).

Since this post already is too long, I’ll close by simply noting that items 2, 4, 7, 8, 11, and 12 are not loopholes. They are not “tax expenditures.” And they are not “spending in the tax code.” Every one of those provisions is designed to mitigate a penalty in the tax code.

So even if lawmakers have good motives (i.e., pursuing real tax reform such as the flat tax) when looking to get rid of special tax breaks, they need to understand what’s actually a loophole.

But since politicians rarely have good motives, there’s a real threat that they will take existing tax penalties and make them even worse. That’s another reason why tax increases should be a non-starter.

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Grousing about the GOP’s timidity in the battle against big government will probably become an ongoing theme over the next few months, and  let’s start with two items that don’t bode well for fiscal discipline.

First, it appears that Republicans didn’t really mean it when they promised to cut $100 billion of so-called discretionary spending as part of their pledge. According to the New York Times,

As they prepare to take power on Wednesday, Republican leaders are scaling back that number by as much as half, aides say, because the current fiscal year, which began Oct. 1, will be nearly half over before spending cuts could become law.

This is hardly good news, particularly since the discretionary portion of the budget contains entire departments, such as Housing and Urban Development, that should be immediately abolished.

That being said, I don’t think this necessarily means the GOP has thrown in the towel. The real key is to reverse the Bush-Obama spending binge and put the government on some sort of diet so that the federal budget grows slower than the private economy. I explain in this video, for instance, that it is simple to balance the budget and maintain tax cuts so long as government spending grows by only 2 percent each year.

It is a good idea to get as many savings as possible for the remainder of the 2011 fiscal year, to be sure, but the real key is the long-run trajectory of federal spending.

The other item for discussion is the GOP’s apparent interest in retaining Douglas Elmendorf, the current Director of the Congressional Budget Office.

Many of you will remember that the CBO cooked the books last year to help ram through Obamacare. Under Elmendorf’s watch, CBO also was a relentless advocate and defender Obama’s failed stimulus. And CBO under Elmendorf published reports saying higher taxes would improve economic performance.

But Elmendorf’s statist positions apparently are not a problem for some senior Republicans, as reported by The Hill.

The new House Budget Committee chairman, Rep. Paul Ryan (R-Wis.), gave a very public endorsement of the embattled head of the Congressional Budget Office during his first major speech as committee head Wednesday night. …“You’re doing a great job at CBO, Doug,” Ryan said after receiving the first annual Fiscy Award for his efforts at tackling the national debt. He added that he looked forward to crunching budget numbers with him in the future.

In the long run, the failure to deal with the problems at CBO (as well as the Joint Committee on Taxation) may cause even more problems than the timidity about cutting $100 billion of waste from the 2011 budget. Given the rules on Capitol Hill, it makes a huge difference whether CBO and JCT are putting out flawed numbers.

I’ve already written that fixing the mess at CBO and JCT is a critical test of GOP resolve, and I actually thought this would be a relatively easy test for them to pass. It is an ominous sign that Republicans aren’t even trying to clean house.

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