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Posts Tagged ‘Supply-side economics’

I wrote a column for the Wall Street Journal last week about the policy debate over whether it’s better to lower tax rates or to provide targeted tax cuts for parents.

Since this meant I was wading into a fight between so-called reform conservatives (or “reformicons”) and traditional conservatives (or “supply-siders”), I wasn’t surprised to learn that not everyone agreed with my analysis.

James Pethokoukis of the American Enterprise Institute, for instance, doesn’t approve of what I wrote.

…why are some folks on the right against giving middle-class families a big tax cut and letting them keep more of what they earn? …Cato’s Dan Mitchell, in a Wall Street Journal commentary today, concedes Stein’s idea would indeed help middle-class families right now… Yet Mitchell still thinks cutting marginal tax rates is the better idea.

Pethokoukis accurately notes that I want lower marginal tax rates because, from my perspective, faster long-run growth would be even more beneficial to middle-class families.

He disagrees and offers five counter-arguments. Here they are (summarized fairly, I hope), along with my response.

1.) House Ways and Means Chairman Dave Camp has put forward tax reform with a top rate of 25% vs. 40% today. Yet his plan would likely increase the economy’s size by less than 1% over the next decade, according to the Joint Tax Committee. …This is not to say lower tax rates aren’t good for economic growth. But marginal rates at those levels are almost certainly already deep on the good side of the Laffer Curve.

I have a couple of reactions.

First, the top tax rate in the Camp plan is 35 percent rather than 25 percent, so we shouldn’t be surprised that the plan doesn’t generate much additional growth.

Second, the JCT’s model is flawed and it should not be given credibility by any supporter of good tax policy. The Tax Foundation has a much better model.

Though it doesn’t really matter in this case because the Tax Foundation analysis of the Camp plan also shows a very weak growth response, largely because the slightly lower tax rates in the Camp plan are “paid for” by increasing the tax burden on saving and investment. Which is why I also wrote that the plan was disappointing.

Regarding the point about the Laffer Curve, the Tax Foundation responded to the Pethokoukis criticism of my column by noting “the Laffer Curve refers to tax revenue, not economic growth. It says there is a tax rate at which tax revenue is maximized. The tax rate at which economic growth is maximized is almost certainly well below that.”

Needless to say, I fully agree. I want to maximize growth, not tax revenue.

Now let’s move to his second point.

2.) And consider this: just how would the GDP gains, such as they are, from cutting top marginal rates be distributed in an economy where middle-wage jobs are disappearing and income gains are tilted toward the highly skilled and educated? The US economy needs to grow faster, but faster growth alone in the Age of Automation may not substantially increase living standards for a larger swath of the American people. That reality is a big difference between the 2010s economy and the 1980s economy, one many on the right have yet to grasp. Cranking up GDP growth is necessary but not sufficient.

If I understand correctly, Pethokoukis is saying that faster growth doesn’t guarantee good jobs for everyone.

I don’t disagree with this point, but I’m not sure why this is a criticism of lower marginal tax rates. Isn’t it better to get some extra growth rather than no extra growth?

Now let’s address the third point from the Pethokoukis column.

3.) Mitchell asserts, “Tax-credit conservatives generally admit that child-oriented tax cuts have few, if any, pro-growth benefits.” That’s not true. …expanding the child tax credit would serve as a sort of human-capital gains tax cut for worker creators (also known as families). It might just be nudge enough for financially-stressed families to have another kid… Modern pro-growth policymakers should fret as much about the nation’s birthrate as productivity and labor-force participation rates. …A younger American society with a higher birth rate, helped by a tax code that offsets anti-family government policy, would be more dynamic, creative, and entrepreneurial.

I’m less than overwhelmed by this argument.

Yes, we have a demographic problem, but more population is merely a way of increasing total GDP, not per-capita GDP. And it’s the latter than matters if we want higher living standards.

In his fourth point, Pethokouis notes that both supply-siders and reformicons agree on policies to reduce the tax burden on saving and investment.

4.) To give Mitchell some credit here, he does acknowledge there is more to the conservative-reform tax agenda than the child tax credit.

Since we both agree, there’s no need to rebut this part of the column.

And I don’t think there’s anything for me to rebut in Pethokoukis’ final point.

5.) Let me add that there is more to the conservative reform agenda for the middle class than just tax reform, including regulatory, health care, K-12, and higher-education reform. And there should be more to the supply-side, pro-growth agenda than cutting marginal tax rates, including reducing crony capitalist barriers — such as Too Big To Fail megabank subsidies… American needs more growth, and worker creators (strong families) are just as important to achieving that as job creators (strong companies). Let’s have both.

Since I’m among the first to acknowledge that fiscal policy is only about 20 percent of what determines a nation’s prosperity, this is an area where I’m on the same page as Pethokoukis.

Reformicon Founding Fathers

Indeed, I wrote last year that there’s much to admire about the agenda of the reformicons.

I just think that they don’t have sufficient appreciation for the value of even small increases in long-run growth.

Let’s close by looking at one sentence from some supposed analysis by Matt O’Brien in the Wonkblog section of the Washington Post.

His column is dedicated to the proposition that Republicans are overly fixated on cutting taxes for the rich. That might be a defensible hypothesis, but I doubt O’Brien has much credibility since he misrepresents my position.

 Daniel Mitchell of the Cato Institute downplays the idea that giving middle-class families more money even helps them, and says Republicans should keep focusing on cutting tax rates.

Just for the record, here’s what I actually wrote about middle-class families in my WSJ piece.

Child-based tax cuts are an effective way of giving targeted relief to families with children… The more effective policy—at least in the long run—is to boost economic growth so that families have more income in the first place. Even very modest changes in annual growth, if sustained over time, can yield big increases in household income. … If good tax policy simply raised annual growth to 2.5%, it would mean about $4,500 of additional income for the average household within 25 years. This is why the right kind of tax policy is so important. …since more saving and investment will lead to increased productivity, workers will enjoy higher wages, including households with children.

Does any of that sound like I’m indifferent to middle-class families? And the first sentence of that excerpt specifically says that the reformicon approach would mean relief to families with kids.

And the entire focus of my column is that supply-side tax policy would be even more beneficial to those households in the long run.

But accurately reporting what I wrote would have ruined O’Brien’s narrative. Sigh.

P.S. I wrote a couple of days ago that France was is a downward spiral because of high-tax statism. A few people have pointed out that French President Francois Hollande has picked a new industry and economy minister, Emmanuel Macron, who famously said that the new 75 percent top tax rate meant that France was “Cuba without the sun.”

Does this change my opinion, these folks have asked. Doesn’t this signal that taxes will start going down?

The answer is no. At best, I think it simply means that Hollande won’t push policy further to the left. But that doesn’t mean we’ll see genuine liberalization and a reduction in the fiscal burden of government.

If you think I’m being pessimistic, just keep in mind this excerpt from a Bloomberg story.

Macron apologized yesterday for his “exaggerated reputation” for free-market thinking.

I hope I’m wrong, but that doesn’t sound like the words of someone committed to smaller government?

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Some folks on the right in Washington, generally known as reformicons (short for reform conservatives), want the Republican Party to de-emphasize marginal tax rate reductions and instead focus on providing tax relief to parents.

There are many leaders in this movement and, if you want to learn more about the tax proposals being discussed, I specifically recommend the writings of Robert Stein, James Capretta, James Pethokoukis, Ramesh Ponnuru, Yuval Levin, Charles Blahous, Jason Fichtner, and Reihan Salam (and I’m sure I’m unintentionally leaving off many other worthy contributions).

I explained last year what I like (and don’t like) about reform conservatism, but I haven’t specifically analyzed the tax agenda of the reformicons.

Time to rectify that oversight. The Wall Street Journal was kind enough to give me some space so I could share my thoughts on this topic.

I start by outlining the debate, albeit in simplified form because of space constraints.

There’s a policy debate among conservatives in Washington about the best way to cut taxes and reform the tax code. The supply-siders want to replicate the success of Reaganomics with lower marginal tax rates. But there’s also a camp who call themselves “reform conservatives” who want income tax credits or payroll tax cuts explicitly for the purpose of reducing tax liabilities for middle-class parents. The supply-siders argue that if you want to encourage more work, saving, investment and entrepreneurship, then it is a good idea to reduce marginal tax rates on productive behavior. …Those in the other camp…don’t necessarily disagree with the supply-siders. They note that it was important to lower marginal tax rates in 1980 when the top personal tax rate was a confiscatory 70%. But now that the top rate is “only” about 40%, they argue, lower tax rates won’t deliver nearly as much bang for the buck.

The reformicons are right. Dropping the top tax rate from 40 percent will help the economy, but the pro-growth effect won’t be enormous. At least not compared to what happened during the Reagan years when the top tax rate was slashed from 70 percent to 28 percent.

And, as this leftist cartoon suggests, many Republicans act as if across-the-board tax rate reductions are an elixir for every ill.

But can reformicons suggest a better way of cutting and/or reforming taxes?

I’m not convinced that their agenda of child-oriented tax relief is the right answer.

In my column, I note that many of their policies have already been implemented, yet there’s little if any evidence that these tax cuts have generated positive outcomes.

…reform conservatives say it’s time for new ideas. That’s a nice concept, but Republicans already have enacted many of their proposed policies. The child tax credit was adopted in the 1990s and expanded during the Bush years. The earned income credit also funnels a lot of money (in the form of tax relief or cash payments) to families with children, and that provision also has been significantly expanded over the years. These policies have worked, at least in the sense that households with children now face lower tax liabilities. There is little evidence, though, to suggest positive economic or social outcomes. Were families strengthened? Did the economy grow faster? Did middle-income households feel more secure?

The reformicons often argue that their tax proposals are politically more appealing.

That may be true, but that doesn’t mean they are political winners, particularly if reformicons are trying to appease the class-warfare left, which will simply argue that tax cuts targeted at families making less than, say, $100,000 will be even “fairer” if they are targeted at families making less than $50,000.

Or maybe targeted at households who pay no tax, which means more transfer spending through the tax code!

The tax-credit reformers also argue that their proposals are much less susceptible to class-warfare demagoguery that is the supply-side approach, since tax relief flows to lower- and middle-income voters. …But here’s the downside: Conservatives can bend over backward to appease the class-warfare crowd, but they can never outflank them. …Once conservatives have accepted the left’s premise that tax policy should be based on static distribution tables, they won’t have a ready answer for the left’s gambit.

But as far as I’m concerned, the real issue is how to raise take-home pay.

The reformicons want to make families more secure by reducing how much the IRS takes from their paychecks.

I certainly like the idea of boosting post-tax income, but I contend that it would be even better to focus on policies that increase pre-tax income.

The most commonly cited reason for family-based tax relief is to raise take-home pay. That’s a noble goal, but it overlooks the fact that there are two ways to raise after-tax incomes. Child-based tax cuts are an effective way of giving targeted relief to families with children… The more effective policy—at least in the long run—is to boost economic growth so that families have more income in the first place. Even very modest changes in annual growth, if sustained over time, can yield big increases in household income. … long-run growth will average only 2.3% over the next 75 years. If good tax policy simply raised annual growth to 2.5%, it would mean about $4,500 of additional income for the average household within 25 years. This is why the right kind of tax policy is so important.

In other words, our economy is under-performing and that is the greatest threat to the financial security of families.

Folks on the left say it is the fault of “secular stagnation” and that the burden of government should be further expanded, but both reformicons and supply-siders agree that we’ll get far better results by focusing on tax cuts.

But which tax cuts?

I end my column with some glass-half-full analysis. The reformicons may not be thrilled by lower income tax rates and the supply-siders may not be excited by child-oriented tax cuts, but both camps are quite sympathetic to tax reforms that address the punitive double taxation of income that is saved and invested.

While the camps disagree on lower individual income tax rates vs. child-oriented tax relief, both agree that the tax code’s bias against capital formation is very misguided. The logical compromise might be to focus on reforms that boost saving and investment, such as lowering the corporate tax rate, reducing the double taxation of dividends and capital gains, and allowing immediate expensing of business investment. These reforms would have strong supply-side effects. And since more saving and investment will lead to increased productivity, workers will enjoy higher wages, including households with children.

To be sure, some critics will say this type of tax agenda is too “business friendly,” which is an indirect way of saying that average voters may not understand how they benefit from tax reforms that don’t have a big and fast impact on their paychecks.

So maybe the right answer is to rip up the entire tax code and replace it with a simple and fair flat tax.

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If you appreciate the common-sense notion of the Laffer Curve, you’re in for a treat. Today’s column will discuss the revelation that Francois Hollande’s class-warfare tax hikes have not raised nearly as much money as predicted.

And after the recent evidence about the failure of tax hikes in Hungary, Ireland, Detroit, Italy, Portugal, the United Kingdom, and the United States, this news from the BBC probably should be filed in the category of “least surprising story, ever.”

The French government faces a 14bn-euro black hole in its public finances after overestimating tax income for the last financial year. French President Francois Hollande has raised income tax, VAT and corporation tax since he was elected two years ago. The Court of Auditors said receipts from all three taxes amounted to an extra 16bn euros in 2013. That was a little more than half the government’s forecast of 30bn euros of extra tax income.

And why have revenues been sluggish, generating barely half as much money as the politicians wanted? For the simple reason that Hollande and the other greedy politicians in France failed to properly anticipate that higher tax rates on work, saving, investment, and entrepreneurship would discourage productive behavior and thus lead to less taxable income.

…economic growth has been inconsistent and the unemployment rate hit a record high of 11% at the end of 2013. The French economy saw zero growth in the first three months of 2014, compared with 0.2% growth three months earlier. The income tax threshold for France’s wealthiest citizens was raised to 75% last year, prompting some French citizens, including the actor Gerard Depardieu, to leave the country and seek citizenship elsewhere in Europe.

But we do have some good news. A French politician is acknowledging the Laffer Curve!

French Prime Minister Manuel Valls, who was appointed in March following the poor showing of Mr Hollande’s Socialists in municipal elections, appeared to criticise the president’s tax policy by saying that “too much tax kills tax”.

By the way, France’s national auditor also admitted that tax hikes were no longer practical because of the Laffer Curve. Heck, taxes in France are so onerous that even the EU’s Economic Affairs Commissioner came to the conclusion that tax hikes were reducing taxable income.

Though here’s the most surprising thing that’s ever been said about the Laffer Curve.

…taxation may be so high as to defeat its object… given sufficient time to gather the fruits, a reduction of taxation will run a better chance than an increase of balancing the budget.

And I bet you’ll never guess who wrote those words. For the answer, go to the 6:37 mark of the video embedded in this post.

P.S. Just in case you’re not convinced by the aforementioned anecdotes, there is lots of empirical evidence for the Laffer Curve.

  • Such as this study by economists from the University of Chicago and Federal Reserve.
  • Or this study by the IMF, which not only acknowledges the Laffer Curve, but even suggests that the turbo-charged version exists.
  • Or this European Central Bank study showing substantial Laffer-Curve effects.
  • Or this research from the American Enterprise Institute about the Laffer Curve for the corporate income tax.

P.P.S. For other examples of the Laffer Curve in France, click here and here.

P.P.P.S. To read about taxpayers escaping France, click here and here.

P.P.P.P.S. On a completely different subject, here’s the most persuasive political ad for 2014.

I realize the ad doesn’t include much-needed promises by the candidate to rein in the burden of government, but I’m a bit biased. And in a very admirable way, so is Jack Kingston.

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My main goal for fiscal policy is shrinking the size and scope of the federal government and lowering the burden of government spending.

But I’m also motivated by a desire for better tax policy, which means lower tax rates, less double taxation, and fewer corrupting loopholes and other distortions.

One of the big obstacles to good tax policy is that many statists think that higher tax rates on the rich are a simple and easy way of financing bigger government.

I’ve tried to explain that soak-the-rich tax policies won’t work because upper-income taxpayers have considerable ability to change the timing, level, and composition of their income. Simply stated, when the tax rate goes up, their taxable income goes down.

And that means it’s not clear whether higher tax rates lead to more revenue or less revenue. This is the underlying principle of the Laffer Curve.

For more information, here’s a video from Prager University, narrated by UCLA Professor of Economics Tim Groseclose.

An excellent job, and I particularly like the data showing that the rich paid more to the IRS following Reagan’s tax cuts.

But I do have one minor complaint.

The video would have been even better if it emphasized that the tax rate shouldn’t be at the top of the “hump.”

Why? Because as tax rates get closer and closer to the revenue-maximizing point, the economic damage becomes very significant. Here’s some of what I wrote about that topic back in 2012.

…labor taxes could be approximately doubled before getting to the downward-sloping portion of the curve. But notice that this means that tax revenues only increase by about 10 percent. …this study implies that the government would reduce private-sector taxable income by about $20 for every $1 of new tax revenue. Does that seem like good public policy? Ask yourself what sort of politicians are willing to destroy so much private sector output to get their greedy paws on a bit more revenue.

The key point to remember is that we want to be at the growth-maximizing point of the Laffer Curve, not the revenue-maximizing point.

P.S. Here’s my video on the Laffer Curve.

Since it was basically a do-it-yourself production, the graphics aren’t as fancy as the ones you find in the Prager University video, but I’m pleased that I emphasized on more than one occasion that it’s bad to be at the revenue-maximizing point on the Laffer Curve.

Not as bad as putting rates even higher, as some envy-motivated leftists would prefer, but still an example of bad tax policy.

P.P.S. Switching to a different topic, it’s been a while since I’ve mocked Sandra Fluke, a real-life Julia.

To fix this oversight, here’s an amusing image based on Ms. Fluke’s apparent interest in becoming a politician.

Fluke Filing Fee

But she’s apparently reconsidered her plans to run for Congress and instead now intends to seek a seat in the California state legislature.

She’ll fit in perfectly.

If you want to see previous examples of Fluke mockery, check out this great Reason video, this funny cartoon, and four more jokes here.

P.P.P.S. And since I’m making one of left-wing women, we may as well include some humor about Wendy Davis.

Check out this excerpt from a story in the Daily Caller.

A dating service that pairs wealthy “sugar daddies” with “sugar babies” for “mutually beneficial dating arrangements” has endorsed Texas Democratic gubernatorial candidate Wendy Davis. SeekingArrangement.com’s Friday announcement followed a recent report in the Dallas Morning News which detailed a number of discrepancies in Davis’ personal narrative, including that she left a man 13 years her senior the day after he made the last payment for her Harvard Law School education. “Wendy Davis is proof that the sugar lifestyle is empowering,” seeking arrangements founder and CEO Brandon Wade said in his endorsement.

Mr. Wade obviously is a clever marketer, but he may also be a closet libertarian.

After all, he also mocked Obamacare with an ad telling young women to join his site so they could find a sugar daddy to pay for the higher premiums caused by government-run healthcare.

Then again, I’ve also speculated that Jay Leno and Bill Maher may be closet libertarians, so I may be guilty of bending over backwards to find allies.

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The title of this piece has an asterisk because, unfortunately, we’re not talking about progress on the Laffer Curve in the United States.

Instead, we’re discussing today how lawmakers in other nations are beginning to recognize that it’s absurdly inaccurate to predict the revenue impact of changes in tax rates without also trying to measure what happens to taxable income (if you want a short tutorial on the Laffer Curve, click here).

But I’m a firm believer that policies in other nations (for better or worse) are a very persuasive form of real-world evidence. Simply stated, if you’re trying to convince a politician that a certain policy is worth pursuing, you’ll have a much greater chance of success if you can point to tangible examples of how it has been successful.

That’s why I cite Hong Kong and Singapore as examples of why free markets and small government are the best recipe for prosperity. It’s also why I use nations such as New Zealand, Canada, and Estonia when arguing for a lower burden of government spending.

And it’s why I’m quite encouraged that even the squishy Tory-Liberal coalition government in the United Kingdom has begun to acknowledge that the Laffer Curve should be part of the analysis when making major changes in taxation.

UK Laffer CurveI don’t know whether that’s because they learned a lesson from the disastrous failure of Gordon Brown’s class-warfare tax hike, or whether they feel they should do something good to compensate for bad tax policies they’re pursuing in other areas, but I’m not going to quibble when politicians finally begin to move in the right direction.

The Wall Street Journal opines that this is a very worthwhile development.

Chancellor of the Exchequer George Osborne has cut Britain’s corporate tax rate to 22% from 28% since taking office in 2010, with a further cut to 20% due in 2015. On paper, these tax cuts were predicted to “cost” Her Majesty’s Treasury some £7.8 billion a year when fully phased in. But Mr. Osborne asked his department to figure out how much additional revenue would be generated by the higher investment, wages and productivity made possible by leaving that money in private hands.

By the way, I can’t resist a bit of nit-picking at this point. The increases in investment, wages, and productivity all occur because the marginal corporate tax rate is reduced, not because more money is in private hands.

I’m all in favor of leaving more money in private hands, but you get more growth when you change relative prices to make productive behavior more rewarding. And this happens when you reduce the tax code’s penalty on work compared to leisure and when you lower the tax on saving and investment compared to consumption.

The Wall Street Journal obviously understands this and was simply trying to avoid wordiness, so this is a friendly amendment rather than a criticism.

Anyhow, back to the editorial. The WSJ notes that the lower corporate tax rate in the United Kingdom is expected to lose far less revenue than was predicted by static estimates.

The Treasury’s answer in a report this week is that extra growth and changed business behavior will likely recoup 45%-60% of that revenue. The report says that even that amount is almost certainly understated, since Treasury didn’t attempt to model the effects of the lower rate on increased foreign investment or other “spillover benefits.”

And maybe this more sensible approach eventually will spread to the United States.

…the results are especially notable because the U.K. Treasury gnomes are typically as bound by static-revenue accounting as are the American tax scorers at Congress’s Joint Tax Committee. While the British rate cut is sizable, the U.S. has even more room to climb down the Laffer Curve because the top corporate rate is 35%, plus what the states add—9.x% in benighted Illinois, for example. This means the revenue feedback effects from a rate cut would be even more substantial.

The WSJ says America’s corporate tax rate should be lowered, and there’s no question that should be a priority since the United States now has the least competitive corporate tax system in the developed world (and we rank a lowly 94 out of the world’s top 100 nations).

But the logic of the Laffer Curve also explains why we should lower personal tax rates. But it’s not just curmudgeonly libertarians who are making this argument.

Writing in London’s City AM, Allister Heath points out that even John Maynard Keynes very clearly recognized a Laffer Curve constraint on excessive taxation.

Supply-side economist?!?

Even Keynes himself accepted this. Like many other economists throughout the ages, he understood and agreed with the principles that underpinned what eventually came to be known as the Laffer curve: that above a certain rate, hiking taxes further can actually lead to a fall in income, and cutting tax rates can actually lead to increased revenues.Writing in 1933, Keynes said that under certain circumstances “taxation may be so high as to defeat its object… given sufficient time to gather the fruits, a reduction of taxation will run a better chance than an increase of balancing the budget. For to take the opposite view today is to resemble a manufacturer who, running at a loss, decides to raise his price, and when his declining sales increase the loss, wrapping himself in the rectitude of plain arithmetic, decides that prudence requires him to raise the price still more—and who, when at last his account is balanced with nought on both sides, is still found righteously declaring that it would have been the act of a gambler to reduce the price when you were already making a loss.”

For what it’s worth, Keynes also thought that it would be a mistake to let government get too large, having written that “25 percent [of GDP] as the maximum tolerable proportion of taxation.”

But let’s stay on message and re-focus our attention on the Laffer Curve. Amazingly, it appears that even a few of our French friends are coming around on this issue.

Here are some passages from a report from the Paris-based Institute for Research in Economic and Fiscal Issues.

In an interview given to the newspaper Les Echos on November 18th, French Prime Minister Jean -Marc Ayrault finally understood that “the French tax system has become very complex, almost unreadable, and the French often do not understand its logic or are not convinced that what they are paying is fair and that this system is efficient.” …The Government was seriously disappointed when knowing that a shortfall of over 10 billion euros is expected in late 2013 according to calculations by the National Assembly. …In fact, we have probably reached a threshold where taxation no longer brings in enough money to the Government because taxes weigh too much on production and growth.

This is a point that has also been acknowledged by France’s state auditor. And even a member of the traditionally statist European Commission felt compelled to warn that French taxes had reached the point whether they “destroy growth and handicap the creation of jobs.”

But don’t hold your breath waiting for good reforms in France. I fear the current French government is too ideologically fixated on punishing the rich to make a shift toward more sensible tax policy.

P.S. The strongest single piece of evidence for the Laffer Curve is what happened to tax collections from the rich in the 1980s. The top tax rate dropped from 70 percent to 28 percent, leading many statists to complain that the wealthy wouldn’t pay enough and that the government would be starved of revenue. To put it mildly, they were wildly wrong.

I cite that example, as well as other pieces of evidence, in this video.

P.P.S. And if you want to understand specifically why class-warfare tax policy is so likely to fail, this post explains why it’s a fool’s game to target upper-income taxpayers since they have considerable control over the timing, level, and composition of their income.

P.P.P.S. Above all else, never forget that the goal should be to maximize growth rather than revenues. That’s because we want small government. But even for those that don’t want small government, you don’t want to be near the revenue-maximizing point of the Laffer Curve since that implies significant economic damage per every dollar collected.

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Among the right-leaning policy wonks and intellectuals in Washington, there’s a lot of attention being given to the something called “reform conservatism.”

Underlying this school of thought is the notion that the Reagan-era message no longer works since Republicans have lost the popular vote in five out of the last six elections.

A few people have asked my opinion about this movement, and since Ross Douthat of the New York Times just put together a good description of this school of thought, it makes it easy for me to offer my thoughts.

But before digging into his column, I think that some of the angst on the right is misplaced. Why blame a Reagan-era message for GOP electoral problems when all the Republicans presidential nominees in recent years have favored big government? Does anybody really think that Bush 41, Dole, Bush 43, McCain, and Romney were Reaganites?!?

Could any of those candidates have given these remarks, at least with any credibility? Or made these comments in a sincere fashion? It’s much more plausible to say that Republicans have lagged because they didn’t have candidates with a Reagan-style message.

But let’s assume, for the sake of argument, that Republicans would have fared poorly even if Reaganites had been nominated. Does “reform conservatism” offer a path to electoral salvation.

Here’s what Douthat identifies as the “two major premises” of reform conservatism.

1. First, he writes that the “core economic challenge facing the American experiment is not income inequality per se, but rather stratification and stagnation — weak mobility from the bottom of the income ladder and wage stagnation for the middle class.” Conservatives, he says, should strive to make “family life more affordable, upward mobility more likely, and employment easier to find.”

2. Second, he warns that the “existing welfare-state institutions we’ve inherited from the New Deal and the Great Society, however, often make these tasks harder rather than easier: Their exploding costs crowd out every other form of spending, require middle class tax increases and threaten to drag on economic growth.”

I’m not an expert on income mobility, so I’m not sure I would identify stratification and stagnation as the nation’s core economic challenge, but he may be right. Regardless, it’s definitely a good idea to have more mobility.

And I definitely agree that the welfare state hinders upward mobility by creating dependency. And he’s right that this is a drag on growth. That being said, I disagree with his assertion that rising entitlement expenditures crowd out other spending and lead to middle class tax hikes. Those things may happen at some point, particularly once we get into the peak years for retiring baby boomers, but they haven’t happened yet.

The more important question, at least to me, is what sort of policies do reform conservatives embrace? Here’s Douthat’s list, bolded, followed by my thoughts.

a. A tax reform that caps deductions and lowers rates, but also reduces the burden on working parents and the lower middle class, whether through an expanded child tax credit or some other means of reducing payroll tax liability. Tax Distribution CBOI obviously like the idea of lowering rates and reducing deductions since that moves the system closer to a flat tax. That being said, it’s difficult to reduce the tax burden on the lower middle class since they pay very little income tax under the current system (see accompanying table from CBO). But I like the idea of addressing the payroll tax, though I disagree with their approach (see section “c” below).

b. A repeal or revision of Obamacare that aims to ease us toward a system of near-universal catastrophic health insurance, and includes some kind of flat tax credit or voucher explicitly designed for that purpose. I fully agree with repeal of Obamacare, and I think an unfettered marketplace would evolve into a system of near-universal catastrophic insurance, but I don’t want the federal government subsidizing or coercing that approach (though current healthcare policy has far more subsidies and coercion, so Douthat’s plan would be a big improvement over the status quo).

c. A Medicare reform along the lines of the Wyden-Ryan premium support proposal, and a Social Security reform focused on means testing and extending work lives rather than a renewed push for private accounts. I’m glad they embrace Medicare reform, but I’m puzzled by the hostility to personal retirement accounts.  If you increase the retirement age and/or means test, you force people to pay more and get less, yet Social Security already is a bad deal for younger workers. So why make it worse? How can that be good for those with low mobility? Personal accounts would be akin to a tax cut for such workers since the payroll tax would be transformed into something much closer to deferred compensation.

d. An immigration reform that tilts much more toward Canadian-style recruitment of high-skilled workers, and that doesn’t necessarily seek to accelerate the pace of low-skilled immigration. As I noted in this interview, I very much favor bringing more high-skilled people into the country.

e. A “market monetarist” monetary policy as an alternative both to further fiscal stimulus and to the tight money/fiscal austerity combination advanced by many Republicans today. I try to avoid monetary policy. That being said, I’m a bit skeptical of “market monetarism.” No nation has ever tried this system, so it’s uncharted territory, and I’m reluctant to embrace an approach which is premised on the notion that bubbles can’t exist (what about the tech bubble of the late 1990s or the housing bubble last decade?!?). I’m also suspicious of a system which requires an activist central bank. Watch this George Selgin video if you want to know why.

f. An attack not only on explicit subsidies for powerful incumbents (farm subsidies, etc.) but also other protections and implicit guarantees, in arenas ranging from copyright law to the problem of “Too Big To Fail.” Amen. I fully agree.

Since I’m a tax policy wonk, let me address in greater detail some of the tax reform proposals put forward by reform conservatives.

Jim Pethokoukis of the American Enterprise Institute is identified in the column as a reform conservative, and he recently expressed skepticism about the flat tax in a column for National Review.

It’s an elegant, compelling model that might work  splendidly if you were creating a tax code ex nihilo. …America, however, is in a much different place. Millions of individuals and businesses have made long-term plans based on expectations that the tax code will remain more or less the same. Half the nation, thanks to all those deductions and credits, pays no income tax. …it’s unlikely the U.S. can keep spending down at historical levels of 20 percent to 21 percent of GDP while also maintaining a floor for defense spending at 4 percent of output. The best a group of AEI scholars could manage was limiting spending to 23 percent of GDP by 2035.

The clear implication of his column is that we need a tax system that raises more revenue. I obviously disagree. We should never “feed the beast” by giving politicians more money to spend.

Pethokoukis also says the flat tax is politically unrealistic. Since I’m not expecting a flat tax in my lifetime, I obviously can’t argue with that statement. But he then proposes another plan that would be far less popular – and far more dangerous.

One solution is to take the essentially flat consumption tax devised by economists Robert Hall and Alvin Rabushka and give it a progressive rate structure. Or we could combine a consumption tax with a flat income tax on wealthier Americans, as suggested by Yale’s Michael Graetz.

So we should keep the income tax as a vehicle for class warfare and augment it with a VAT?!? Yeah, good luck trying to sell that idea. And Heaven help us if it ever succeeded since politicians would have another major source of tax revenue.

Another plan, which Douthat explicitly cites in his paper, was put together by Robert Stein, a former Bush Treasury official. He thinks traditional supply-side policies today are either irrelevant or unpopular.

Lowering tax rates today could still enhance the incentives to invest, particularly in the corporate sector. But the distortions caused by marginal tax rates are not nearly as great as they were in 1980. And attempts to solve other problems caused by the tax code itself — like the biases in favor of consumption over saving, or home building over business investment — could never in themselves garner the public support necessary for a major overhaul.

As I noted, I’m not holding my breath for a flat tax, so I can’t disagree with Stein’s prognostication.

He also has a very novel way of defining the problem we should be trying to fix.

…it is time to rethink how the tax code treats ­parents. …raising children is hardly just another pastime: It is one of the most important services any American can perform for our country. …even as Social Security and Medicare depend on large numbers of future workers, they have created an enormous fiscal bias against procreation, undermining an important motive for raising children: to safeguard against poverty in old age. ……our system of taxes and entitlements not only fails to reward parents — it actively discourages Americans from having children. …Recent studies (especially work by Michele Boldrin, ­Mariacristina De Nardi, and Larry Jones and by Isaac Ehrlich and Jinyoung Kim) show that Social Security and Medicare actually reduce the fertility rate by about 0.5 children per woman. In European countries, where retirement systems are larger, the effect is closer to one child per woman.

As a libertarian, the beginning section of that passage grated on me. My children are individuals, not a “service” to prop up entitlement programs. I agree with Stein that these programs are a problem, but the solution is to reform entitlements, not to rejigger the tax code in hopes of pumping out more taxpayers.

Stein disagrees.

Unfortunately, these negative effects on fertility cannot be cured simply by converting old-age entitlement programs into mandatory savings programs, as the Bush administration proposed for Social Security in 2005. After all, requiring workers to save for retirement through private financial instruments would also crowd out the traditional motive to raise kids.

Instead, he wants to change the tax system based on the notion that today’s kids are tomorrow’s taxpayers.

…the present value of future Social Security and Medicare contributions for a typical worker born today is about $150,000. Rewarding parents for creating these future contributions suggests annual tax relief of about $8,500 per child. To correct for this inadequate treatment of households with ­children, the existing dependent exemption for children, the child credit, the ­child-care credit, and the adoption credit should be replaced with one new $4,000 credit per child that can be used to offset both income and payroll taxes. (This amount is set much closer to the $3,250 figure than the $8,500 one mostly to reduce the plan’s negative impact on federal revenue.)

I have no philosophical objection to some form of exemption – or even credit – based on family size. Almost all flat tax systems, for instance, have some sort of family allowance.

But it’s also important to realize that bigger family allowances generally don’t have pro-growth effects. It’s the marginal tax rate that impacts incentives.

And Stein, unfortunately, would “pay” for his credits by raising marginal tax rates on a significant share of taxpayers.

Some of these costs would be offset by eliminating itemized deductions (other than mortgage interest and charitable contributions). The rest would have to be offset by ­allowing the top rate of 35% to touch more taxpayers than it currently affects. …who pays more? Primarily high-income workers, but also upper-middle-class taxpayers who do not have children in the home (either because they have decided not to raise children at all, or because their children have already turned 18). To be blunt, the plan is a tax hike on the rich and makes the tax code even more progressive than it is today.

To be fair, Stein also proposes some good policies such as AMT repeal and reductions in double taxation, so he’s definitely not in the Obama class-warfare camp. But it’s also fair to say that his plan won’t do much for growth. Some tax rates are lowered but others are increased.

Yet if you really want families to be in stronger shape, more growth is the only long-run solution.

Moreover, it’s not clear that Stein’s agenda would be terribly popular. Though I confess that’s just a guess since no politician has latched onto the idea in the years since the proposal was unveiled.

Returning to the broader issue of “reform conservatism,” it’s difficult to assign an overall grade to the movement since I’m not sure whether we’re supposed to interpret it as a political strategy or an economic plan.

Regardless, I guess I’m generally sympathetic. I assume the RCers want government to be smaller than it is today and I don’t think you have to be a 100 percent libertarian to be my ally in the fight to restrain excessive government. And I also think it’s a good idea for people to be thinking of how to best articulate a message of smaller government. Heck, I do that every time I go on TV or give a speech.

So I reserve the right to object to any of the specific proposals that reform conservatives put forward (such as the tax plans discussed above), but I like the project.

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Last month, Amity Shlaes came to Cato to discuss her superb new book about Calvin Coolidge.

I heard her discuss the book back in January while participating in Hillsdale College’s conference on the 100th anniversary of the income tax, but the book is so rich with information that I was glad for the opportunity to listen to her provide additional insights on a great President.

I also got to provide some commentary on the book and the lessons that we can learn from the Coolidge era.

I managed to talk for more than 15 minutes, but I could have boiled my remarks down to these two points.

  1. Small government is the best way to achieve competent and effective government. Coolidge and his team were able to monitor government and run it efficiently because the federal budget consumed only about 5 percent of GDP. But when the federal budget is 23 percent of GDP, by contrast, it’s much more difficult to keep tabs on what’s happening – particularly when the federal government operates more than 1,000 programs. Even well-intentioned bureaucrats and politicians are unlikely to do a good job, as illustrated by this Eric Allie cartoon.
  2. Higher tax rates don’t automatically lead to more tax revenue. Coolidge and his Treasury Secretary practiced something called “scientific taxation,” but it’s easier just to call it common sense. Since Amity’s book covered the data from the 1920s, I shared with the audience some amazing data from the 1980s showing that lower tax rates on the “rich” led to big revenue increases.

But if you don’t believe me, listen to these powerful remarks from “Silent Cal.”

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