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Archive for the ‘Double Taxation’ Category

More than 10 years ago, I narrated this video explaining why there should be no capital gains tax.

The economic argument against capital gains taxation is very simple. It is wrong to impose discriminatory taxes on income that is saved and invested.

It’s bad enough that government gets to tax our income one time, but it’s even worse when they get to impose multiple layers of tax on the same dollar.

Unfortunately, nobody told Biden. As part of his class-warfare agenda, he wants to increase the capital gains tax rate from 23.8 percent to 43.4 percent.

Even worse, he wants to expand the capital gains tax so that it functions as an additional form of death tax.

And that tax would be imposed even if assets aren’t sold. In other words, it would a tax on capital gains that only exist on paper (a nutty idea associated with Sens. Ron Wyden and Elizabeth Warren).

I’m not joking. In an article for National Review, Ryan Ellis explains why Biden’s proposal is so misguided.

The Biden administration proposes that on top of the old death tax, which is assessed on estates, the federal government should add a new tax on the deceased’s last 1040 personal-income-tax return. This new, second tax would apply to tens of millions of Americans. …the year someone died, all of their unrealized capital gains (gains on unsold real estate, family farms and businesses, stocks and other investments, artwork, collectibles, etc.) would be subject to taxation as if the assets in question had been sold that year. …In short, what the Biden administration is proposing is to tax the capital gains on a person’s property when they die, even if the assets that account for those gains haven’t actually been sold. …to make matters worse, the administration also supports raising the top tax rate on long-term capital gains from 23.8 percent to 43.4 percent. When state capital-gains-tax rates are factored in, this would make the combined rate at or above 50 percent in many places — the highest capital-gains-tax rate in the world, and the highest in American history.

This sounds bad (and it is bad).

But there’s more bad news.

…that’s not all. After these unrealized, unsold, phantom gains are subject to the new 50 percent double death tax, there is still the matter of the old death tax to deal with. Imagine a 50 percent death tax followed by a 40 percent death tax on what is left, and you get the idea. Karl Marx called for the confiscation of wealth at death, but even he probably never dreamed this big. …Just like the old death tax, the double death tax would be a dream for the estate-planning industry, armies of actuaries and attorneys, and other tax professionals. But for the average American, it would be a nightmare. The death tax we have is bad enough. A second death tax would be a catastrophic mistake.

Hank Adler and Madison Spach also wrote about this topic last month for the Wall Street Journal.

Here’s some of what they wrote.

Mr. Biden’s American Families Plan would subject many estates worth far less than $11.7 million to a punishing new death tax. The plan would raise the total top rate on capital gains, currently 23.8% for most assets, to 40.8%—higher than the 40% maximum estate tax. It would apply the same tax to unrealized capital gains at death… The American Families Plan would result in negative value at death for many long-held leveraged real-estate assets. …Scenarios in which the new death tax would significantly reduce, nearly eliminate or even totally eliminate the net worth of decedents who invested and held real estate for decades wouldn’t be uncommon. …The American Families Plan would discourage long-term investment. That would be particularly true for those with existing wealth who would begin focusing on cash flow rather than long-term investment. The combination of the new death tax plus existing estate tax rates would change risk-reward ratios.

The bottom line is that it is very misguided to impose harsh and discriminatory taxes on capital gains. Especially if the tax occurs simply because a taxpayer dies.

P.S. Keep in mind that there’s no “indexing,” which means investors often are being taxed on gains that merely reflect inflation.

P.P.S. Rather than increasing the tax burden on capital gains, we should copy Belgium, Chile, Costa Rica, Czech Republic, Hungary, Luxembourg, New Zealand, Singapore, Slovenia, Switzerland, and Turkey. What do they have in common? A capital gains tax rate of zero.

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There are three important principles for sensible tax policy.

  1. Low marginal tax rates on productive behavior
  2. No tax bias against capital (i.e., saving and investment)
  3. No tax preferences that distort the economy

Today, let’s focus on #2.

I’ve written many times about why double taxation is a bad idea. This occurs when governments – thanks to capital gains taxes, dividend taxes, death taxes, etc – impose harsher tax burdens on income that is saved and invested compared to income that is immediately consumed.

Which is a bad idea since wages for workers are linked to productivity, which is linked to the amount of capital.

Which countries imposes the heaviest tax burdens on capital? According to a new report from the Tax Foundation, Canada is the worst of the worst (somewhat surprising), followed by Denmark (no surprise) and France (also no surprise).

The nations of Eastern Europe, along with Ireland, win the prize for the lowest tax burdens on capital.

The authors of the report, Jacob Lundberg and Johannes Nathell, make a much-needed point about why governments should not penalize saving and investment.

…capital should not be taxed at all. Taxing capital distorts individuals’ savings decisions. By reducing the return on savings, capital taxes penalize those who postpone their consumption rather than consuming their income as it is earned. Due to compounding interest, capital taxation penalizes saving more the longer the saving horizon is. For long saving horizons, the distortion is very large. This leads to lower saving, a lower capital stock, and lower GDP. Therefore, not taxing capital is in the interest of everyone, even those who spend everything they earn.

The report also contains this fascinating map comparing capital taxation in European nations.

At the risk of stating the obvious, it’s better to be a lighter-colored nation.

This is fascinating data for tax wonks, but it might not perfectly capture the relative attractiveness (or unattractiveness) of various countries. I think two caveats are warranted.

First, it’s quite likely that some Western European nations accumulated lots of capital and generated lots of wealth back in the 1800s and early 1900s when the burden of government was very small and taxes were very low. If some of the capital from that period is still generating returns (and thus tax revenue), it may overstate the tax burden on current saving and investment.

Second, the methodology looks at capital revenues as a percentage of capital income. This perfectly reasonable approach overlooks the fact that tax rates have an effect on the amount of income that is both earned and reported. This is the core insight of the Laffer Curve and it could mean that some countries show high levels of revenue in part because tax burdens are modest (and vice-versa).

That being said, I wouldn’t expect major changes in the rankings, even if there was a way to address these concerns.

The bottom line is that we know how to define good tax policy, but very few governments have an interest in maximizing liberty and prosperity. The challenge is that politicians 1) usually want more money so they can buy more votes, but 2) sometimes let envy trump their desire for more revenue.

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Back in 2015, I joked that my life would be simpler if I had an “automatic fill-in-the-blanks system” for columns dealing with the Organization for Economic Cooperation and Development.

Here’s what I proposed.

We can use this shortcut today because the OECD has just churned out a report embracing the death tax. So all we need to do is fill in the blanks and we have an appropriate intro:

The bureaucrats at the Paris-based OECD, working in cooperation with greedy politicians, have released a new study urging more power for governments in order to increase death taxes.

But the purpose of this column is not to mock the OECD, even though its reflexive statism makes it an easy target. Let’s actually dig into this new report and explain why it is so misguided.

This paragraph is a summary of the bureaucracy’s main argument, which is basically an envy-driven cry for more tax revenue.

The report explores the role that inheritance taxation could play in raising revenues, addressing inequalities and improving efficiency in the future. …taxes on wealth transfers – including inheritance, estate, and gift taxes – are levied in 24 of the 36 OECD countries… In 2018, only 0.5% of total tax revenues were sourced from those taxes on average across the countries that levied them. …Overall, the report finds that there is a good case for making greater use of well-designed inheritance and gift taxation… There are strong equity arguments in favour of inheritance taxation..

Here’s some more of the OECD’s dirigiste analaysis.

The report finds that well-designed inheritance taxes can raise revenue and enhance equity… There are strong equity arguments in favour of inheritance taxation… From an equality of opportunity perspective, inheritances and gifts can create a divide between the opportunities that people face. Wealth transfers might give recipients a head start… By breaking down the concentration of wealth…, inheritance and gift taxation can contribute to levelling the playing field… ‘The recent progress made on international tax transparency…is greatly increasing countries’ ability to tax capital… Progressive tax rates have several advantages compared to flat tax rates. …Taxing unrealised gains at death may be the most efficient and equitable approach.

As you can see, the OECD’s argument revolves around class warfare. They think it’s unfair that some parents want to help their children.

By contrast, the argument against the OECD revolves around economics. More specifically, the death tax is a terrible idea because it directly and unambiguously reduces private savings and investment, thus undermining productivity and putting a damper on wages.

Interestingly, the OECD admits this happens. Here’s Figure 2.4 from the OECD report, showing how death taxes (combined with annual income taxes) reduce saving and investment over five generations.

And the above charts don’t even show the true impact because there’s no line showing how much saving and investment would exist with no death tax and no double taxation.

For what it’s worth, the OECD report does acknowledge some practical and economic problems with death taxes.

An inheritance tax directly reduces wealth accumulation over generations. …inheritance taxes may also affect wealth accumulation prior to being levied by encouraging changes in donors’ behaviours. …Susceptibility to tax planning is one of the most common criticisms levelled against inheritance taxes. …There is evidence of widespread inheritance tax planning… Inheritance taxes might lower entrepreneurship by heirs… Inheritance taxes may also jeopardise existing businesses when they are transferred if business owners do not have enough liquid assets to pay the tax. …Double taxation is a popular objection to inheritance taxes…wage earnings, savings, or personal business income…will have in many cases already been taxed. …There might be challenges associated with estimating fair market value for some assets.

If you wade through the report, you’ll notice that the OECD doesn’t have good answers for these problems.

Instead, the basic message is, “yeah, there are a bunch of downsides, but we want to finance bigger government and we resent successful people.”

The only good news is that the report gives us a list of nations that have eliminated (or never adopted) death taxes.

Among the OECD countries that do not levy inheritance or estate taxes, nine have abolished them since the early 1970s. …Austria, Czech Republic, Norway, Slovak Republic, ans Sweden have abolished their inheritance or estate taxes since 2000. Israel and New Zealand abolished these taxes between 1980 and 2000. Australia, Canada, and Mexico abolished these taxes before 1980, and Estonia and Latvia have never levied inheritance or estate taxes. …This is consistent with evidence that inheritance and estate taxes tend to be unpopular.

Here’s the part of Table 3.1 that shows when these taxes were implemented and when they were repealed.

Needless to say, I’d like to see the United States on this list at some point (we were there for one year!).

The OECD closed with some cheerleading and strategizing on how to overcome popular opposition.

…this section considers ways in which governments may enhance the public acceptability of inheritance tax reform… Reframing reforms aiming to raise more revenue.around notions of equality of opportunity and inequality reduction may help increase their public acceptability. …packaging may also be helpful. …If the introduction of an inheritance tax or an increase in existing inheritance or estate taxes…goes hand-in-hand with a decrease in other taxes, especially in labour taxes, which a majority of people are subject to, it may be more acceptable politically.

I can’t resist pointing out that it’s utter nonsense to think that governments would use revenue from a death tax to lower other taxes.

The goal of politicians is always to finance bigger government. That’s true with the death tax. It’s true with the carbon tax. It’s true with the value-added tax. It’s true with the financial transactions tax.

Which is why I wrote four years ago that, “Some people say the most important rule to remember is to never feed gremlins after midnight, but I think it’s even more important not to give politicians a new source of revenue.”

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As an economist, I strongly oppose the wealth tax (as well as other forms of double taxation) because it’s foolish to impose additional layers of tax that penalize saving and investment.

Especially since there’s such a strong relationship between investment and worker compensation.

The politicians may tell us they’re going to “soak the rich,” but the rest of us wind up getting wet.

That being said, there are also administrative reasons why wealth taxation is a fool’s game. One of them, which I mentioned as part of a recent tax debate, is the immense headache of trying to measure wealth every single year.

Yes, that’s not difficult if someone has assets such as stock in General Motors or Amazon. Bureaucrats from the IRS can simply go to a financial website and check the value for any given day.

But the value of many assets is very subjective (patents, royalties, art, heirlooms, etc), and that will create a never-ending source of conflict between taxpayers and the IRS if that awful levy is ever imposed.

Let’s look at a recent dispute involving another form of destructive double taxation. The New York Times has an interesting story about a costly dispute involving the death tax to be imposed on Michael Jackson’s family.

Michael Jackson died in 2009… But there was another matter that has taken more than seven years to litigate: Jackson’s tax bill with the Internal Revenue Service, in which the government and the estate held vastly different views about what Jackson’s name and likeness were worth when he died. The I.R.S. thought they were worth $161 million. …Judge Mark V. Holmes of United States Tax Court ruled that Jackson’s name and likeness were worth $4.2 million, rejecting many of the I.R.S.’s arguments. The decision will significantly lower the estate’s tax burden… In a statement, John Branca and John McClain, co-executors of the Jackson estate, called the decision “a huge, unambiguous victory for Michael Jackson’s children.”

I’m glad the kids won this battle.

Michael Jackson paid tax when he first earned his money. Those earnings shouldn’t be taxed again simply because he died.

But the point I want to focus on today is that a wealth tax would require these kinds of fights every single year.

Given all the lawyers and accountants this will require, that goes well beyond adding insult to injury. Lots of time and money will need to be spent in order to (hopefully) protect households from a confiscatory tax that should never exist.

P.S. The potential administrative nightmare of wealth taxation, along with Biden’s proposal to tax unrealized capital gains at death, help to explain why the White House is proposing to turbo-charge the IRS’s budget with an additional $80 billion.

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Because of the negative impact on competitiveness, productivity, and worker compensation, it’s a very bad idea to impose double taxation of saving and investment.

Which is why there should be no tax on capital gains, and a few nations sensibly take this approach.

But they’re outnumbered by countries that do impose this pernicious form of double taxation. For instance, the Tax Foundation has a new report about the level of capital gains taxation in Europe, which includes this very instructive map.

As you can see, some countries, such as Denmark (gee, what a surprise), have very punitive rates.

However, other nations (such as Switzerland, Belgium, Czech Republic, Slovakia, Luxembourg, and Slovenia) wisely don’t impose this form of double taxation.

If the United States was included, we would be in the middle of the pack. Actually, we would be a bit worse than average, especially when you include the Obamacare tax on capital gains.

But if Joe Biden succeeds, the United States soon will have the dubious honor of being the worst of the worst.

The Wall Street Journal opined this morning about the grim news.

Biden officials leaked that they will soon propose raising the federal tax on capital gains to 43.4% from a top rate of 23.8% today. …Mr. Biden will tax capital gains for taxpayers who earn more than $1 million at the personal income tax rate, which he also wants to raise to 39.6% from 37%. Add the 3.8% ObamaCare tax on investment, and you get to 43.4%. And that’s merely the federal rate. Add 13.3% in California and 11.85% in New York (plus 3.88% in New York City), which also tax capital gains as regular income, and you are heading toward the 60% rate range. Keep in mind this is on the sale of gains that are often inflated as assets are held for years without adjustment for inflation. Oh, and Mr. Biden also wants to eliminate the step-up in basis on capital gains that accrues at death.

Beating out Denmark for the highest capital gains tax rate is bad.

But it’s even worse when you realize that capital gains often occur because investors expect an asset to generate more future income. But that future income gets hit by the corporate income tax (as well as the tax on dividends) when it actually materializes.

So the most accurate way to assess the burden on new investment is to look at the combined rate of corporate taxation and capital gains (as as well as the combined rate of corporate taxation and dividend taxation).

By that measure, the United States already has one of the world’s most-punitive tax regimes, And Biden wants to increase all of those tax rates.

Sort of a class-warfare trifecta, and definitely not a recipe for good economic results.

For those interested in more details, here’s a video I narrated on the topic back in 2010.

And I also recommend these columns (here, here, and here) for additional information on why we should be eliminating the capital gains tax rather than increasing it.

P.S. Don’t forget that there’s no indexing to protect taxpayers from having to pay tax on gains that are due only to inflation.

P.P.S. And also keep in mind that some folks on the left want to impose tax on capital gains that only exist on paper.

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My Eighth Theorem of Government is very simple.

If someone writes and talks about poverty, I generally assume that they care about poor people. They may have good ideas for helping the poor, or they may have bad ideas. But I usually don’t doubt their sincerity.

But when someone writes and talks about inequality, I worry that they don’t really care about the less fortunate and that they’re instead motivated by envy, resentment, and jealousy of rich people.

And this concern probably applies to a couple of law professors, Michael Heller of Columbia and James Salzman of UCLA. They recently wrote a column for the Washington Post on how the government should grab more money from the private sector when rich people die.

They seem particularly agitated that states such as South Dakota have strong asset-protection laws that limit the reach of the death tax.

Income inequality has widened. One…way to tackle the problem. Instead of focusing only on taxing wealth accumulation, we can address the hidden flip side — wealth transmission. …The place to start is South Dakota… The state has created…wealth-sheltering tools including the aptly named “dynasty trust.” …Congress can…plug holes in our leaky estate tax system. One step would be to tax trusts at the passage of each generation and limit generation-skipping tax-exempt trusts. A bigger step would be to ensure that appreciated stocks…are taxed… Better still, let’s start anew. Ditch the existing estate tax and replace it with an inheritance tax

There’s nothing remarkable in their proposals. Just a typical collection of tax-the-rich schemes one might expect from a couple of academics.

But I can’t resist commenting on their article because of two inadvertent admissions.

First, we have a passage that reveals a twisted sense of morality. They apparently think it’s a “heist” if people keep their own money.

America’s ultra-wealthy have pulled off a brilliantly designed heist, with a string of South Dakota governors as accomplices.

For all intents and purposes, the law professors are making an amazing claim that it’s stealing if you don’t meekly surrender your money to politicians.

Apparently they agree with Richard Murphy that all income belongs to the government and it’s akin to an entitlement program or “state aid” if politicians let you keep a slice.

Second, the law professors make the mistake of trying to be economists. They want readers to think the national economy suffers if money stays in the private sector.

Nearly no one in South Dakota complains, because the harm falls on the national economy… We all suffer high and hidden costs…getting less in government services. …South Dakota locks away resources that could spark entrepreneurial innovation.

According to their analysis, a nation such as Singapore must be very poor while a country such as Greece must be very rich.

Needless to say, the opposite is true. Larger burdens of government spending are associated with less prosperity and dynamism.

I’ll offer one final observation. Professors Heller and Salzman obviously want more and more taxes on the rich.

But I wonder what they would say if confronted with the data showing that the United States already collects a greater share of tax revenue from the rich than any other OECD country.

P.S. The reason the U.S. collects proportionately more taxes from the rich is that other developed countries have bigger welfare states, and that necessarily leads to much higher tax burdens on lower-income and middle-class taxpayers (as honest folks on the left acknowledge).

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A “capital gain” occurs when you buy something and later sell it for a higher price. A capital gains tax is when politicians decide they get to grab a slice of that additional wealth.

I’ve repeatedly explained that it is economically foolish to have such a tax because it punishes saving, investment, risk taking, and entrepreneurship.

Simply stated, the capital gains tax is “double taxation,” which is what happens when there are additional layers of tax on income that is saved and invested.

I’m motivated to address this issue again because of a recent column in the Washington Post by Charles Lane.

He wants us to believe that singer-songwriter Bob Dylan has been rewarded by the capital gains tax.

Bob Dylan…just sold the rights to “Blowin’ in the Wind” and 600 other songs to Universal Music Publishing Group for a reported $300 million. …This is a tribute to his genius and, on the whole, to a political and economic system that rewards artists… Nevertheless, some socially conscious musician could write a song protesting the Dylan deal, because of what it reveals about that engine of irrationality and inequality known as the U.S. tax system. A cardinal defect of the system is highly favorable treatment of capital gains relative to ordinary income. The top rate on the former stands at 20 percent; on the latter, it is 37 percent. …the obscure 2006 law known as the Songwriters Capital Gains Tax Equity Act, which permits songwriters — but not painters, video game makers or novelists — to treat the proceeds from selling their copyrights as capital gains, too. …The capital gains break, for him and for others similarly situated, is basically a windfall. …President-elect Joe Biden supports equalizing capital gains and ordinary income rates, at least for households earning more than $1 million. If kept, Biden’s promise would restore a measure of equity and efficiency to the tax system.

At the risk of understatement, I disagree.

What Mr. Lane doesn’t appreciate or understand is that the Universal Music Publishing Group purchased the rights to Dylan’s music for $300 million because they expect his songs to generate more than $300 million of income in the future.

And that future income will be taxed when (and if) it actually materializes.

In other words, a capital gains tax is – for all intents and purposes – an added layer of tax on the expectation of future income. Double taxation in every possible sense.

This is why I’ve pointed out that Biden’s plan will make the tax code more punitive, not more equitable and efficient as Lane asserted.

Since we’re on the topic of capital gains taxation, I’ll also cite some relatively new research from the San Francisco Federal Reserve.

Here are the key findings in the working paper from Sungki Hong and Terry Moon.

This paper quantifies the aggregate effects of reducing capital gains taxes in the long run. We build a dynamic general equilibrium model with heterogeneous firms facing discrete capital gains tax rates based on firm size. We calibrate our model by targeting relevant micro moments and the difference-in-differences estimate of the capital elasticity based on the institutional setting in Korea. We find that the reform that reduced the capital gains tax rates from 24 percent to 10 percent for the firms affected by the new regulations increased aggregate investment by 2.6 percent and 1.7 percent in the short run and in the steady state, respectively. Moreover, a counterfactual analysis where we set a uniformly low tax rate of 10 percent shows that aggregate investment rose by 6.8 percent in the long run. …Our findings suggest that reducing capital gains tax rates would substantially increase investment in the short run, and accounting for dynamic and general equilibrium responses is important for understanding the aggregate effects of capital gains taxes.

And here are two of the key charts from the study.

And here’s the part of the study that explains the above charts.

Panel A in Figure 2…shows the parallel trend in investment between the affected and unaffected firms…positive and statistically significant coefficients after the year 2014 indicate that lower tax rates induced the affected firms to increase investment. Panel B in Figure 2…shows the parallel trend in investment between the affected and unaffected firms…positive and statistically significant coefficients after the year 2014 indicate that lower tax rates induced the affected firms to increase the size of tangible assets.

The bottom line is that is that you get higher wages with more productivity…and you get more productivity with more investment…and you get more investment if you don’t impose harsh tax policies on people who invest.

Which is why the correct capital gains tax rate is zero, whether you’re looking at theory or evidence.

Which is the core message in my video on capital gains taxation.

P.S. There’s also a video explaining why it’s especially wrong to impose the capital gains tax on “gains” that are solely the result of inflation.

P.P.S. And somebody needs to do a video on why it’s an awful idea for the government to tax capital gains that only exist in theory.

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Two weeks ago, I shared some video from a presentation to the New Economic School of Georgia (the country, not the state) as part of my “Primer on the Laffer Curve.”

Here’s that portion of that presentation that outlines the principles of sensible taxation.

Just in case you don’t want to watch me pontificate for nearly 14 minutes, here’s the slide from the presentation that most deserves attention since it captures the key principle of good tax policy.

Simply stated, the more you tax of something, the less you get of that thing.

By the way, I had an opportunity earlier this year to share some similar thoughts about the principles of sound tax policy with the United Nations’ High-Level Panel on Financial Accountability Transparency & Integrity.

Given my past interactions with fiscal people at the U.N., I’m not overflowing with optimism that the following observations will have an impact, but hope springs eternal.

The ideal fiscal environment is one that has a vibrant and productive economy that generates sufficient revenue with modest tax rates that do not needlessly penalize productive behavior. Public finance experts generally agree on the following features

  • Low marginal tax rates. A tax operates by increasing the “price” of whatever is being taxed. This is most obvious in the case of some excise taxes –such as levies on tobacco –where governments explicitly seek to discourage certain behaviors. …but there should be a general consensus in favor of keeping tax rates reasonable on the behaviors –work, saving, investment, risk-taking, and entrepreneurship –that make an economy more prosperous.
  • A “consumption-base.” Because of capital gains taxes, death taxes, wealth taxes, and double taxation of interest and dividends, many nations impose a disproportionately harsh tax burden on income that is saved and invested. This creates a bias against capital formation, which is problematical since every economic theory –including various forms of socialism –share the view that saving and investment are necessary for rising wages and higher living standards.
  • Neutrality. Special preferences in a tax system distort the relative “prices” of how income is earned or how income is spent. Such special tax breaks encourage taxpayers to make economically inefficient choices simply to lower their tax liabilities. Moreover, loopholes, credits, deductions, exemptions, holidays, exclusions, and other preferences reduce tax receipts, thus creating pressure for higher marginal tax rates, which magnifies the adverse economic impact.
  • Territoriality. This is the simple notion that governments should not tax activity outside their borders. If income is earned in Brazil, for instance, the Brazilian government should have the authority over how that income is taxed.The same should be true for all other nations.

By the way, “consumption-base” is simply the jargon used by public-finance economists when referring to a tax system that doesn’t impose double taxation (i.e., extra layers of tax on income that is saved and invested).

Here’s a flowchart I prepared showing the double taxation in the current system compared to what happens with a flat tax.

P.S. At the risk of understatement, it’s impossible to have a good tax system with a bloated public sector, which means it’s not easy to be optimistic about future fiscal policy in the United States.

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Speculating about tax policy in 2021, with Washington potentially being controlling by Joe Biden, Chuck Schumer, and Nancy Pelosi, there are four points to consider.

  1. The bad news is that Joe Biden has endorsed a wide range of punitive tax increases.
  2. The good news is that Joe Biden has not endorsed a wealth tax, which is one of the most damaging ways – on a per-dollar raised basis – for Washington to collect more revenue.
  3. The worse news is that the additional spending desired by Democrats is much greater than Biden’s proposed tax increases, which means there will be significant pressures for additional sources of money.
  4. The worst news is that the class-warfare mentality on the left means the additional tax increases will target successful entrepreneurs, investors, innovators, and business owners – which means a wealth tax is a very real threat.

Let’s consider what would happen if this odious example of double taxation was imposed in the United States.

Two scholars from Rice University, John Diamond and George Zodrow, produced a study for the Center for Freedom and Prosperity on the economic impact of a wealth tax.

They based their analysis on the plan proposed by Senator Elizabeth Warren, which is probably the most realistic option since Biden (assuming he wins the election) presumably won’t choose the more radical plan proposed by Senator Bernie Sanders.

They have a sophisticated model of the U.S. economy. Here’s their simplified description of how a wealth tax would harm incentives for productive behavior.

The most direct effect operates through the reduction in wealth of the affected taxpayers, including the reduction in accumulated wealth over time. Although such a reduction in wealth is, for at least some proponents of the wealth tax, a desirable result, the associated reduction in investment and thus in the capital stock over time will have deleterious effects, reducing labor productivity and thus wage income as well as economic output. …A wealth tax would also affect saving by changing the relative prices of current and future consumption. In the standard life-cycle model of household saving, a wealth tax effectively increases the price of future consumption by lowering the after-tax return to saving, creating a tax bias favoring current consumption and thus reducing saving. … we should note that the apparently low tax rates under the typical wealth tax are misleading if they are compared to income tax rates imposed on capital income, and the capital income tax rates that are analogous to wealth tax rates are often in excess of 100 percent. …For example, with a 1 percent wealth tax and a Treasury bond earning 2 percent, the effective income tax rate associated with the wealth tax is 50 percent; with a 2 percent tax rate, the effective income tax rate increases to 100 percent.

And here are the empirical findings from the report.

We compare the macroeconomic effects of the policy change to the values that would have occurred in the absence of any changes — that is, under a current law long run scenario… The macroeconomic effects of the wealth tax are shown in Table 1. Because the wealth tax reduces the after-tax return to saving and investment and increases the cost of capital to firms, it reduces saving and investment and, over time, reduces the capital stock. Investment declines initially by 13.6 percent…and declines by 4.7 percent in the long run. The total capital stock declines gradually to a level 3.5 percent lower ten years after enactment and 3.7 percent lower in the long run… The smaller capital stock results in decreased labor productivity… The demand for labor falls as the capital stock declines, and the supply of labor falls as households receive larger transfer payments financed by the wealth tax revenues… Hours worked decrease initially by 1.1 percent and decline by 1.5 percent in the long run. …the initial decline in hours worked of 1.1 percent would be equivalent to a decline in employment of approximately 1.8 million jobs initially. The declines in the capital stock and labor supply imply that GDP declines as well, by 2.2 percent 5 years after enactment and by 2.7 percent in the long run.

Here’s the table mentioned in the above excerpt. At the risk of understatement, these are not favorable results.

Other detailed studies on wealth taxation also find very negative results.

The Tax Foundation’s study, authored by Huaqun Li and Karl Smith, also is worth perusing. For purposes of today’s analysis, I’ll simply share one of the tables from the report, which echoes the point about how “low” rates of wealth taxation actually result in very high tax rates on saving and investment.

The American Action Forum also released a study.

Authored by Douglas Holtz-Eakin and Gordon Gray, it’s filled with helpful information. The part that deserves the most attention is this table showing how a wealth tax on the rich results in lost wages for everyone else.

Yes, the rich definitely lose out because their net wealth decreases.

But presumably the rest of us are more concerned about the fact that lower levels of saving and investment reduce labor income for ordinary people.

The bottom line is that wealth taxes are very misguided, assuming the goal is a prosperous and competitive America.

P.S. One obvious effect of wealth taxation, which is mentioned in the study from the Center for Freedom and Prosperity, is that some rich people will become tax expatriates and move to jurisdictions (not just places such as Monaco, Bermuda, or the Cayman Islands, but any of the other 200-plus nations don’t tax wealth) where politicians don’t engage in class warfare.

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Assuming the goal is more prosperity, lawmakers who work on tax issues should be guided by the “Holy Trinity” of good policy.

  1. Low marginal tax rates on productive activity such as work and entrepreneurship.
  2. No tax bias (i.e., extra layers of tax) that penalizes saving and investment.
  3. No complicating preferences and loopholes that encourage inefficient economic choices.

Today, with these three principles as our guide, we’re going to discuss a major problem in how dividends are taxed in the United States.

Simply stated, there’s an unfair and counterproductive double tax. All you really need to know is that if a corporation earns a profit, the corporate income tax takes a chunk of the money. But that money then gets taxed again as dividend income when distributed to shareholders (the people who own the company).

So why is this a bad thing?

From an economic perspective, the extra layer of tax means that the actual tax burden on corporate income is not 21 percent (the corporate tax rate) or 23.8 percent (how dividends are taxed on the 1040 form), but a combination of the two rates. And when you include the average additional tax imposed at the state level, the real tax rate on dividends in the United States can be as high as 47.47 percent according to the OECD.

You don’t need to be a wild-eyed supply-sider to think that incentives to build businesses and create jobs are adversely affected when the government grabs nearly half of the additional income generated by corporate investment.

Keep in mind, by the way, that workers ultimately bear most of this tax since lower levels of investment translate to lower wages.

So what’s the solution?

If we want a properly designed system for taxing businesses, we know the answer. Just get rid of the extra layer of tax.

A 2015 report from the Tax Foundation explains how various types of “corporate integration” can achieve this goal.

The United States’ tax code treats corporations and their shareholders as separate taxable entities. The result is two layers of taxation on corporate income: one at the corporate level and a second at the shareholder level. This creates a high tax burden on corporate income, increasing the cost of capital. The double taxation of corporate income reduces investment and distorts business decisions. … Many developed countries have integrated their tax systems in order to mitigate or completely eliminate the double taxation of corporate income. …There are several ways to integrate the corporate tax code. Corporate income can be fully taxed at the entity level (a corporate income tax) and then tax exempt when passed to shareholders as dividend income, or corporations could be given a deduction for dividends passed to their shareholders, who pay tax on the dividend income. Alternatively, shareholders and corporations both pay tax on their income, but shareholders can be given a credit to offset taxes the corporation already paid on their behalf.

For what it’s worth, I think it would be best to get rid of the double tax by eliminating the layer of tax that is imposed on individuals.

In other words, modify the above image in this way.

Though the economic benefit would be the same if the corporate income tax was abolished and the income was taxed one time at the individual level.

I’ll close today’s column with a bit of good news.

A few years ago, the United States had a much higher burden of double taxation because the corporate tax rate was so high. Indeed, the combined tax rate on dividends was the fourth-highest in the developed world.

Today, thanks to the 2017 tax reform, the combined tax rate is “only” the tenth-highest in the developed world.

P.S. The Estonian tax system for businesses is a good role model.

P.P.S. Under Joe Biden’s tax plan, the U.S. would have the world’s-highest combined tax rate on dividends.

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The folks who don’t want to let a crisis go to waste have been very busy in the era of coronavirus, pushing an ever-expanding menu of bad ideas.

Now we have another bad idea to add to the list.

A professor from Yale Law School, Daniel Markovits, argues in a column in the New York Times that the virus is a great excuse to impose a wealth tax.

Our extraordinary battle against the pandemic should draw on the immense reserves that the most privileged among us have accumulated over decades of abundance. To achieve this goal, America should institute a wealth tax. …the relief effort should be funded through a one-time wealth tax imposed on the richest Americans… An exemption for the first $2.5 million of household wealth would exclude the bottom 95 percent from paying any tax at all and leave the top 5 percent with total taxable wealth of roughly $40 trillion. A 5 percent tax on the richest 5 percent of households could thus raise up to $2 trillion. …this one-time wealth tax…appeal ought to cross partisan lines. …A wealth tax would fund the relief effort in a way that gives meaning to shared sacrifice in the face of a universal threat.

My initial suggestion for Professor Markovits is the same one I put forth for Bill Gates. He should lead by example and donate a big chunk of his income, as well as the bulk of his savings and investments, to the IRS.

As an Ivy League professor, I’m sure he’s comfortably positioned as a member of the infamous “top 1 percent” of taxpayers, so he can be a guinea pig for his idea. To make things easy, the government has a website for him to use.

But let’s set aside snark and focus on the economic consequences. This issue deserves serious attention, not only because it is a threat in the United States, but also because it’s becoming an issue in other nations.

Such as Argentina.

Argentine Economy Minister Martin Guzman has backed the idea of a wealth tax on the country’s rich…to…find money to help cope with the Covid-19 pandemic. The tax would affect 11,000 people with fortunes of at least $2 million, Guzman said… He spoke in an interview with journalist Horacio Verbitsky, published on the website El Cohete a la Luna. President Alberto Fernandez, in a separate interview, spoke of the need for wealth redistribution.

And South Africa.

The South African government will consider a proposal for a one-off wealth tax during an economic recovery planning meeting… Such a tax could assist Africa’s most industrialized economy as it bounces back from the coronavirus outbreak and a five-week lockdown that is scheduled to be lifted on 30 April. The proposal comes from a group of economists, led by former South African National Treasury budget chief Michael Sachs.

The big problem with all of these proposals is that they ignore the crippling economic impact of wealth taxation.

The important thing to understand is that such taxes impose very punitive implicit tax rates on saving and investment. As seen in the accompanying chart, the actual tax rate depends on how well affected taxpayers are investing their money.

And it doesn’t take extreme assumptions to see that many taxpayers will face implicit tax rates of more than 100 percent!

And since all economic theories – even foolish ones such as socialism – agree that saving and investment are vitally important if we want higher living standards, any sort of wealth tax is a big mistake.

Actually, that’s an understatement.

In a normal economy, a wealth tax is a big mistake. But we’re now dealing with the very painful economic fallout from the coronavirus.

We will have a desperate need for lots of private capital if we want to restore prosperity as fast as possible, which is why imposing a wealth tax nowadays (in addition to other forms of double taxation that already exist) would be a catastrophic blunder.

And if the class-warfare crowd succeeds in their campaign to punish the rich, poor people will suffer the most.

P.S. Some people argue that a one-time wealth tax, similar to what Prof. Markovitz proposes and what South Africa is considering, wouldn’t have adverse economic effects because it penalizes productive behavior in the past (and there’s no way for people to reduce work, saving, and investment that already took place). But as I explained when debunking IMF arguments for a one-time wealth tax, this assertion is flawed because a) people will adjust their behavior when such a tax is discussed, b) people won’t trust it is a one-time tax, and c) the money will be used to finance a larger burden of government spending.

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In this interview on Fox Business, I repeated my oft-stated concern that the Federal Reserve’s easy-money policy of artificially low interest rates (avidly supported by Trump) may have created the conditions for a boom-bust cycle.

For today’s column, though, I want to focus on the part of the interview where I fret about structural rather than cyclical factors.

More specifically, whenever there is angst and concern about household debt, I get rather frustrated because some folks want to blame the American people for not saving enough.

That may be true, but I point out that the real problem is that the federal government lures people into being short-sighted.

Given all these policies, I’m actually surprised that the national savings rate isn’t much lower.

By the way, I should emphasize that there’s nothing necessarily wrong with debt. It’s perfectly sensible for many households to borrow to buy a house, a car, or to finance education.

As I noted in the interview, what matters is keeping a sound ratio of debt to assets, and a sound ratio of interest expense to income.

It’s not easy for people to be sensible, however, when there are so many anti-savings policies from Washington.

I’ll close with a bit of good news.

Because the United States is a quasi-tax haven for foreigners, we do attract an immense amount of money from overseas. So even though the federal government discourages us from saving, we have access to capital from all over the world.

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With their punitive proposals for wealth taxes, Bernie Sanders and Elizabeth Warren are leading the who-can-be-craziest debate in the Democratic Party.

But what would happen if either “Crazy Bernie” or “Looney Liz” actually had the opportunity to impose such levies?

At the risk of gross understatement, the effect won’t be pretty.

Based on what’s happened elsewhere in Europe, the Wall Street Journal opined that America’s economy would suffer.

Bernie Sanders often points to Europe as his economic model, but there’s one lesson from the Continent that he and Elizabeth Warren want to ignore. Europe has tried and mostly rejected the wealth taxes that the two presidential candidates are now promising for America. …Sweden…had a wealth tax for most of the 20th century, though its revenue never accounted for more than 0.4% of gross domestic product in the postwar era. …The relatively small Swedish tax still was enough of a burden to drive out some of the country’s brightest citizens. …In 2007 the government repealed its 1.5% tax on personal wealth over $200,000. …Germany…imposed levies of 0.5% and 0.7% on personal and corporate wealth in 1978. The rate rose to 1% in 1995, but the Federal Constitutional Court struck down the wealth tax that year, and it was effectively abolished by 1997. …The German left occasionally proposes resurrecting the old system, and in 2018 the Ifo Institute for Economic Research analyzed how that would affect the German economy. The authors’ baseline scenario suggests that long-run GDP would be 5% lower with a wealth tax, while employment would shrink 2%. …The best argument against a wealth tax is moral. It is a confiscatory tax on the assets from work, thrift and investment that have already been taxed at least once as individual or corporate income, and perhaps again as a capital gain or death tax. The European experience shows that it also fails in practice.

Karl Smith’s Bloomberg column warns that wealth taxes would undermine the entrepreneurial capitalism that has made the United States so successful.

…a wealth tax…would allow the federal government to undermine a central animating idea of American capitalism. …The U.S. probably could design a wealth tax that works. …If a country was harboring runaway billionaires, the U.S. could effectively lock it out of the international financial system. That would make it practically impossible for high-net-worth people to have control over their wealth, even if it they could keep the U.S. government from collecting it. The necessity of this type of harsh enforcement points to a much larger flaw in the wealth tax… Billionaires…accumulate wealth…it allows them to control the destiny of the enterprises they founded. A wealth tax stands in the way of this by requiring billionaires to sell off stakes in their companies to pay the tax. …One of the things that makes capitalism work is the way it makes economic resources available to those who have demonstrated an ability to deploy them effectively. It’s the upside of billionaires. …A wealth tax designed to democratize control over companies would strike directly at this strength. …a wealth tax would penalize the founders with the most dedication to their businesses. Entrepreneurs would be less likely to start businesses, in Silicon Valley or elsewhere, if they think their success will result in the loss of their ability to guide their company.

The bottom line, given the importance of “super entrepreneurs” to a nation’s economy, is that wealth taxes would do considerable long-run damage.

Andy Kessler, in a column for the Wall Street Journal, explains that wealth taxes directly harm growth by penalizing income that is saved and invested.

Even setting comical revenue projections aside, the wealth-tax idea doesn’t stand up to scrutiny. Never mind that it’s likely unconstitutional. Or that a wealth tax is triple taxation… The most preposterous part of the wealth-tax plans is their supporters’ insistence that they would be good for the economy. …a wealth tax would suck money away from productive investments. …liberals in favor of taxation always trot out the tired trope that the poor drive growth by spending their money while the rich hoard it, tossing gold coins in the air in their basement vaults. …So just tax the rich and government spending will create great jobs for the poor and middle class. This couldn’t be more wrong. As anyone with $1 billion—or $1,000—knows, people don’t stuff their mattresses with Benjamins. They invest them. …most likely…in stocks or invested directly in job-creating companies… A wealth tax takes money out of the hands of some of the most productive members of society and directs it toward the least productive uses. …existing taxes on interest, dividends and capital gains discourage the healthy savings that create jobs in the economy. These are effectively taxes on wealth—and we don’t need another one.

Professor Noah Smith leans to the left. But that doesn’t stop him, in a column for Bloomberg, from looking at what happened in France and then warning that wealth taxes have some big downsides.

Studies on the effects of taxation when rates are moderate might not be a good guide to what happens when rates are very high. Economic theories tend to make a host of simplifying assumptions that might break down under a very high-tax regime. …One way to predict the possible effects of the taxes is to look at a country that tried something similar: France, where Piketty, Saez and Zucman all hail from. …France…shows that inequality, at least to some degree, is a choice. Taxes and spending really can make a big difference. But there’s probably a limit to how much even France can do in this regard. The country has experimented with…wealth taxes…with disappointing results. France had a wealth tax from 1982 to 1986 and again from 1988 to 2017. …The wealth tax might have generated social solidarity, but as a practical matter it was a disappointment. The revenue it raised was rather paltry; only a few billion euros at its peak, or about 1% of France’s total revenue from all taxes. At least 10,000 wealthy people left the country to avoid paying the tax; most moved to neighboring Belgium… France lost not only their wealth tax revenue but their income taxes and other taxes as well. French economist Eric Pichet estimates that this ended up costing the French government almost twice as much revenue as the total yielded by the wealth tax.

In other words, the much-maligned Laffer Curve is very real. When looking at total tax collections from the rich, the wealth tax resulted in less money for France’s greedy politicians.

And this chart from the column shows that French lawmakers are experts at extracting money from the private sector.

The dirty little secret, of course, is that lower-income and middle-class taxpayers are the ones being mistreated.

By the way, Professor Smith’s column also notes that President Hollande’s 75 percent tax rate on the rich also backfired.

Let’s close with a report from the Wall Street Journal about one of the grim implications of Senator Warren’s proposed tax.

Elizabeth Warren has unveiled sweeping tax proposals that would push federal tax rates on some billionaires and multimillionaires above 100%. That prospect raises questions for taxpayers and the broader economy… How might that change their behavior? And would investment and economic growth suffer? …The rate would vary according to the investor’s circumstances, any state taxes, the profitability of his investments and as-yet-unspecified policy details, but tax rates of over 100% on investment income would be typical, especially for billionaires. …After Ms. Warren’s one-two punch, some billionaires who generate pretax returns could pay annual taxes that would leave them with less money than they started with.

Here’s a chart from the story (which I’ve modified in red for emphasis) showing that investors would face effective tax rates of more than 100 percent unless they somehow managed to earn very high returns.

For what it’s worth, I’ve been making this same point for many years, starting in 2012.

Nonetheless, I’m glad to see it’s finally getting traction. Hopefully this will deter lawmakers from ever imposing such a catastrophically bad policy.

Remember, a tax that discourages saving and investment is a tax that results in lower wages for workers.

P.S. Switzerland has the world’s best-functioning wealth tax (basically as an alternative to other forms of double taxation), but even that levy is destructive and should be abolished.

P.P.S. Sadly, because their chief motive is envy, I don’t think my left-leaning friends can be convinced by data about economic damage.

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When I wrote about the wealth tax early this year, I made three simple points.

I obviously have not been very persuasive.

At least in certain quarters.

A story in the Wall Street Journal explores the growing interest on the left in this new form of taxation.

The income tax..system could change fundamentally if Democrats win the White House and Congress. …Democrats want to shift toward taxing their wealth, instead of just their salaries and the income their assets generate. …At the end of 2017, U.S. households had $3.8 trillion in unrealized gains in stocks and investment funds, plus more in real estate, private businesses and artwork… Democrats are eager to tap that mountain of wealth to finance priorities such as expanding health-insurance coverage, combating climate change and aiding low-income households. …The most ambitious plan comes from Sen. Warren of Massachusetts, whose annual wealth tax would fund spending proposals such as universal child care and student-loan forgiveness. …rich would pay whether they make money or not, whether they sell assets or not and whether their assets are growing or shrinking.

The report includes this comparison of current law with various soak-the-rich proposals (click here for my thoughts on the Wyden plan).

The article does acknowledge that there are some critiques of this class-warfare tax proposal.

European countries tried—and largely abandoned—wealth taxes. …For an investment yielding a steady 1.5% return, a 2% wealth levy would be equivalent to an income-tax rate above 100% and cause the asset to shrink. …The wealth tax also has an extra asterisk: it would be challenged as unconstitutional.

The two economists advising Elizabeth Warren, Emmanuel Saez and Gabriel Zucman, have a new study extolling the ostensible benefits of a wealth tax.

I want to focus on their economic arguments, but I can’t resist starting with an observation that I was right when I warned that the attack on financial privacy and the assault on so-called tax havens was a precursor to big tax increases.

Indeed, Saez and Zucman explicitly argue this is a big reason to push their punitive new wealth tax.

European countries were exposed to tax competition and tax evasion through offshore accounts, in a context where until recently there was no cross-border information sharing. …offshore tax evasion can be fought more effectively today than in the past, thanks to recent breakthrough in cross-border information exchange, and wealth taxes could be applied to expatriates (for at least some years), mitigating concerns about tax competition. …Cracking down on offshore tax evasion, as the US has started doing with FATCA, is crucial.

Now that I’m done patting myself on the back for my foresight (not that it took any special insight to realize that politicians were attacking tax competition in order to grab more money), let’s look at what they wrote about the potential economic impact.

A potential concern with wealth taxation is that by reducing large wealth holdings, it may reduce the capital stock in the economy–thus lowering the productivity of U.S. workers and their wages. However, these effects are likely to be dampened in the case of a progressive wealth tax for two reasons. First, the United States is an open economy and a significant fraction of U.S. saving is invested abroad while a large fraction of U.S. domestic investment is financed by foreign saving. Therefore, a reduction in U.S. savings does not necessarily translate into a large reduction in the capital stock used in the United States. …Second, a progressive wealth tax applies to only the wealthiest families. For example, we estimated that a wealth tax above $50 million would apply only to about 10% of the household wealth stock. Therefore increased savings from the rest of the population or the government sector could possibly offset any reduction in the capital stock. …A wealth tax would reduce the financial payoff to extreme cases of business success, but would it reduce the socially valuable innovation that can be associated with such success? And would any such reduction exceed the social gains of discouraging extractive wealth accumulation? In our assessment the effect on innovation and productivity is likely to be modest, and if anything slightly positive.

I’m not overly impressed by these two arguments.

  1. Yes, foreign savings could offset some of the damage caused by the new wealth tax. But it’s highly likely that other nations would copy Washington’s revenue grab. Especially now that it’s easier for governments to track money around the world.
  2. Yes, it’s theoretically possible that other people may save more to offset the damage caused by the new wealth tax. But why would that happen when Warren and other proponents want to give people more goodies, thus reducing the necessity for saving and personal responsibility?

By the way, they openly admit that there are Laffer Curve effects because their proposed levy will reduce taxable activity.

With successful enforcement, a wealth tax has to deliver either revenue or de-concentrate wealth. Set the rates low (1%) and you get revenue in perpetuity but little (or very slow) de-concentration. Set the rates medium (2-3%) and you get revenue for quite a while and de-concentration eventually. Set the rates high (significantly above 3%) and you get de-concentration fast but revenue does not last long.

Now let’s look at experts from the other side.

In a column for Bloomberg, Michael Strain of the American Enterprise Institute takes aim at Elizabeth Warren’s bad math.

Warren’s plan would augment the existing income tax by adding a tax on wealth. …The tax would apply to fortunes above $50 million, hitting them with a 2% annual rate; there would be a surcharge of 1% per year on wealth in excess of $1 billion. …Not only would such a tax be very hard to administer, as many have pointed out. It likely won’t collect nearly as much revenue as Warren claims. …Under Warren’s proposal, the fair market value of all assets for the wealthiest 0.06% of households would have to be assessed every year. It would be difficult to determine the market value of partially held private businesses, works of art and the like… This helps to explain why the number of countries in the high-income OECD that administer a wealth tax fell from 14 in 1996 to only four in 2017. …It is highly unlikely that the tax would yield the $2.75 trillion estimated by Emmanuel Saez and Gabriel Zucman, the University of California, Berkeley, professors who are Warren’s economic advisers. Lawrence Summers, the economist and top adviser to the last two Democratic presidents, and University of Pennsylvania professor Natasha Sarin…convincingly argued Warren’s plan would bring in a fraction of what Saez and Zucman expect once real-world factors like tax avoidance…are factored in. …economists Matthew Smith, Owen Zidar and Eric Zwick present preliminary estimates suggesting that the Warren proposal would raise half as much as projected.

But a much bigger problem is her bad economics.

…a household worth $50 million would lose 2% of its wealth every year to the tax, or 20% over the first decade. For an asset yielding a steady 1.5% return, a 2% wealth tax is equivalent to an income tax of 133%. …And remember that the wealth tax would operate along with the existing income tax system. The combined (equivalent income) tax rate would often be well over 100%. Underlying assets would routinely shrink. …The tax would likely reduce national savings, resulting in less business investment in the U.S… Less investment spending would reduce productivity and wages to some extent over the longer term.

Strain’s point is key. A wealth tax is equivalent to a very high marginal tax rate on saving and investment.

Of course that’s going to have a negative effect.

Chris Edwards, in a report on wealth taxes, shared some of the scholarly research on the economic effects of the levy.

Because wealth taxes suppress savings and investment, they undermine economic growth. A 2010 study by Asa Hansson examined the relationship between wealth taxes and economic growth across 20 OECD countries from 1980 to 1999. She found “fairly robust support for the popular contention that wealth taxes dampen economic growth,” although the magnitude of the measured effect was modest. The Tax Foundation simulated an annual net wealth tax of 1 percent above $1.3 million and 2 percent above $6.5 million. They estimated that such a tax would reduce the U.S. capital stock in the long run by 13 percent, which in turn would reduce GDP by 4.9 percent and reduce wages by 4.2 percent. The government would raise about $20 billion a year from such a wealth tax, but in the long run GDP would be reduced by hundreds of billions of dollars a year.Germany’s Ifo Institute recently simulated a wealth tax for that nation. The study assumed a tax rate of 0.8 percent on individual net wealth above 1 million euros. Such a wealth tax would reduce employment by 2 percent and GDP by 5 percent in the long run. The government would raise about 15 billion euros a year from the tax, but because growth was undermined the government would lose 46 billion euros in other revenues, resulting in a net revenue loss of 31 billion euros. The study concluded, “the burden of the wealth tax is practically borne by every citizen, even if the wealth tax is designed to target only the wealthiest individuals in society.”

The last part of the excerpt is key.

Yes, the tax is a hassle for rich people, but it’s the rest of us who suffer most because we’re much dependent on a vibrant economy to improve our living standards.

My contribution to this discussion it to put this argument in visual form. Here’s a simply depiction of how income is generated in our economy.

Now here’s the same process, but with a wealth tax.

For the sake of argument, as you can see from the letters that have been fully or partially erased, I assumed the wealth tax would depress the capital stock by 10 percent and that this would reduce national income by 5 percent.

I’m not wedded to these specific numbers. Both might be higher (especially in the long run), both might be lower (at least in the short run), or one of them might be higher or lower.

What’s important to understand is that rich people won’t be the only ones hurt by this tax. Indeed, this is a very accurate criticism of almost all class-warfare taxes.

The bottom line is that you can’t punish capital without simultaneously punishing labor.

But some of our friends on the left – as Margaret Thatcher noted many years ago – seem to think such taxes are okay if rich people are hurt by a greater amount than poor people.

P.S. Since I mentioned foresight above, I was warning about wealth taxation more than five years ago.

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The crown jewel of the 2017 tax plan was the lower corporate tax rate.

I appeared on CNBC yesterday to debate that reform, squaring off against Jason Furman, who served as Chairman of Obama’s Council of Economic Advisers.

Here are a couple of observations on our discussion.

  • Jason Furman thinks it would be crazy to raise the corporate tax rate back to 35 percent. Yes, he wants to rate to be higher, but rational folks on the left know it would be very misguided to fully undo that part of the tax plan. That signifies a permanent victory.
  • Based on his comments about expensing and interest deductibility, he also seems to have a sensible view on properly and neutrally defining corporate income. These are boring and technical issues, but they have very important economic implications.
  • Critics say the lower corporate rate is responsible for big increases in red ink, but it’s noteworthy that the corporate rate was reduced by 40 percent and revenue is down by only 8.7 percent (a possible Laffer-Curve effect?). Here’s the relevant chart from the latest Monthly Budget Report from the Congressional Budget Office.

  • There’s a multi-factor recipe that determines prosperity, so it’s extremely unlikely that any specific reform will have a giant effect on growth, but even a small, sustained uptick in growth can be hugely beneficial for a nation.
  • There’s a big difference between a pro-market Democrat like Bill Clinton and some of the extreme statists currently seeking the Democratic nomination (just like there’s a big difference between Ronald Reagan and some of today’s big-government Republicans).
  • I close the discussion by explaining why “double taxation” is a profound problem with the current tax code. For all intents and purposes, we are punishing the savers and investors who generate future growth.

P.S. This wasn’t addressed in the interview, but I can’t resist pointing out that overall revenues for the current fiscal year have increased 2.2 percent, which is faster than needed to keep pace with inflation. So why has the deficit increased? Because spending has jumped by 5.8 percent. We have a spending problem in America, not a deficit problem. Fortunately, there’s a very practical solution.

P.P.S. It also wasn’t mentioned, but the other crown jewel of tax reform was the restriction on the state and local tax deduction.

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Welcome Instapundit readers! Thanks, Glenn

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Earlier today at the Friedman Conference in Australia, I spoke on the proper design of a tax system.

My goal was to explain the problem of double taxation.

I’ve repeatedly shared a flowchart to illustrate the pervasive double taxation in the current system (my example is for the United States, but many other nations make the same mistake).

And to help explain why this is economically misguided, I developed a (hopefully) compelling visual based on how to harvest apples.

But I’ve always wondered if I was presenting the information in an accessible and understandable manner. So for today’s presentation, I decided to experiment with some different visuals.

Here’s how I illustrated the current system.

As you can see, there are several additional layers of tax on people who save and invest their after-tax income.

And I explained to the crowd that this is very foolish since every economic theory agrees that saving and investment are key to long-run growth.

Even socialism. Even Marxism. (Socialists and Marxists are foolish to think government can be in charge of allocating capital, but at least they realize that future growth requires saving and investment.)

In other words, you don’t achieve good tax policy solely by having a low tax rate.

Yes, that’

s important, but genuine tax reform also means no bias against saving and investment.

Here’s another visual. This one shows the difference between the current system and the flat tax. As you can see, all the added layers of tax on saving and investment are jettisoned under true tax reform.

By the way, there are some people who prefer a national sales tax over a flat tax.

I question the political viability of that approach, but I’ve always defended the sales tax.

Why? Because it’s conceptually identical to the flat tax.

As you can see from this next visual, the difference between the two systems is that the flat tax grabs a bit of money when income is earned and the sales tax grabs a bit of money when income is spent (either today or in the future).

Remember, the goal is to eliminate the bias against saving and investing.

To economists who specialize in public finance, this is known as shifting to a “consumption base” system.

But I’ve never liked that language. What really happens under true tax reform is that we tax income, but using the right definition.

The current system, by contrast, is known as a “comprehensive income tax” with a “Haig-Simons” tax base. But that simply means a system that taxes some forms of income over and over again.

Time for one final point.

Some people like a value-added tax because it avoids the problem of double taxation.

That’s certainly true.

But this final visual shows that adding a VAT to the current system doesn’t solve the problem. All that happens is that politicians have a new source of revenue to expand the welfare state.

If a VAT was used to replace the current tax system, that might be a very worthwhile approach.

But that’s about as likely as me playing the outfield later this year for the New York Yankees.

P.S. The VAT visual is overly simplified and it sidesteps the logistical issue of whether politicians would go for a credit-invoice VAT or a subtraction-method VAT. But the visual is correct in terms of how a VAT would interact with the current system.

P.P.S. All you need to know about the VAT is that Reagan was against it and Nixon was for it.

 

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President Kennedy’s tax rate reductions were a big success. Sadly, very few modern Democrats share JFK’s zeal for pro-growth tax policy.

And there’s another arrow in the class-warfare quiver.

The Wall Street Journal reports on a misguided new idea from Ron Wyden, the ranking Democrat on the Senate Finance Committee.

The top Democrat on the Senate’s tax-writing committee proposed taxing unrealized gains in investment assets every year at the same rates as other income…an idea that would transform how the U.S. taxes the wealthiest people. …Under Mr. Wyden’s concept, capital gains would be taxed annually based on how much assets have gained in value. Now, by contrast, gains are taxed only when assets are sold and at a top rate of 23.8% instead of 37% for ordinary income.

There are two big reasons why this is a terrible idea.

First, the right policy is to abolish any tax on capital gains. Drop the rate to zero.

Simply stated, there shouldn’t be an added layer of tax on people who earn money, pay tax on that money, and then buy assets with some of the remaining after-tax income.

Especially since the income generated by that additional investment already would be hit by the corporate income tax and the extra layer of tax on dividends.

This system is also very bad for workers because of the long-standing relationship between investment and employee compensation.

Second, levying such a tax would be a logistical nightmare. Here’s another brief excerpt from the article.

Mr. Wyden’s concept would present logistical challenges. He would need to figure out how to value complex assets, handle declines in value, deal with people without enough cash to pay the tax and address illiquid investments such as closely held businesses and real estate.

So why would Sen. Wyden propose such a clunky class-warfare scheme?

Because it would generate (at least on paper) a lot of money that could be used to buy votes.

This mark-to-market tax concept…could raise substantial money. A similar proposal…would generate an estimated $125 billion in 2025 alone… Democrats, who are campaigning on wide-ranging and costly ideas for more spending on health care, infrastructure and education, can point to plans by Mr. Wyden and others to explain how they would pay for policy proposals.

Of course, no amount of tax increases would generate the revenue to finance the so-called Green New Deal.

In reality, a major reason for Wyden’s plan is that the left is motivated by class warfare rather than revenue collection.

Democrats have frequently found unfairness in the different ways that the U.S. tax system approaches wage and investment income. They have focused their response, in part, on the “Buffett Rule”, inspired by Warren Buffett’s claim that he pays a lower tax rate than his secretary.

I added this final excerpt simply so I can point out that Buffett’s claim is utter nonsense.

And so is the “Buffett rule” that some folks on the left have proposed.

I’ll close by noting that the United States has one of the world’s least friendly tax codes for investment.

The lower corporate rate in the Trump tax plan was a step in the right direction.

But even with that positive reform, the overall tax burden on capital gains is very high compared to America’s major trading partners.

And now Senator Wyden wants to make a bad situation worse.

For further information, here’s my video explaining why there shouldn’t be any tax on capital gains.

P.S. Uncle Sam also forces investors to pay capital gains tax when assets rise in value because of inflation.

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I despise the death tax. It should be abolished.

My main objection is that it is immoral. If a person earns money, pays tax on the money, and then responsibly saves and invests the money (which generally requires paying another layer of tax), it is reprehensible that politicians want to tax the money yet again simply because the person dies.

But I’m also an economist, so I don’t like the tax because it is the most pernicious form of double taxation. The levy not only drains capital from the private sector, it also discourages the building and creating of wealth in the first place, while also lining the pockets of accountants and tax lawyers.

None of that is good for those of us who will never have enough money to get hit by the tax.

The only silver lining to this dark cloud is that we get very interesting stories of what people are willing to do to escape this unfair and destructive levy.

Jeanne Calment’s apparent longevity turned her into a global celebrity before she died at the age of 122 years and 164 days in 1997. However, that age is being challenged… Yuri Deigin, a genealogist, claims that Mrs Calment actually died in 1934 and that her daughter, Yvonne, usurped her identity… The genealogist said that Mrs Calment, born in 1875, and Fernand, her husband, were the joint owners of a department store in Arles, in Provence. If Mrs Calment’s death had been registered, Mr Calment would have had to pay inheritance tax of up to 38 per cent on his wife’s half of the business. …Mr Deigin said that Mr Calment avoided the bill by telling officials that it was his daughter who had died. The daughter then passed herself off as her mother for the rest of her life.

Not everyone accepts Mr. Deigin’s analysis and it’s possible that will be genetic testing of Mrs. Calment’s remains.

For what it’s worth, I’m guessing the story is accurate. We already have lots of evidence that people will take extraordinary steps to protect family funds from this additional layer of tax.

Sadly, I don’t have to worry about the death tax. But if I did, I would do everything in my power to make sure my kids got my money rather than the despicable people in Washington.

So I admire Mrs. Calment. Yes, she broke the law, but that doesn’t bother me when the law is unjust.

P.S. I’ll defend just about anybody who benefits from dodging the death tax, even if they are hypocrites or buffoons.

P.P.S. Sadly, the U.S. death tax is more punitive than the French death tax.

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I’ve advocated for some of the President’s policies, but I’ve never defended Donald Trump when he’s personally attacked.

That’s partly because I’m a policy wonk rather than political pundit, but also because many of the attacks seem justified. Indeed, his boorish behavior is one of the reasons I thought he would lose the presidential race.

Today, though, I’m going to defend Trump. Albeit only because of my disdain for the death tax.

To be more specific, the New York Times published a major hit job last week that asserted the Trump family played all sorts of games – and perhaps even broke the law – to minimize gift taxes when Trump’s father was alive and to minimize death taxes when he passed away.

The president…received at least $413 million in today’s dollars from his father’s real estate empire, much of it through tax dodges in the 1990s. President Trump participated in dubious tax schemes during the 1990s, including instances of outright fraud, that greatly increased the fortune he received from his parents… Much of this money came to Mr. Trump because he helped his parents dodge taxes. He and his siblings set up a sham corporation to disguise millions of dollars in gifts from their parents, records and interviews show. Records indicate that Mr. Trump helped his father take improper tax deductions worth millions more. He also helped formulate a strategy to undervalue his parents’ real estate holdings by hundreds of millions of dollars on tax returns, sharply reducing the tax bill when those properties were transferred to him and his siblings.

That meant less money went to Washington (hopefully helping to starve the beast).

The president’s parents, Fred and Mary Trump, transferred well over $1 billion in wealth to their children, which could have produced a tax bill of at least $550 million under the 55 percent tax rate then imposed on gifts and inheritances. The Trumps paid a total of $52.2 million, or about 5 percent, tax records show.

The article implies the Trump family broke the law, though both the IRS and state government accepted the tax return.

The line between legal tax avoidance and illegal tax evasion is often murky, and it is constantly being stretched by inventive tax lawyers. There is no shortage of clever tax avoidance tricks that have been blessed by either the courts or the I.R.S. itself. The richest Americans almost never pay anything close to full freight. But tax experts briefed on The Times’s findings said the Trumps appeared to have done more than exploit legal loopholes. They said the conduct described here represented a pattern of deception and obfuscation, particularly about the value of Fred Trump’s real estate, that repeatedly prevented the I.R.S. from taxing large transfers of wealth to his children.

There’s not much ambiguity in my reaction to this report. I think the death tax is both immoral and economically misguided. It’s a terrible example of double taxation and it drains job-creating capital from the private economy.

The correct rate for the death tax is zero, so I’m glad the Trump family did everything possible to minimize the amount of money grabbed by Washington.

I’m embarrassed that death taxes are worse in the United States than they are in Venezuela.

Sadly, not everyone shares my perspective. Some folks are even using this NYT story as an excuse to make the death tax more onerous.

Here are some excerpts from a story in the Hill.

Democrats are calling for changes to the estate tax following a bombshell news report detailing how the Trump family navigated the tax code to protect the family’s financial assets. …”We need to look at the estate tax and certainly the issue that is raised by this investigation about the undervaluation of assets and gifts and the use of the various devices,” Rep. Lloyd Doggett (Texas), the top Democrat on the House Ways and Means Subcommittee on Tax Policy, who called for hearings on the matter. Sen. Bob Menendez (D-N.J.) said it was time to reexamine the loopholes. …Democrats say their interest in closing the loopholes are not new.

The last sentence in that excerpt is true. Obama wanted to make the death tax worse. So did Hillary.

And I’m disgusted that there are people in the business of financial planning who support the death tax since it creates business for them.

This awful levy should be repealed. Yesterday, if possible.

P.S. I assume everyone will admit that death taxes impact incentives to build wealth, but how many people realize that death taxes change incentives on when people die?

P.P.S. Smart rich people opted to die in 2010 (admittedly an extreme form of tax avoidance). They also avoid certain states.

P.P.P.S. I’ll defend just about anybody who tries to escape the vicious and destructive death tax, including straight men who marry each other and gay men who arrange fake adoptions.

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When I write about the economics of fiscal policy and need to give people an easy-to-understand explanation on how government spending affects growth, I share my four-part video series.

But. other than a much-too-short primer on growth and taxation from 2016, I don’t have something similar for tax policy. So I have to direct people to various columns about marginal tax rates, double taxation, tax favoritism, tax reform, corporate taxation, and tax competition.

Today’s column isn’t going to be a comprehensive analysis of taxes and growth, but it is going to augment the 2016 primer by taking a close look at how some taxes are more destructive than others.

And what makes today’s column noteworthy is that I’ll be citing the work of left-leaning international bureaucracies.

Let’s look at a study from the OECD.

…taxes…affect the decisions of households to save, supply labour and invest in human capital, the decisions of firms to produce, create jobs, invest and innovate, as well as the choice of savings channels and assets by investors. What matters for these decisions is not only the level of taxes but also the way in which different tax instruments are designed and combined to generate revenues…investigating how tax structures could best be designed to promote economic growth is a key issue for tax policy making. … this study looks at consequences of taxes for both GDP per capita levels and their transitional growth rates.

For all intents and purposes, the economists at the OECD wanted to learn more about how taxes distort the quantity and quality of labor and capital, as illustrated by this flowchart from the report.

Here are the main findings (some of which I cited, in an incidental fashion, back in 2014).

The reviewed evidence and the empirical work suggests a “tax and growth ranking” with recurrent taxes on immovable property being the least distortive tax instrument in terms of reducing long-run GDP per capita, followed by consumption taxes (and other property taxes), personal income taxes and corporate income taxes. …relying less on corporate income relative to personal income taxes could increase efficiency. …Focusing on personal income taxation, there is also evidence that flattening the tax schedule could be beneficial for GDP per capita, notably by favouring entrepreneurship. …Estimates in this study point to adverse effects of highly progressive income tax schedules on GDP per capita through both lower labour utilisation and lower productivity… a reduction in the top marginal tax rate is found to raise productivity in industries with potentially high rates of enterprise creation. …Corporate income taxes appear to have a particularly negative impact on GDP per capita.”

Here’s how the study presented the findings. I might quibble with some of the conclusions, but it’s worth noting all the minuses in the columns for marginal tax, progressivity, top rates, dividends, capital gains, and corporate tax.

This is all based on data from relatively prosperous countries.

A new study from the International Monetary Fund, which looks at low-income nations rather than high-income nations, reaches the same conclusion.

The average tax to GDP ratio in low-income countries is 15% compared to that of 30% in advanced economies. Meanwhile, these countries are also those that are in most need of fiscal space for sustainable and inclusive growth. In the past two decades, low-income countries have made substantial efforts in strengthening revenue mobilization. …what is the most desirable tax instrument for fiscal consolidation that balances the efficiency and equity concerns. In this paper, we study quantitatively the macroeconomic and distributional impacts of different tax instruments for low-income countries.

It’s galling that the IMF report implies that there’s a “need for fiscal space” and refers to higher tax burdens as “strengthening revenue mobilization.”

But I assume some of that rhetoric was added at the direction of the political types.

The economists who crunched the numbers produced results that confirm some of the essential principles of supply-side economics.

…we conduct steady state comparison across revenue mobilization schemes where an additional tax revenues equal to 2% GDP in the benchmark economy are raised by VAT, PIT, and CIT respectively. Our quantitative results show that across the three taxes, VAT leads to the least output and consumption losses of respectively 1.8% and 4% due to its non-distorting feature… Overall, we find that among the three taxes, VAT incurs the lowest efficiency costs in terms of aggregate output and consumption, but it could be very regressive… CIT, on the other hand, though causes larger efficiency costs, but has considerable better inequality implications. PIT, however, deteriorates both the economic efficiency and equity, thus is the most detrimental instrument.

Here’s the most important chart from the study. It shows that all taxes undermine prosperity, but that personal income taxes (grey bar) and corporate income tax (white bar) do the most damage.

I’ll close with two observations.

First, these two studies are further confirmation of my observation that many – perhaps most – economists at international bureaucracies generate sensible analysis. They must be very frustrated that their advice is so frequently ignored by the political appointees who push for statist policies.

Second, some well-meaning people look at this type of research and conclude that it would be okay if politicians in America imposed a value-added tax. They overlook that a VAT is bad for growth and are naive if they think a VAT somehow will lead to lower income tax burdens.

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I wrote last month about a new book from the Fraser Institute about demographics and entrepreneurship.

My contribution was a chapter about the impact of taxation, especially the capital gains tax.

At a panel in Washington, I had a chance to discuss my findings.

If you don’t want to watch an 11-minute video, my presentation can be boiled down to four main points.

1. Demographics is destiny – Other authors actually had the responsibility of explaining in the book about the importance of demographic change. But it never hurts to remind people that this is a profound and baked-in-the-cake ticking time bomb.

So I shared this chart with the audience and emphasized that a modest-sized welfare state may have been feasible in the past, but will be far more burdensome in the future for the simple reason that the ratio of taxpayers to tax-consumers is dramatically changing.

And it goes without saying that big-sized welfare states are doomed to collapse. Think Greece and extend it to Italy, France, Japan, and other developed nations (including, I fear, the United States).

2. Entrepreneurship drives growth – Capital and labor are the two factors of production, but entrepreneurs are akin to the chefs who figure out news ways of mixing those ingredients.

For all intents and purposes, entrepreneurs produce the creative destruction that is a prerequisite for growth.

3. The tax code discourages entrepreneurship – The bulk of my presentation was dedicated to explaining that double taxation is both pervasive and harmful.

I shared my flowchart showing how the American tax code is biased against income that is saved and invest, which discourages entrepreneurial activity.

And then showed the capital gains tax burden in developed countries.

The U.S. is probably even worse than shown in the above chart since our capital gains tax is imposed on inflationary gains.

4. The United States need to be more competitive – Last but not least, I pointed out that America’s class-warfare tax policies are the fiscal equivalent of an “own goal” (soccer reference for World Cup fans).

And this chart from my chapter shows how the United States, as of mid-2016, had the highest combined tax rate on capital gains when including the effect of the capital gains tax.

That’s the bad news. The good news is that the Trump tax cuts did produce a lower corporate rate. So in the version below, I’ve added my back-of-the-envelope calculation of where the U.S. now ranks.

But the bottom line is still uncompetitive when looking at the tax burden on investment.

And never forget that this ultimately backfires against workers since it translates into lower pay.

P.S. The Wall Street Journal produced an excellent description of why capital gains taxation is very destructive.

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Though it gets strong competition from the International Monetary Fund, the Organization for Economic Cooperation and Development wins the prize for being the worst international bureaucracy.

The Paris-based organization is infamous for pushing a statist agenda on a wide range of issues, including class-warfare taxation, energy taxation, business taxation, value-added taxes, Keynesian spendinggreen energy, and government-run healthcare.

And it relies on dodgy, dishonest, and misleading data when pushing big-government policies regarding povertypay equityinequality, and comparative economics.

But what gets me most agitated is the OECD’s attempt, beginning in the late 1990s, to prop up decrepit welfare states by undermining tax competition.

I elaborated on my concerns in this interview last June.

To make matters worse, American taxpayers finance the lion’s share of the OECD’s statist agenda. Eliminating subsidies for the OECD arguably would be the budget cut with the greatest value per dollar saved.

Which is the point of some new research from the Heritage Foundation. James Roberts and Adam Michel make a strong case that the OECD is using handouts from American taxpayers to push policy that are contrary to U.S. interests.

The Organization for Economic Cooperation and Development (OECD)…has transformed itself into a dunning agency for European mega-welfare states that are straining to fund the generous but unsustainable pension, health care, and other government programs they have over-promised to their constituents. One need only undertake a cursory examination of research over the past five years to see that tax-related work by the OECD’s Centre for Tax Policy and Administration and by other OECD directorates (for example, on carbon taxes) has been focused almost entirely on studies that buttress political arguments for higher taxes and implementation of more intrusive ways to collect them. …high-taxing European members of the OECD have pushed the organization toward an almost obsessive research focus on international tax avoidance and evasion. These manifest through its base erosion and profit shifting (BEPS) project, and a proposed protocol amending the Multilateral Convention on Mutual Assistance in Tax Matters. …The BEPS project also complements a disproportionate OECD focus on income inequality…that, in the eyes of OECD’s international civil servants, could be addressed best by international wealth redistribution schemes… The Trump Administration should consider whether U.S. taxpayers should continue to subsidize an organization that increasingly acts contrary to the expressed wishes of a significant number of Americans, who voted into office in 2016 a government with a mandate to cut government spending and reduce taxes. It could decide to withdraw the United States completely from the OECD.

I normally would exclaim “amen” at this point, except the folks at Heritage are being far too nice, writing that the White House “should consider” whether to subsidize the OECD and noting that the U.S. “could” withdraw from the Paris-based bureaucracy.

I’m in no mood for diplomatic niceties when dealing with an organization that is pervasively hostile to economic liberty. The OECD is beyond salvage. If Republicans had any brains (yes, I realize that the GOP is known as “the stupid party” for good reason), handouts would have ended last decade.

I’ll close with an example of the OECD’s perfidy.

From the moment the bureaucracy’s anti-tax competition project began about 20 years ago, I explained that the OECD was seeking to destroy financial privacy so that uncompetitive governments could track capital and impose high tax rates on income that is saved and invested. In effect, the battle over “tax havens” and “tax competition” were a proxy for whether there should be more double taxation and more extra-territorial taxation.

OECD bureaucrats and others scoffed at such assertions and said the project was simply about closing off options for tax evasion so that nations could afford to lower tax rates.

I viewed that explanation as laughably dishonest. After all, did oil-producing nations create OPEC so they could reduce petroleum prices?

Were my suspicions warranted? Well, see what the bureaucrats just wrote.

…opportunities may exist…to increase progressivity in the…taxation of capital income as a result of major changes to the international tax environment. …the recent move towards the automatic exchange of financial account information between tax administrations is likely to make it harder…for taxpayers to evade tax by hiding income and wealth offshore… This may present a particular opportunity for countries that previously moved away from progressive taxation of capital income (due to concerns regarding such tax evasion) to reintroduce a degree of progressivity.

In other words, now that the OECD has succeeded in greatly weakening financial privacy, the bureaucrats openly admit that the real goal was to make it possible for uncompetitive welfare states to impose higher tax burdens on saving and investment. I’m shocked, shocked.

Here’s my video on the OECD. It was released in 2010, but nothing has changed other than there’s even more evidence against the parasitical bureaucracy.

P.S. To add more insult to all the injury, the tax-loving bureaucrats at the OECD get tax-free salaries. Must be nice to be exempt from the bad policies they support.

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I’ve written over and over again that changing demographics are a very under-appreciated economic development. I’ve also written about why entrepreneurship is a critical determinant of growth.

But I never thought of combining those topics. Fortunately, the folks at the Fraser Institute had the foresight to do just that, having just published a book entitled Demographics and Entrepreneurship: Mitigating the Effects of an Aging Population.

There are chapters on theory and evidence. There are chapters on specific issues, such as taxes, regulation, migration, financial markets, and education.

It’s basically the literary equivalent of one-stop-shopping. You’ll learn why you should be concerned about demographic change. More important, since there’s not much policy makers can do to impact birthrates, you’ll learn everything you need to know about the potential policy changes that could help nations adapt to aging populations.

This short video is an introduction to the topic.

Let’s look at just a few of the highlights of the book.

In the opening chapter, Robert Murphy offers a primer on the importance of entrepreneurship.

…there is a crucial connection between entrepreneurship and economic prosperity. …There is a growing recognition that a society’s economic prosperity depends…specifically on entrepreneurship. …Two of the top names associated with the theory of entrepreneurship are Joseph Schumpeter and Israel Kirzner… Schumpeter famously invoked the term “creative destruction” to describe the volatile development occurring in a capitalist system… Kirzner has written extensively on entrepreneurship…and how…the alert entrepreneurial class who perceive these misallocations before their more complacent peers, and in the process earn pure profits… Schumpeter’s entrepreneur is a disruptor who creates new products first in his mind and then makes them a reality, whereas Kirzner’s entrepreneur is a coordinator who simply observes the profit opportunities waiting to be grasped. …If the goal is maximum economic efficiency in the long run, to provide the highest possible standard of living to citizens within the unavoidable constraints imposed by nature, then we need bold, innovative entrepreneurs who disrupt existing modes of production by introducing entirely new goods and services, but we also need vigilant, alert entrepreneurs who spot arbitrage opportunities in the existing price structure and quickly move to whittle them away.

Murphy describes in the chapter how there was a period of time when the economics profession didn’t properly appreciate the vital role of entrepreneurs.

But that fortunately has changed and academics are now paying closer attention. He cites some of the recent research.

An extensive literature documents the connection between entrepreneurship and economic growth. The studies vary in terms of the specific measure of entrepreneurship (e.g., small firms, self-employment rate, young firms, etc.) and the size of the economic unit being studied. …Carree et al. (2002) look at 23 OECD countries from 1976 to 1996. …They “find confirmation for the hypothesized economic growth penalty on deviations from the equilibrium rate of business ownership… An important policy implication of our exercises is that low barriers to entry and exit of businesses are necessary conditions for the equilibrium seeking mechanisms that are vital for a sound economic development” …Holtz-Eakin and Kao (2003) look at the birth and death rates of firms across US states, and find that this proxy for entrepreneurship contributes to growth. Similarly, Callejón and Segarra (1999) look at manufacturing firm birth and death rates in Spain from 1980 to 1992, and conclude that this measure of “turbulence” contributes to total factor productivity growth. …Wennekers and Thurik (1999) use business ownership rates as a proxy for “entrepreneurship.” Looking at a sample of 23 OECD countries from 1984 to 1994, they, too, find that entrepreneurship was associated with higher rates of employment growth at the national level.

In a chapter on taxation, Seth Giertz highlights the negative impact of taxes on entrepreneurship, particularly what happens with tax regimes have a bias against saving and investment.

High tax rates discourage both consumption and savings. But, for a given average tax rate, taxes on an income base penalize savings more heavily than taxes on consumption. …a consumption tax base is neutral between the decision to save versus consume. By contrast, an income tax base results in the double taxation of savings. …three major features of tax policy that are important for entrepreneurship. First, capital accumulation and access to capital is essential for innovation to have a big impact. Despite this, tax systems generally tax savings more heavily than consumption….Second, the tax treatment of risk affects incentives for entrepreneurship, since entrepreneurship tends to entail high risk. …progressivity can sometimes discourage entrepreneurship. This is because tax systems do not afford full offsets for losses, making progressivity effectively a tax increase. …Third, tax policy can lead entrepreneurial activity to shift from productive toward unproductive or destructive aims. Productive entrepreneurship tends to flourish when the route to great wealth is achieved primarily through private markets… High taxes reduce the rewards from productive entrepreneurship. All too often, smart, talented, and innovative people are drawn out of socially productive endeavours and into unproductive ones because the private returns from devising an innovative tax scheme—or lobbying government for special tax preferences—are greater than those for building the proverbial better mousetrap.

In a chapter I co-authored with Brian Garst, Charles Lammam, and Taylor Jackson, we look specifically at the negative impact of capital gains taxation on entrepreneurship.

We spend a bit of time reminding readers of what drives growth.

One of the more uncontroversial propositions in economics is that output is a function of labor (the workforce) and capital (machines, technology, land, etc.). Indeed, it is almost a tautology to say that growth exists when people provide more labor or more capital to the economy, or when—thanks to vital role of entrepreneurs—labor and capital are allocated more productively. In other words, labor and capital are the two “factors of production,” and the key for policymakers is to figure out the policy recipe that will increase the quantity and quality of those two resources. …In the absence of taxation, people provide labor to the economy so long as they value the income they earn more than they value the foregone leisure. And they provide capital to the economy (i.e., they save and invest) so long as they value future consumption (presumably augmented by earnings on capital) more than they value current consumption.

And we highlight how entrepreneurs generate the best type of growth.

this discussion also helps illustrate why entrepreneurship is so important. The preceding analysis basically focused on achieving growth by increasing the quantity of capital and labor. Such growth is real, but it has significant “opportunity costs” in that people must forego leisure and/or current consumption in order to have more disposable income. Entrepreneurs, by contrast, figure out how to increase the quality of capital and labor. More specifically, entrepreneurs earn profits by satisfying consumer desires with new and previously unknown or underused combinations of labor and capital. In their pursuit of profit, they come up with ways of generating more or better output from the same amount of labor and capital. This explains why we have much higher living standards today even though we work far fewer hours than our ancestors.

And here’s what we say about the counterproductive impact of capital gains taxation, particularly when combined with other forms of double taxation.

…the effective marginal tax rate on saving and investment is considerably higher than the effective marginal tax rate on consumption. This double taxation is understandably controversial since all economic theories—even Marxism and socialism—agree that capital is critical for long-run growth and higher living standards. …capital gains taxes harm economies in ways unique to the levy. …entrepreneurs play a vital role in the economy since they figure out more efficient ways to allocate labor and capital. …The potential for a capital gain is a big reason for the risk they incur and the effort they expend. Thus, the existence of capital gains taxes discourages some entrepreneurial activity from ever happening. …the capital gains tax is more easily avoidable than other forms of taxation. Entrepreneurs who generate wealth with good ideas can avoid the levy by simply choosing not to sell. This “lock-in effect” is not good for the overall economy… Most governments do not allow taxpayers to adjust the value of property for inflation when calculating capital gains. Even in a low-inflation environment, this can produce perverse results. …taxpayers can sometimes pay tax even when assets have lost value in real terms. …Capital gains taxes contribute to the problem of “debt bias,” which occurs when there is a tax advantage for corporate investments to be financed by debt instead of equity. …Excessive debt increases the probability of bankruptcy for the firm and contributes to systemic risk.

We then cite a lot of academic studies. I strongly encourage folks to peruse that section, but to keep this column manageable, let’s close by looking at two charts that reveal how some nation – including the United States – have uncompetitive tax systems.

Here are long-run capital gains tax rates in developed nations.

By the way, even though the data comes from a 2018 OECD report, it shows tax rates as of July 1, 2016. So not all the numbers will be current. For instance, I assume Macron’s reforms have mitigated France’s horrible score.

Speaking of horrible scores, here are the numbers showing the combined burden of the corporate income tax and capital gains tax. Sadly, the United States was at the top of this list as of July 1, 2016.

The good news is that the recent tax reform means that the United States no longer has the world’s most punitive tax system for new investment.

Though keep in mind that the United States doesn’t allow investors to index capital gains for inflation, so the effective tax rate on capital gains will always be higher than the statutory tax rate.

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I was a big fan of the lower corporate tax rate in last year’s tax bill, largely because I want a better investment climate, which then will lead to higher productivity and rising wages.

Simply stated, the current tax code (as shown in the chart) has a very harsh bias against income that is saved and invested.

Anything that can be done to reduce the magnitude of this “double taxation” will lead to better economic performance.

Now that the lower corporate tax rate has been implemented, there’s a debate about whether it is having desirable affects.

In this CNBC debate, I explain that stock “buybacks” and employee bonuses are positive short-run results, but that I’m much more interested in the potential long-run benefits.

As with all brief interviews, it’s difficult to share a lot of information. My main goal was to point out that there’s nothing wrong with buybacks for shareholders or bonuses for workers, but that it’s much more important to focus on potential changes in long-run growth.

And we’ll get more long-run growth, I argue, because the lower corporate rate reduces the tax burden on capital (i.e., saving and investment). Jared dismisses this as “trickle-down economics,” but that’s simply his pejorative term for common-sense microeconomics.

But you don’t have to believe me. Many scholars have pointed out that harsh taxes on capital wind up hurting workers. Let’s look at some of the findings from an academic study by Gregory Mankiw, Matthew Weinzierl,  and Danny Yagan.

Perhaps the most prominent result from dynamic models of optimal taxation is that the taxation of capital income ought to be avoided. …The intuition for a zero capital tax can be developed in a number of ways. …First, because capital equipment is an intermediate input to the production of future output, the Diamond and Mirrlees (1971) result suggests that it should not be taxed. Second, because a capital tax is effectively a tax on future consumption but not on current consumption, it violates the Atkinson and Stiglitz (1976) prescription for uniform taxation. In fact, a capital tax imposes an ever-increasing tax on consumption further in the future, so its violation of the principle of uniform commodity taxation is extreme. A third intuition for a zero capital tax comes from elaborations of the tax problem considered by Frank Ramsey (1928). In important papers, Chamley (1986) and Judd (1985) examine optimal capital taxation in this model. They find that…a zero tax on capital is optimal. …any tax on capital income will leave the after-tax return to capital unchanged but raise the pre-tax return to capital, reducing the size of the capital stock and aggregate output in the economy. This distortion is so large as to make any capital income taxation suboptimal compared with labor income taxation, even from the perspective of an individual with no savings.

And here’s some analysis by Garret Jones at George Mason University.

Chamley and Judd separately came to the same discovery: In the long run, capital taxes are far more distorting that most economists had thought, so distorting that the optimal tax rate on capital is zero.  If you’ve got a fixed tax bill it’s better to have the workers pay it. …let me sum up a key implication of Chamley-Judd: Under standard, pretty flexible assumptions, it’s impossible to tax capitalists, give the money to workers, and raise the total long-run income of workers. Not, hard, not inefficient, not socially wasteful, not immoral: Impossible. If you tax capital income and hand all of the tax revenue to workers, then in the long run (or the “steady state”) you’ll wind up with a smaller capital stock. And since workers use the capital stock to earn their wages, the capital tax pushes down their wages.

Even economists on the left agree about the link between productivity and wages. Here’s a recent article from the Wall Street Journal, citing Larry Summers about why wages are still linked to productivity and why growth should still be the goal.

Wages are supposed to track worker productivity… Many on the left argue the link is now broken and redistributing income from the wealthy downward would help workers more than faster economic growth. But a new study co-authored by Harvard University economist Lawrence Summers says that’s wrong. …The problem, they conclude, is that the positive influence of productivity on pay has been overwhelmed by other forces pushing the other way. …Over one- to five-year periods between 1973 and 2015, they found that a one-percentage-point increase in productivity growth generally led to a 0.5- to one-percentage-point increase in average or median pay growth, depending on the type of workers measured. …In an interview, Mr. Summers says the idea that “policy should shift from growth to inequality is badly misleading.”

Let’s close with some excerpts from an article in the Cayman Financial Review by Orphe Divounguy.

Historically, productivity growth has led to gains in compensation for workers and greater profits for firms. This has big implications for tax policy – especially the degree to which capital is taxed since capital – an essential ingredient to improvements in workers’ living standards – is highly responsive to changes in the tax climate. …The standard theory of optimal taxation argues that a tax system should maximize social welfare subject to a set of constraints. The goal should be to enact a tax system that maximizes households’ welfare… Pioneering work on optimal taxation is the work of Frank Ramsey (1927), who suggested…only commodities with inelastic demand are taxed. Another important contribution on this topic is the work of James Mirlees (1971), who posits that when a tax system aims to redistribute income from high ability to low ability individuals, the tax system should provide sufficient incentive for high-ability/high-income taxpayers to keep producing… the empirical evidence on the effects of taxation largely supports a move away from capital taxation. …higher taxes on capital income discourage investments in productive capital. This reduction in productive capital causes workers to become less productive, thus causing the real wage to decrease.

Amen. The bottom line is that you can’t punish capital without punishing labor.

Which is the point of this great cartoon, which I gather was campaign literature at some point for the British Liberal Party (with “liberal” meaning “classical liberal“). It correctly captures the key point about labor and capital being complementary factors of production.

This chart makes the same point.

P.S. I’ve debunked the argument that capital is taxed at a lower rate than labor.

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Politicians routinely assert that they want more economic growth. That’s a laudable sentiment, although I doubt their sincerity for the simple reason that these are the same people who frequently impose policies that discourage productive economic activity.

Growth occurs when there’s an increase in the quantity and/or quality of labor and capital. These so-called factors of production determine how efficiently we produce and how much we produce.

Which is why there should be low taxes on labor and capital.

And it’s also a good idea for these factors of production to be taxed at the same rate so government policy isn’t tilting the playing field.

Unfortunately, we don’t have low taxes and we also don’t have neutral taxes.

Indeed, Timothy Egan argues in the New York Times that these two factors of production are not taxed equally. I agree.

Except Egan completely bungles the analysis and preposterously claims that labor is taxed at a higher rate.

Dear Government: Enclosed please find my 2017 tax form, and a check for the amount I owe, just ahead of the deadline. …you’re still punishing me for working — taxing wages and business income at a much higher rate than the money I make doing nothing, like holding stocks. Plus, you’re still taxing Warren Buffett at a lower rate than his secretary, despite his plea for fairness.

Wow, he manages to cram a lot of inaccuracy into a couple of sentences.

In reality, the current tax code is very biased against saving and investment.

Here’s some of what I wrote when I debunked Warren Buffett’s deeply flawed claim about relative tax burdens back in 2011.

…dividends and capital gains are both forms of double taxation. …if he wants honest effective tax rate numbers, he needs to show the…corporate tax rate. …Moreover, …Buffett completely ignores the impact of the death tax

For years, I’ve been recycling a chart showing how the American tax code mistreats saving and investment. But that chart became outdated by the fiscal cliff deal, then became even more inaccurate because of Obamacare tax hikes, and most recently became even more inaccurate thanks to the Trump tax plan.

So here’s an up-to-date version.

And for purposes of today’s issue, the top side and left side of the flowchart combine to show how labor income is taxed and the top side and right side of the flowchart combine to show how capital is taxed.

The problem with Egan’s analysis is that he compares taxes on labor income (as high as 37 percent) with the 23.8 percent rate on dividends and/or capital gains. Yet that’s either incredibly sloppy or grievously dishonest because that income also gets hit by the corporate income tax.

And it’s worth pointing out that stocks and other financial assets are purchased with after-tax dollars (captured by the top portion of the chart).

P.S. Adding payroll taxes to the flowchart doesn’t change anything. There would be an additional levy at the top of the chart, leading to a lower level of after-tax earning. So the net result is simply that people have less money to either spend or invest.

P.P.S. Warren Buffett periodically – and inaccurately – asserts that his tax rate in higher than his secretary’s tax rate. Yet his theoretical support for higher tax burdens crashes into the reality of his professional tax-minimization behavior.

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Ideally, there should be no capital gains tax.

After all, the levy is a self-destructive form of double taxation that reduces the quantity and quality of investment. And that’s not good for wages and jobs.

To add insult to injury (to be more accurate, to add injury to injury), the tax isn’t indexed for inflation. So investors get taxed on the full increase in the value of an asset even though a significant chunk of the increase often is due solely to inflation.

Steven Entin of the Tax Foundation has some new research on this issue.

Many elements of the income tax are adjusted for inflation, such as tax brackets, standard deductions, and income thresholds or dollar amounts of some tax credits. However, the purchase price of assets later sold for capital gains or losses is not adjusted for inflation. As a result, inflation can do a real number on savers by turning real losses into taxable nominal gains. To avoid such outcomes, it would make sense for the government to allow an inflation adjustment for the cost of assets.

Steve points out that the absence of indexing is very brutal during periods of high inflation – which may soon become a relevant issue again.

During the late 1960s and 1970s, when inflation was high and the stock market was flat, it was not uncommon for people who sold assets to report inflated nominal capital gains that were negative in terms of purchasing power. In effect, the savers were taxed on a real loss. …Suppose one had bought $100 of stock in the XYZ Corporation in 1965, and sold it in 1981, for $110. This looks like a $10 gain. But…The stock would have had to rise to $286 just to keep pace with inflation. …the investor lost $176, in 1981 dollars ($286 – $110). Any tax collected on the nominal $10 gain was, in fact, a tax on a real loss.

But even if inflation remains low, this is still an important issue.

Taxing genuine capital gains is bad enough, so it’s not a surprise to learn that taxing inflationary gains is even worse. It exacerbates the anti-capital bias in the current tax code.

Taxation of fictitious gains or other capital income reduces saving and raises the cost of capital, thereby retarding investment, productivity growth, and wage growth. …In an ideal tax system, saving would not be treated worse than consumption. …When we earn income and pay tax, and use the after-tax income for consumption, the federal government generally leaves the consumption alone, except for a few excise taxes… The earnings are taxed, but not the enjoyment of the subsequent purchases. Saving is a purchase too. It lets us “buy” a stream of future income with after-tax money. But if we buy a bond, the stream of interest is taxed. If we buy a share of stock, the dividends are taxed, and any reinvested earnings that increase the value of the company are taxed as capital gains.

Here’s Steve’s conclusion.

Inflation raises the price of many assets acquired by savers. When they sell the assets, much of their capital gains may be due only to inflation. Inflation-related gains are not a real increase in wealth. Indexing the purchase price (tax basis) for inflation would provide savers some relief for this type of tax on fictitious income.

Well said, though I have one minor quibble. A capital gain, whether real or caused by inflation, is not income. It’s a change in nominal net worth.

Though I’m sure Steve would agree with me. He’s presumably using “income” because the tax code treats that change in net worth as income.

There is a chance we’ll see some progress on this issue. Ryan Ellis, writing for Forbes, is optimistic that the newly appointed head of Trump’s National Economic Council will try to fix this problem.

There’s one project that Kudlow needs to get to work on right away: indexing the basis of capital gains to inflation. …Just last August, Kudlow wrote an op-ed…urging President Trump to do this by executive order. …This finally may be the time that this issue is ready to cross the finish line.

Executive order?

Yes, because the law specifies the rates for capital gains taxation, but it’s up to the Treasury Department to specify what counts as a gain. And there’s a very strong argument that it’s not a genuine gain if an asset rises in value solely because of inflation.

Ryan explains the mechanics of how indexing would work..

How would indexing capital gains basis to inflation work? In the tax world, reporting a capital gain is a pretty simple exercise. When you sell an asset, like a stock, you report how much you sold it for. You can subtract what you bought it for (your “basis”) from what you sold it for to arrive at your gain. …If you’ve held the asset longer than a year, you generally pay tax at…20 percent, plus the 3.8 percent Obamacare investment surtax… A problem arises in that your basis purchase may have happened many years ago. The real value of the money you used to buy a stock has been eroded by inflation. For example, $100 in 1990 is only worth $51.41 today, a little more than half the supposed basis in real terms. …Someone whose $100 initial investment has grown to $500 would see a big difference in taxes.

Here’s the table showing that difference.

And here’s what it means.

Uncle Sam still gets to tax the gain–he just doesn’t get to take the phantom gains attributable to inflation. In fact, $22.50 of the current law tax–nearly one quarter of the tax bill–is entirely due to inflation, not any real increase in wealth. …This law change would help owners of real estate, including corporate owners of real estate. It would help small businesses who pay the capital gains tax when acquired by larger firms. It would help everyone in America with a prized collection of old baseball cards or stamps sitting in an album in their den. This is truly a tax cut for everyone.

For more information, here’s a video on the topic from the Center for Freedom and Prosperity.

As was pointed out in the video, Ronald Reagan indexed much of the tax code as part of his 1981 tax cut. Now it’s time to take the next step.

But let’s not forget that indexing should only be an interim step (assuming, of course, that the White House and Treasury are willing to do the right thing and protect investors from inflation).

The real goal should be total repeal of the capital gains tax.

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I strongly applauded the tax reform plan that was enacted in December, especially the lower corporate tax rate and the limit on the deduction for state and local taxes.

But I’m not satisfied. Our long-run goal should be fundamental tax reform. And that means replacing the current system with a simple and fair flat tax.

And the recent tax plan only took a small step in that direction. How small? Well, the Tax Foundation just calculated that it only improved the United States from #30 to #25 in their International Tax Competitiveness Ranking. In other words, we have a long way to go before we catch up to Estonia.

 

It’s possible, of course, to apply different weights and come up with a different list. I think the Tax Foundation’s numbers could be improved, for instance, by including a measure of the aggregate tax burden. And that presumably would boost the U.S. score.

But the fact would remain that the U.S. score would be depressingly low. In other words, the internal revenue code is still a self-imposed wound and huge improvements are still necessary.

That’s why we need another round of tax reform, based on the three core principles of good tax policy.

  1. Lower tax rates
  2. Less double taxation
  3. Fewer loopholes

But how is tax reform possible in a fiscal environment of big government and rising deficits?

This is a challenge. In an ideal world, there would be accompanying budget reforms to save money, thus creating leeway for tax reform to be a net tax cut.

But even in the current fiscal environment, tax reform is possible if policy makers finance pro-growth reforms by closing undesirable loopholes.

Indeed, that’s basically what happened in the recent tax plan. The lower corporate rate was financed by restricting the state and local tax deduction and a few other changes. The budget rules did allow for a modest short-run tax cut, but the overall package was revenue neutral in the long run (i.e., starting in 2027).

It’s now time to repeat this exercise.

The Congressional Budget Office periodically issues a report on Budget Options, which lists all sort of spending reforms and tax increases, along with numbers showing what those changes would mean to the budget over the next 10 years.

I’ve never been a huge fan of this report because it is too limited on the spending side. You won’t find fleshed-out options to shut down departments, for instance, which is unfortunate given the target-rich environment (including TransportationHousing and Urban DevelopmentEducationEnergy, and Agriculture).

And on the tax side, it has a lengthy list of tax hikes, generally presented as ways to finance an ever-expanding burden of government spending. The list must be akin to porn for statists like Bernie Sanders.

It includes new taxes.

And it includes increases in existing taxes.

But the CBO report also includes some tax preferences that could be used to finance good tax reforms.

Here are four provisions of the tax code that should be the “pay-fors” in a new tax reform plan.

We’ll start with two that are described in the CBO document.

Further reductions in itemized deductions – The limit on the state and local tax deduction should be the first step. The entire deduction could be repealed as part of a second wave of tax reform. And the same is true for the home mortgage interest deduction and the charitable contributions deduction.

Green-energy pork – The House version of tax reform gutted many of the corrupt tax preferences for green energy. Unfortunately, those changes were not included in the final bill. But the silver lining to that bad decision is that those provisions can be used to finance good reforms in a new bill.

Surprisingly, the CBO report overlooks or only gives cursory treatment to a couple of major tax preferences that each could finance $1 trillion or more of pro-growth changes over the next 10 years.

Municipal bond interest – Under current law, there is no federal tax on the interest paid to owners of bonds issued by state and local governments. This “muni-bond” loophole is very bad tax policy since it creates an incentive that diverts capital from private business investment to subsidizing the profligacy of cities like Chicago and states like California.

Healthcare exclusion – Current law also allows a giant tax break for fringe benefits. When companies purchase health insurance plans for employees, that compensation escapes both payroll taxes and income taxes. Repealing – or at least capping – this exclusion could raise a lot of money for pro-growth reforms (and it would be good healthcare policy as well).

What’s potentially interesting about the four loopholes listed above is that they all disproportionately benefit rich people. This means that if they are curtailed or repealed and the money as part of tax reform, the left won’t be able to argue that upper-income taxpayers are getting unfair benefits.

Actually, they’ll probably still make their usual class-warfare arguments, but they will be laughably wrong.

The bottom line is that we should have smaller government and less taxation. But even if that’s not immediately possible, we can at least figure out revenue-neutral reforms that will produce a tax system that does less damage to growth, jobs, and competitiveness.

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Since Republicans screwed up Obamacare repeal and haven’t even tried to impose spending restraint, I was rather pessimistic about tax reform earlier this year.

Given my dour attitude, I thought the best-possible outcome was nothing more than a reduction in the corporate tax rate.

But now I’m actually somewhat hopeful that we’ll get a lower corporate rate and repeal of the pernicious deduction for state and local income taxes.

And I’m even wondering whether I should allow myself to hope that the death tax can be repealed. The final outcome will depend on negotiations on Capitol Hill. The House bill gets rid of the tax (albeit only for people who can stay alive a few more years). The Senate bill isn’t as good since it only increases the exemption.

Is it possible the final deal will kill this destructive form of double taxation?

Folks on the left are afraid it may happen. The New York Times is predictably editorializing in favor of keeping the tax.

“Only morons pay the estate tax,” Gary Cohn, Mr. Trump’s chief economic adviser, told Senate Democrats, meaning, it was later explained, “rich people with really bad tax planning.” Many of the very wealthy use loopholes, like trusts, to avoid paying inheritance tax. …An estate tax repeal would provide a tax windfall of more than $3 million apiece for the top 0.2 percent of earners, and more than $20 million for the wealthiest Americans. It would cost $239 billion in revenue over a decade. It offers nothing for middle-class people, except more evidence of Mr. Trump’s and Republicans’ bad faith.

Frankly, I don’t care whether rich people benefit. I want the tax repealed because it penalizes saving and investment.

The actual victims of the tax (the “morons” who failed to hire clever lawyers and accountants) are forced to liquidate assets and turn the money over to government.

And potential victims of the tax engage in inefficient forms of tax planning to protect assets from the government.

Call me crazy, but I want capital to be allocated efficiently since that’s one of the keys for economic growth and rising wages.

The U.K.-based Economist has just published a defense of the death tax that begins by acknowledging that it’s not a popular levy.

Inheritance tax is routinely seen as the least fair by Britons and Americans. This hostility spans income brackets. …The estate of a dead adult American is 95% less likely to face tax now than in the 1960s. …For a time before the second world war, Britons were more likely to pay death duties than income tax; today less than 5% of estates catch the taxman’s eye. It is not just Anglo-Saxons. Revenue from these taxes in OECD countries, as a share of total government revenue, has fallen sharply since the 1960s. Many other countries have gone down the same path. In 2004 even the egalitarian Swedes decided that their inheritance tax should be abolished.

Notwithstanding the magazine’s name, the article shows very little understanding of economics.

…this trend towards trifling or zero estate taxes ought to give pause. Such levies pit two vital…principles against each other. One is that governments should leave people to dispose of their wealth as they see fit. The other is that a permanent, hereditary elite makes a society unhealthy and unfair. How to choose between them? …The positive argument for steep inheritance taxes is that they promote fairness and equality. …Unlike capital-gains taxes, heavier estate taxes do not seem to dissuade saving or investment.

I’m glad that the article pays lip service to the notion that people should be able to decide how to spend their own money, but then the article veers into pure class warfare.

What’s really remarkable, though, is that we’re supposed to believe that death taxes don’t have a negative impact on capital formation (i.e., saving and investment). Utter nonsense. Let’s think this through. Imagine a successful entrepreneur who earns income and gets hit with, say, a 40 percent personal income tax. That entrepreneur than invests some of the after-tax income, which then presumably triggers additional layers of tax (business taxes, capital gains taxes, dividend taxes), which easily can confiscate 30 percent of affected funds. And then there can be a death tax that may grab another 40 percent.

At the risk of plagiarizing the New York Times, only a “moron” is going to ignore the cumulative impact of all those taxes. There’s either going to be less quantity of saving and investment or less quality of saving and investment (because of inefficient tax planning).

Fortunately, governments in the real world increasingly understand that death taxes are very damaging. In another article, the Economist shares some specific details on how death taxes have become less popular around the world.

In OECD countries the proportion of total government revenues raised by such taxes has fallen by three-fifths since the 1960s, from over 1% to less than 0.5%. Over the same period Australia, Canada, Russia, India and Norway are among countries that have abolished death duties. More than 20 American states binned wealth-transfer taxes between 1976 and 2000… In 1976 roughly 8% of American estates filed a taxable return; that has since fallen to around 0.2%.

I actually think tax competition deserves a lot of the credit for the good reforms that have happened, but that’s an issue for another day.

Here’s a chart from the article, which is supposed to show how death taxes have become a smaller and smaller share of tax revenue. This seems like good news, but keep in mind that what it really shows is that personal income taxes, payroll taxes, and (in the U.K.) the value-added tax have grown enormously since the pre-World War II era. If the Economist wanted to be honest, it would have shown inflation-adjusted death tax revenue.

I can’t resist commenting on one other thing. The Economist wants people to think that the death tax is okay because compliance costs supposedly are modest.

A study published in 1999 suggests that the overall cost of estate-tax compliance is 7% of estate-tax revenues. Yet a chunk of those costs, such as selecting executors and drafting documents, would still be paid even in the absence of the tax. So it is hardly clear that the rich would be left with much extra time for more productive undertakings.

I’m skeptical of their compliance calculations, but let’s set that aside.

What the article overlooks (and what is far more important from an economic perspective) is that the death tax causes capital to be misallocated. Successful families make decisions about saving and investment based on potential tax implications rather than what is most productive. And really successful families create trusts and foundation to protect their wealth. Good for them (and good for their financial advisers), but not so good for everyone else since money won’t be used as efficiently.

And if you don’t think the death tax distorts incentives, consider that evidence from Australia indicates it even impacts when people die.

I’m not going to hold my breath, but it would be great news if congressional Republicans can kill the death tax.

P.S. Here’s a semi-amusing left-wing humor on Trump and the death tax.

Not as good as the video on Somalia as a libertarian paradise, but still worth sharing.

P.P.S. You won’t be surprised to know that both Barack Obama and Hillary Clinton actually wanted to make the death tax more punitive. Which is really remarkable since the current U.S. approach is even more punitive than Greece and Venezuela.

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For months, I’ve been arguing that the big reduction in the corporate tax rate is the most important part of Trump’s tax agenda.

But not because of politics or anything like that. Instead, my goal is to enable additional growth by shifting to a system that doesn’t do as much damage to investment and job creation. A lower rate is consistent with good theory, and there’s also recent research from Australia and Germany to support my position.

Especially since the United States is falling behind the rest of the world. America now has the highest corporate tax rate in the developed world and arguably may have the highest rate in the entire world.

Needless to say, this is a self-inflicted wound on U.S. competitiveness.

But since the numbers I’ve been sharing are now a few year’s old, let’s now update some of this data.

Check out these four charts from a new OECD annual report on tax policy changes (the some one that I cited a few days ago when explaining that European-sized government means a suffocating tax burden on the poor and middle class).

Here’s the grim data on the corporate income tax rate (the vertical blue bars). As you can see, the United wins the booby prize for having the highest rate.

But here’s some “good news.” When you add in the second layer of tax on corporate income, the United States is “only” in third place, about where we were back in 2011.

France imposes the highest combined rate on corporate and dividend income (no surprise since the nation’s national sport is taxation), while Ireland is in second place (the corporate rate is very low, but personal rates are high and dividends receive no protection from double taxation).

For what it’s worth, I think it’s incredibly bad policy when governments are skimming 30 percent, 40 percent, 50 percent, and even 60 percent of the income being generated by business investment.

Particularly since high rates don’t translate into high revenue. Check out this third chart. You’ll notice that revenues are relatively low in the United States even though (or perhaps because) the tax rate is very high.

But our final chart provides the strongest evidence. Just like the IMF, the OECD is admitting that tax revenues have remained constant over time, even though (or because) corporate tax rates have plunged.

In other words, the Laffer Curve is alive and well.

Incidentally, the global shift to lower tax rates hasn’t stopped. I wrote back in May about plans for lower corporate tax burdens in Hungary and the United Kingdom and I noted last November that Croatia was lowering its corporate rate.

And, thanks to liberalizing effect of tax competition, more and more nations are hopping on the tax cut bandwagon.

Consider what’s happening in Sweden.

Sweden’s center-left minority government is proposing a corporate tax cut to 20 percent from 22 percent, Finance Minister Magdalena Andersson and Financial Markets Minister Per Bolund said on Monday… “With the proposals we want to strengthen competitiveness and create a more dynamic business climate,” they said… The proposed corporate tax cut would be…implemented on July 1, 2018.

Or what’s taking place in Belgium.

…government ministers finally reached agreement on a number of reforms to the Belgian tax and employment systems. …Belgium is to slash corporation tax from 34% to 29% next year. By 2020 corporation tax will have been cut to 25%. …Capital gains tax on the first 627 euros of dividends from shares disappears, a measure intended to encourage share ownership.

Or what’s looming in Germany.

Germany will likely need to make changes to its corporation tax system in coming years in response to growing tax competition from other countries, Finance Minister Wolfgang Schaeuble said on Wednesday… “I expect there will be a need to take action on corporation tax in coming years because in some countries, from the U.S. to Britain, but also on other continents, there are many considerations where we can’t simply say we’ll ignore them,” Schaeuble told a real estate conference.

This bring a smile to my face. Greedy politicians are being pressured to cut tax rates, even though they would prefer to do the opposite. Let’s hope the United States joins this “race to the bottom” before it’s too late.

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While I realize there’s zero hope of ripping up America’s awful tax code and getting a simple and fair flat tax, I’m nonetheless hopeful that there will be some meaningful incremental changes as part of the current effort to achieve some sort of tax reform.

A package that lowers the corporate rate, replaces depreciation with expensing, and ends the death tax would be very good for growth, and those good reforms could be at least partially financed by eliminating the state and local tax deduction and curtailing business interest deductions so that debt and equity are on a level playing field.

All that sounds good, and a package like this should be feasible since Republicans control both Congress and the White House (especially now that the BAT is off the table), but I warn in this interview that there are lots of big obstacles that could cause tax reform to become a disaster akin to the Obamacare repeal effort.

Here’s my list of conflicts that need to be solved in order to get some sort of plan through Congress and on to the President’s desk.

  • Carried interest – Trump wants to impose a higher capital gains tax on a specific type of investment, but this irks many congressional GOPers who have long understood that any capital gains tax is a form of double taxation and should be abolished. The issue apparently has some symbolic importance to the President and it could become a major stumbling block if he digs in his heels.
  • Tax cut or revenue neutrality – Budget rules basically require that tax cuts expire after 10 years. To avoid this outcome (which would undermine the pro-growth impact of any reforms), many lawmakers want a revenue-neutral package that could be permanent. But that means coming up with tax increases to offset tax cuts. That’s okay if undesirable tax preferences are being eliminated to produce more revenue, but defenders of those loopholes will then lobby against the plan.
  • Big business vs small business – Everyone agrees that America’s high corporate tax rate is bad news for competitiveness and should be reduced. The vast majority of small businesses, however, pay taxes through “Schedule C” of the individual income tax, so they want lower personal rates to match lower corporate rates. That’s a good idea, of course, but would have major revenue implications and complicate the effort to achieve revenue neutrality.
  • Budget balance – Republicans have long claimed that a major goal is balancing the budget within 10 years. That’s certainly achievable with a modest amount of spending restraint. And it’s even relatively simple to have a big tax cut and still achieve balance in 10 years with a bit of extra spending discipline. That’s the good news. The bad news is that there’s very little appetite for spending restraint in the White House or Capitol Hill, and this may hinder passage of a tax plan.
  • Middle class tax relief – The main focus of the tax plan is boosting growth and competitiveness by reducing the burden on businesses and investment. That’s laudable, but critics will say “the rich” will get most of the tax relief. And even though the rich already pay most of the taxes and even though the rest of us will benefit from faster growth, Republicans are sensitive to that line of attack. So they will want to include some sort of provision designed for the middle class, but that will have major revenue implications and complicate the effort to achieve revenue neutrality.

There’s another complicating factor. At the risk of understatement, President Trump generates controversy. And this means he doesn’t have much power to use the bully pulpit.

Though I point out in this interview that this doesn’t necessarily cripple tax reform since the President’s most important role is to simply sign the legislation.

Before the 2016 election, I was somewhat optimistic about tax reform.

A few months ago, I was very pessimistic.

I now think something will happen, if for no other reason than Republicans desperately want to achieve something after botching Obamacare repeal.

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