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Archive for the ‘Flat Tax’ Category

To put it mildly, Italy’s economy is moribund. There’s been almost no growth for the entire 21st century.

Bad government policy deserves much of the blame.

According to Economic Freedom of the World, Italy is ranked only 54th, the worst score in Western Europe other than Greece. The score for fiscal policy is abysmal and regulatory policy and rule of law are also problem areas.

Moreover, thanks to decades of excessive government spending, the nation also has very high levels of public debt. Over the last few years, it has received official and unofficial bailouts from the International Monetary Fund and the European Central Bank, and Italy is considered at high risk for a budgetary meltdown when another recession occurs.

And let’s not forget that the country faces a demographic death spiral.

You don’t have to believe me (though you should).

Others have reached similar conclusions. Here are excerpts from some VoxEU research.

Italy will increasingly need to rely on growth fundamentals to sustain its public debt. Unfortunately, the fundamentals do not look good. Not only was Italy severely battered by Europe’s double dip recession (its GDP is lower today than it was in 2005) but when we look at the growth of labour productivity…, we can see that Italy has been stagnating since the mid-90s. …At the end of 2016, Italy’s central government debt was the third-largest in the world…, at $2.3 trillion. …a debt crisis in Italy could trigger a global financial catastrophe, and could very possibly lead to the disintegration of the Eurozone. To avoid such a scenario, Italy must revive growth…a tentative policy prescription is for Italy, to remove those institutional barriers (such as corruption, judicial inefficiency and government interference in the financial sector) that stifle merit and contribute to cronyism.

Desmond Lachman of the American Enterprise Institute paints a grim picture.

Italy’s economic performance since the Euro’s 1999 launch has been appalling. …an over-indebted Italian economy needs a coherent and reform-minded government to get the country quickly onto a higher economic growth path. …since 2000, German per capita income has increased by around 20 percent, that in Italy has actually declined by 5 percent. Talk about two lost economic decades for the country. …if Italy is to get itself onto a higher economic growth path, it has to find ways improve the country’s labor market productivity… It has to do so through major economic reforms, especially to its very rigid labor market…being the Eurozone’s third largest economy, Italy is simply too big to fail for the Euro to survive in its present form. However, it is also said that being roughly ten times the size of the Greek economy, a troubled Italian economy would be too big for Germany to save.

Even the IMF thinks pro-market reforms are needed.

Average Italians still earn less than two decades ago. Their take-home pay took a dip during the crisis and has still not yet caught up with the growth in key euro area countries. …a key question for policymakers is how to enhance incomes and productivity… In the decade before the global financial crisis, Italy’s spending grew faster than its income, in important part because of increases in pensions. …The tax burden is heavy…a package of high-quality measures on the spending and revenue side the country could balance the need to support growth on the one hand with the imperative of reducing debt on the other. Such a package includes…lower pension spending that is the second highest in the euro area; and lower tax rates on labor, and bringing more enterprises and persons into the tax net. …together with reforms of wage bargaining and others outlined above, can raise Italian incomes by over 10 percent, create jobs, improve competitiveness, and substantially lower public debt.

There’s a chance, however, that all this bad news may pave the way for good news. There are elections in early March and Silvio Berlusconi, considered a potential frontrunner to be the next Prime Minister, has proposed a flat tax.

Bloomberg has some of the details.

A flat tax for all and 2 million new jobs are among the top priorities in the draft program of former premier Silvio Berlusconi’s Forza Italia party… The program aims to relaunch the euro region’s third-biggest economy…and recoup the ground lost in the double-dip, record-long recession of the 2008-2013 period. …Forza Italia’s plan doesn’t cite a level for the planned flat income tax for individuals, Berlusconi has said in recent television interviews it should be 23 percent or even below that. The written draft plan says a flat tax would also apply to companies. The program pursues the balanced budget of the Italian state and calls public debt below 100 percent of GDP a “feasible” goal. It is currently above 130 percent.

Wow. As a matter of principle, I think a 23-percent rate is too high.

But compared to Italy’s current tax regime, 23 percent will be like a Mediterranean version of Hong Kong.

So can this happen? I’m not holding my breath.

The budget numbers will be the biggest obstacle to tax reform. The official number crunchers, both inside the Italian government and at pro-tax bureaucracies such as the International Monetary Fund, will fret about the potential for revenue losses.

In part, those concerns are overblown. The high tax rates of the current system have hindered economic vitality and helped to produce very high levels of evasion. If a simple, low-rate flat tax is adopted, two things will happen.

  • There will be more revenue than expected because of better economic performance.
  • There will be more revenue than expected because of a smaller underground economy.

These things are especially likely in Italy, where dodging tax authorities is a national tradition.

That being said, “more revenue than expected” is not the same as “more revenue.” The Laffer Curve simply says that good policy produced revenue feedback, not that tax cuts always pay for themselves (that only happens in rare circumstances).

So if Italy wants tax reform, it will also need spending reform. As I noted when commenting on tax reform in Belgium, you can’t have a bloated public sector and a decent tax system.

Fortunately, that shouldn’t be too difficult. I pointed out way back in 2011 that some modest fiscal restraint could quickly pay big dividends for the nation.

But can a populist-minded Berlusconi (assuming he even wins) deliver? Based on his past record, I’m not optimistic.

Though I’ll close on a hopeful note. Berlusconi and Trump are often linked because of their wealth, their celebrity, and their controversial lives. Well, I wasn’t overly optimistic that Trump was going to deliver on his proposal for a big reduction in the corporate tax rate.

Yet it happened. Not quite the 15 percent rate he wanted, but 21 percent was a huge improvement.

Could Berlusconi – notwithstanding previous failures to reform bad policies – also usher in a pro-growth tax code?

To be honest, I have no idea. We don’t know if he is serious. And, even if his intentions are good, Italy’s parliamentary system is different for America’s separation-of-powers systems and his hands might be tied by partners in a coalition government. Though I’m encouraged by the fact that occasional bits of good policy are possible in that nation.

And let’s keep in mind that there’s another populist party that could win the election And its agenda, as reported by Bloomberg, includes reckless ideas like a “basic income.”

…economic malaise is increasingly common across Italy, where unemployment tops 11 percent and the number of people living at or below the poverty line has nearly tripled since 2006, to 4.7 million last year, or almost 8 percent of the population… “Poverty will be center stage in the campaign,” says Giorgio Freddi, professor emeritus of political science at the University of Bologna. …Five Star is a fast-growing group fueled by anger at the old political class. …a €500 ($590) monthly subsidy to the disadvantaged…is a key plank in Five Star’s national platform, and the group’s leaders have promised to quickly implement such a program if they take power. Beppe Grillo, the former television comedian who co-founded the party, says fighting poverty should be a top priority. A basic income can “give people back their dignity,”… The Five Star program echoes universal basic income schemes being considered around the world. …Five Star says the plan would cost €17 billion a year, funded in part by…tax hikes on banks, insurance companies, and gambling.

Ugh. Basic income is a very troubling idea.

I’ve already speculated about whether Italy has “passed the point of no return.” If the Five Star Movement wins the election and makes government even bigger, I think I’ll have an answer to that question.

Which helps to explain why I wrote that Sardinians should secede and become part of Switzerland (where a basic income scheme was overwhelmingly rejected).

In conclusion, I suppose I should point out that a flat tax would be very beneficial for Italy’s economy, but other market-friendly reforms are just as important.

P.S. Some people, such as Eduardo Porter in the New York Times, actually argue that the United States should be more like Italy. I’m not kidding.

P.P.S. When asked about my favorite anecdote about Italian government, I’m torn. Was it when a supposedly technocratic government appointed the wrong man to a position that shouldn’t even exist? Or was it when a small town almost shut down because so many bureaucrats were arrested for fraud?

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Earlier this year, I pointed out that Trump and Republicans could learn a valuable lesson from Maine Governor Paul LePage on how to win a government shutdown.

Today, let’s look at a lesson from North Carolina on how to design and implement pro-growth tax policy.

In today’s Wall Street Journal, Senator Thom Tillis from the Tarheel State explains what happened when he helped enact a flat tax as Speaker of the State House.

In 2013, when I was speaker of the state House, North Carolina passed a serious tax-reform package. It was based on three simple principles: simplify the tax code, lower rates, and broaden the base. We replaced the progressive rate schedule for the personal income tax with a flat rate of 5.499%. That was a tax-rate cut for everyone, since the lowest bracket previously was 6%. We also increased the standard deduction for all tax filers and repealed the death tax. We lowered the 6.9% corporate income tax to 6% in 2014 and 5% in 2015. …North Carolina’s corporate tax fell to 3% in 2017 and is on track for 2.5% in 2019. We paid for this tax relief by expanding the tax base, closing loopholes, paring down spending, reducing the cost of entitlement programs, and eliminating “refundable” earned-income tax credits for people who pay no taxes.

Wow, good tax policy enabled by spending restraint. Exactly what I’ve been recommending for Washington.

Have these reforms generated good results?  The Senator says yes.

More than 350,000 jobs have been created, and the unemployment rate has been cut nearly in half. The state’s economy has jumped from one of the slowest growing in the country to one of the fastest growing.

What about tax revenue? Has the state government been starved of revenue?

Nope.

…a well-mobilized opposition on the left stoked fears that tax reform would cause shrinking state revenues and require massive budget cuts. This argument has been proved wrong. State revenue has increased each year since tax reform was enacted, and budget surpluses of more than $400 million are the new norm. North Carolina lawmakers have wisely used these surpluses to cut tax rates even further for families and businesses.

Senator Tillis didn’t have specific details on tax collections in his column. I got suspicious that he might be hiding some unflattering numbers, so I went to the Census Bureau’s database on state government finances. But it turns out the Senator is guilty of underselling his state’s reform. Tax revenue has actually grown faster in the Tarheel State, compared the average of all other states (many of which have imposed big tax hikes).

Another example of the Laffer Curve in action.

And here’s a chart from North Carolina’s Office of State Budget and Management. As you can see, revenues are rising rather than falling.

By the way, I’m guessing that the small drop in 2014 and the big increase in 2015 were caused by taxpayers delaying income to take advantage of the new, friendlier tax system. We saw the same thing in the early 1980s when some taxpayer deferred income because of the multi-year phase-in of the Reagan tax cuts.

But I’m digressing. Let’s get back to North Carolina.

Here’s what the Tax Foundation wrote earlier this year.

After the most dramatic improvement in the Index’s history—from 41st to 11th in one year—North Carolina has continued to improve its tax structure, and now imposes the lowest-rate corporate income tax in the country at 4 percent, down from 5 percent the previous year. This rate cut improves the state from 6th to 4th on the corporate income tax component, the second-best ranking (after Utah) for any state that imposes a major corporate tax. (Six states forego corporate income taxes, but four of them impose economically distortive gross receipts taxes in their stead.) An individual income tax reduction, from 5.75 to 5.499 percent, is scheduled for 2017. At 11th overall, North Carolina trails only Indiana and Utah among states which do not forego any of the major tax types.

And in a column for Forbes, Patrick Gleason was even more effusive.

…the Republican-controlled North Carolina legislature enacted a new budget today that cuts the state’s personal and corporate income tax rates. Under this new budget, the state’s flat personal income tax rate will drop from 5.499 to 5.25% in January of 2019, and the corporate tax rate will fall from 3% to 2.5%, which represents a 16% reduction in one of the most harmful forms of taxation. …This new budget, which received bipartisan support from a three-fifths super-majority of state lawmakers, builds upon the Tar Heel State’s impressive record of pro-growth, rate-reducing tax reform. …It’s remarkable how much progress North Carolina has made in improving its business tax climate in recent years, going from having one of the worst businesses tax climates in the country (ranked 44th), to one of the best today (now 11th best according to the non-partisan Tax Foundation).

Most importantly, state lawmakers put the brakes on spending, thus making the tax reforms more political and economically durable and successful.

Since they began cutting taxes in 2013, North Carolina legislators have kept annual increases in state spending below the rate of population growth and inflation. As a result, at the same time North Carolina taxpayers have been allowed to keep billions more of their hard-earned income, the state has experienced repeated budget surpluses. As they did in 2015, North Carolina legislators are once again returning surplus dollars back to taxpayers with the personal and corporate income tax rate cuts included in the state’s new budget.

Last but not least, I can’t resist sharing this 2016 editorial from the Charlotte Observer. If nothing else, the headline is an amusing reminder that journalists have a hard time understanding that higher tax rates don’t necessarily mean more revenue and that lower tax rates don’t automatically lead to less revenue.

A curious trend you might have noticed of late: North Carolina’s leaders keep cutting taxes, yet the state keeps taking in more money. We saw it happen last year, when the state found itself with a $400 million surplus, despite big cuts in personal and corporate tax rates. …Now comes word that in the first six months of the 2016 budget year (July to December), the state has taken in $588 million more than it did in the same period the previous year. …the overall surge in tax receipts certainly shouldn’t go unnoticed, especially since most of the increased collections for the 2016 cycle so far come from higher individual income tax receipts. They’re up $489 million, 10 percent above the same period of the prior year.

Though the opinion writers in Charlotte shouldn’t feel too bad. Their counterparts at the Washington Post and Wall Street Journal have made the same mistake. As did a Connecticut TV station.

P.S. My leftist friends doubtlessly will cite Kansas as a counter-example to North Carolina. According the narrative, tax cuts failed and were repealed by a Republican legislature. I did a thorough analysis of what happened in the Sunflower State earlier this year. I pointed out that tax cuts are hard to sustain without some degree of spending restraint, but also noted that the net effect of Brownback’s tenure is a permanent reduction in the tax burden. If that’s a win for the left, I hope for similar losses in Washington. It’s also worth comparing income growth in Kansas, California, and Texas if you want to figure out what tax policies are good for ordinary people.

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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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Every so often, I mock the New York Times for biased or sloppy analysis.

Now there’s a new column by David Leonhardt that cries out for correction.

He’s very upset that upper-income people are enjoying higher incomes over time.

A…team of inequality researchers…has been getting some attention recently for a chart… It shows the change in income between 1980 and 2014 for every point on the distribution, and it neatly summarizes the recent soaring of inequality. …the very affluent, and only the very affluent, have received significant raises in recent decades. This line captures the rise in inequality better than any other chart or simple summary that I’ve seen. …only very affluent families — those in roughly the top 1/40th of the income distribution — have received…large raises. …The basic problem is that most families used to receive something approaching their fair share of economic growth, and they don’t anymore.

And here’s the chart that ostensibly shows that the economy is broken.

And what is the solution for this alleged problem? Class-warfare taxation and bigger government, of course.

…there is nothing natural about the distribution of today’s growth — the fact that our economic bounty flows overwhelmingly to a small share of the population. Different policies could produce a different outcome. My list would start with a tax code that does less to favor the affluent, a better-functioning education system, more bargaining power for workers and less tolerance for corporate consolidation.

Whenever I see this type of data, I’m automatically suspicious for two reasons.

  1. The people at various income levels in 1980 aren’t the same as the people at those income levels in 2014. In other words, there is considerable income mobility, with some high-income people falling to the middle of the pack, or even below, and some low-income people climbing the middle of the income distribution, or even higher. At the very least, this type of chart exaggerates the degree to which “the rich are getting richer.”
  2. Moreover, rich people getting rich doesn’t imply that poor people are losing income. This chart shows that all income percentiles generally enjoy more income with each passing year, so it isn’t grossly misleading like the charts that incorrectly imply income gains for the rich are at the expense of the poor. Nonetheless, a reader won’t have any way of knowing that more inequality and poverty reduction can go hand in hand.

But I think this chart from the New York Times inadvertently shows something very interesting.

As shown in the excerpt above, Mr. Leonhardt wants us to look at this data and support bigger government and class warfare.

Yet look at the annual data. The chart above has the numbers for 1980 and 2014. To the right, I’ve put together the numbers for 1987, 1996, and 2004.

One obvious conclusion is that prosperity (as shown by rising income levels) was much more broadly and equally shared in the 1980s and 1990s, back when the economy was moving in the direction of free markets and smaller government under both Reagan and Clinton.

But look at what happened last decade, and what’s been happening this decade. Government has been expanding (as measured by falling scores from Economic Freedom of the World).

And that’s the period, thanks to Bush-Obama statism, when lower-income people began to lag and income gains were mostly concentrated at the top of the income redistribution.

As the very least, this certainly suggests that Leonhardt’s policy agenda is misguided. Assuming, of course, the goal is to enable more prosperity for the less fortunate.

I’ll add another point. I suspect that big income gains for the rich in recent years are the result of easy-money policies from the Federal Reserve, which have – at least in part – pushed up the value of financial assets.

The bottom line is that Leonhardt seems motivated by ideology, so he bends the data in hopes of justifying his leftist agenda.

What makes this sad is that the New York Times used to be far more sensible.

Back in 1982, shortly after the Professors Hall and Rabushka unveiled their plan for a flat tax, here’s what the New York Times opined.

Who can defend a tax code so complicated that even the most educated family needs a professional to decide how much it owes? …President Reagan’s tax package will eventually roll back rates to the level of the late 1970’s, but it will not simplify the code or rid it of provisions that penalize hard work and reward unproductive investment. …the income base that is taxed has been so eroded by exceptions and preferences that the rates on what is left to tax must be kept high. Thus, the tax on an extra dollar of income for a typical family earning $20,000 is 28 percent and progressively higher for the more affluent. …The most dramatic fresh start, without changing the total amount collected, would be a flat-rate tax levied on a greatly broadened income base. Senator Helms of North Carolina would rid the law of virtually every tax preference and tax all income at about 12 percent. Representative Panetta of Cali-fornia would retain a few preferences and tax at a flat 19 percent. Either approach would greatly improve the efficiency of the system, simplifying calculations and increasing the incentive to earn.

And here’s what the editors wrote about Governor Jerry Brown’s modified flat tax in 199s. They started by praising the core principles of the flat tax.

Taking Jerry Brown seriously means taking his flat tax proposal seriously. Needlessly, he’s made that hard to do. By being careless, the former California Governor has bent a good idea out of shape. …Mr. Brown’s basic idea — creating a simplified code that encourages saving — is exactly right. …The present tax code is riddled with wasteful contradictions and complexity. For example, profit from corporate investment is taxed twice — when earned by the corporation and again when distributed to shareholders. That powerfully discourages savings and investment — the exact opposite of what the economy needs to grow. The remedy is, in a word, integration, meshing personal and corporate codes so that the brunt of taxes falls on consumption, not saving. …there is a reform that achieves all these objectives. Robert Hall and Alvin Rabushka, economists at the Hoover Institution, have proposed an integrated code that applies a single rate to both personal and corporate income. Their plan wipes away most deductions and exemptions, permitting a low tax rate of 19 percent. …Under the Hall-Rabushka plan, individuals would pay taxes on earnings and corporations would pay tax on interest, dividends and profits. That way, every dollar of income would be taxed once and only once.

And they rightly criticized Governor Brown for violating those principles.

Jerry Brown borrowed some of the elements of Hall-Rabushka. He too would eliminate wasteful exemptions, adopt a single rate and favor saving by exempting corporate investment. But at that point, he turns glib. He would impose on corporations a value-added tax, similar to a national sales tax. That eliminates the elegant symmetry of Hall-Rabushka. Indirectly, Mr. Brown’s variation would tax some income twice — which is why his supposed 13 percent rate would collect revenue equal to about 20 percent of total income.

Wow, this isn’t what I would write, but it’s within shouting distance.

The editors back then understood the importance of low marginal tax rates and they recognized that double taxation is a bad thing.

Now check out what the New York Times believes today about tax reform.

First and foremost, the editors want more money taken from the productive economy to expand the D.C. swamp.

Real reform would honestly confront the fact that in the next decade we will need roughly $4.5 trillion more revenue than currently projected to meet our existing commitment…. Even more would be needed if the government were to make greater investments.

And even though class-warfare taxation is unlikely to generate much revenue, the editors want both higher tax rates and more double taxation.

…it would make sense to increase the top rates on them and eliminate a break on income from investments. …the richest 1 percent pay 33 percent of their total income in taxes; if rates were changed so they paid 40 percent, it would generate $170 billion of revenue in the first year.

The editors want to take one of the most anti-competitive features of the current system and make it even worse.

It would also be a good idea to scale back accelerated depreciation allowances that let businesses write off investments faster than assets actually wear out. Speedy write-offs for luxuries like corporate jets could be eliminated altogether.

They also want to further undermine the ability of U.S. companies to compete on a level playing field in foreign markets.

…they should agree to close…the ability of corporations to defer tax on profits earned abroad.

In a display of knee-jerk statism, the editors also want new tax burdens to finance an ever-larger burden of government. Such as an energy tax.

New forms of taxation are also needed. Even prominent Republicans like James Baker III, George Shultz and Henry Paulson Jr. support a carbon tax imposed on emissions to reduce greenhouse gases. …revenue generated by carbon taxes could be used for other purposes as well, including investments in renewable energy and public transportation.

And a tax on financial transactions.

Revenue can also be raised by imposing a tax on the trading of stocks, bonds and derivatives. …Estimates show that a financial transaction tax of even 0.01 percent per trade ($10 on a $100,000 trade) could raise $185 billion over 10 years, enough to finance prekindergarten for 3- and 4-year olds, with money left over.

But the granddaddy of new taxes would be the value-added tax, a money machine for bigger government.

A value-added tax would be akin to a national sales tax, but harder to evade than traditional sales taxes and thus an efficient revenue raiser.

I’m genuinely curious whether there is any type of tax increase the NYT wouldn’t support.

But that’s not really the point of this column. The real lesson is that it’s sad that the editors have gone from being rationally left to being ideologically left.

P.S. I confess that I especially enjoy when the New York Times inadvertently publishes pieces that show the benefits of free markets and personal liberty.

Which is sort of what happened with Leonhardt’s data, which shows more broadly shared prosperity when economic liberty was increasing.

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Fundamental tax reform such as a flat tax should accomplish three big goals.

The good news is that almost all Republicans believe in the first two goals and at least pay lip services to the third goal.

The bad news is that they nonetheless can’t be trusted with tax reform.

Here’s why. Major tax reform is based on the assumption that achieving the first two goals will lower tax revenue and achieving the third goal will generate tax revenue. A reform plan doesn’t have to be “revenue neutral,” of course, but politicians would be very reluctant to vote for a package that substantially reduced tax revenue. So serious proposals have revenue-raising provisions that are roughly similar in magnitude to the revenue-losing provisions.

Here’s the problem.   Notwithstanding lip service, Republicans are not willing to go after major tax loopholes like the healthcare exclusion. And that means that they are looking for other sources of revenue. In some cases, such as the proposal in the House plan to put debt and equity on a level playing field, they come up with decent ideas. In other cases, such as the border-adjustment tax, they come up with misguided ideas.

And some of them are even talking about very bad ideas, such as a value-added tax or carbon tax.

This is why it would be best to set aside tax reform and focus on a more limited agenda, such as a plan to lower the corporate tax rate. I discussed that idea a few weeks ago on Neil Cavuto’s show, and I echoed myself last week in another appearance on Fox Business.

Lest you think I’m being overly paranoid about Republicans doing the wrong thing, here’s what’s being reported in the establishment press.

The Hill is reporting that the Trump Administration is still undecided on the BAT.

The most controversial aspect of the House’s plan is its reliance on border adjustability to tax imports and exempt exports. …the White House has yet to fully embrace it. …If the administration opts against the border-adjustment proposal, it would have to find another way to raise revenue to pay for lowering tax rates.

While I hope the White House ultimately rejects the BAT, that won’t necessarily be good news if the Administration signs on to another new source of revenue.

And that’s apparently under discussion.

The Washington Post last week reported that the White House was looking at other ideas, including a value-added tax and a carbon tax… Even if administration officials are simply batting around ideas, it seems clear that Trump’s team is open to a different approach.

The Associated Press also tries to read the tea leaves and speculates whether the Trump Administration may try to cut or eliminate the Social Security payroll tax.

The administration’s first attempt to write legislation is in its early stages and the White House has kept much of it under wraps. But it has already sprouted the consideration of a series of unorthodox proposals including a drastic cut to the payroll tax, aimed at appealing to Democrats.

I’m not a big fan of fiddling with the payroll tax, and I definitely worry about making major changes.

Why? Because it’s quite likely politicians will replace it with a tax that is even worse.

This would require a new dedicated funding source for Social Security. The change, proposed by a GOP lobbyist with close ties to the Trump administration, would transform Brady’s plan on imports into something closer to a value-added tax by also eliminating the deduction of labor expenses. This would bring it in line with WTO rules and generate an additional $12 trillion over 10 years, according to budget estimates.

Last but not least, the New York Times has a story today on the latest machinations, and it appears that Republicans are no closer to a consensus today than they were the day Trump got inaugurated.

…it is becoming increasingly unlikely that there will be a simpler system, or even lower tax rates, this time next year. The Trump administration’s tax plan, promised in February, has yet to materialize; a House Republican plan has bogged down, taking as much fire from conservatives as liberals… Speaker Paul D. Ryan built a tax blueprint around a “border adjustment” tax… With no palpable support in the Senate, its prospects appear to be nearly dead. …The president’s own vision for a new tax system is muddled at best. In the past few months, he has called for taxing companies that move operations abroad, waffled on the border tax and, last week, called for a “reciprocal” tax that would match the import taxes other countries impose on the United States.

The report notes that Trump may have a personal reason to oppose one of the provisions of the House plan.

Perhaps the most consequential concern relates to a House Republican proposal to get rid of a rule that lets companies write off the interest they pay on loans — a move real estate developers and Mr. Trump vehemently oppose. Doing so would raise $1 trillion in revenue and reduce the appeal of one of Mr. Trump’s favorite business tools: debt.

From my perspective, the most encouraging part of the story is that the lack of consensus may lead Republicans to my position, which is simply to cut the corporate tax rate.

With little appetite for bipartisanship, many veterans of tax fights and lobbyists in Washington expect that Mr. Trump will ultimately embrace straight tax cuts, with some cleaning up of deductions, and call it a victory.

And I think that would be a victory as well, even though I ultimately want to junk the entire tax code and replace it with a flat tax.

P.S. In an ideal world, tax reform would be financed in large part with spending restraint. Sadly, Washington, DC, isn’t in the same galaxy as that ideal world.

P.P.S. To further explain why Republicans cannot be trusted, even if they mean well, recall that Rand Paul and Ted Cruz both included VATs in the tax plans they unveiled during the 2016 presidential campaign.

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February 5 Addendum: For my left-wing friends and others who are bending over backwards to misread this column, saying nice things about Russia’s flat tax doesn’t mean (as noted below) that Russia’s overall economic policy is admirable. And it obviously doesn’t imply anything favorable about Russia’s dismal political system or Putin himself. I like the Russia flat tax for the same reason that I like trade liberalization in China and Social Security reform in Chile. Every so often, bad governments stumble upon a good policy and I think that’s laudable because I want people to have better lives. Sadly, I don’t think the Putin-Trump “bromance” will lead to a flat tax in the US, but that would be an unexpected and nice silver lining to that dark cloud.

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I’m obviously a big fan of a simple and fair flat tax.

In part, my support for fundamental reform is driven by my desire for a low rate, for no double taxation, and for the elimination of loopholes. Those are the economic reasons for reform.

But I also am very much motivated by the moral case for tax reform. It offends me that we have 70,000-plus pages of special favors for the friends and contributors of politicians. I value the rule of law, so I want everyone in America to play by the same rules.

And I confess that I’m jealous that other nations have adopted this common-sense reform while we’re still stuck with a punitive and unfair internal revenue code.

But the silver lining to this dark cloud is that we can learn from the experiences of other nations.

A recent report looks at what’s happened in Russia following the introduction of the flat tax.

On December 23, 2016, in his annual end-of-year press conference, Russian President Vladimir Putin said that despite his “many doubts” at the initial stage of introducing a flat 13-percent personal income tax in 2001, tax reform in Russia has been a major success. …Putin claimed that in 2001, when the tax reform was introduced, he was “concerned that the budget would lose revenue, because those who earn more would have to pay less.” He said he was also concerned “whether social justice would be ensured and so on.” However, as the reform gained traction, “personal-income tax collection has increased – pay attention – seven times,” Putin said. …Daniel Mitchell, a senior fellow at the Cato Institute, told Polygraph.info that two factors contributed to a significant increase in personal income tax revenue: “the low rate made tax evasion and avoidance much less attractive, and increased incentives to earn income.”

I appreciated the chance to talk to the reporter and get quoted in the story, but I am naturally suspicious about the claims of government officials. So I wondered about Putin’s claim about a seven-fold increase in income tax receipts.

I know there were good results in the first few years after reform. I authored a study for the Center for Freedom and Prosperity last decade, and there was data at the time showing an impressive increase in revenues from the personal income tax. That data certainly bolstered the argument for tax reform.

But we now have almost another full decade of data. Has the Russian flat tax continued to produce good results? Is the low tax rate continuing to encourage both the earning of income and reporting of income?

To answer these questions, I had my intern cull through various IMF Article IV consultation reports on Russia to get up-to-date data on personal income tax receipts in Russia. And what did I learn? Was Putin wrong?

Yes, Putin’s claim of a seven-fold increase in tax receipts was completely misleading. There was actually a 10-fold jump in personal income tax revenue.

In other words, the flat tax is a success. In today’s Washington, you would say the Russian government is winning bigly.

But there are caveats.

  • Russia has experienced significant inflation, at least compared to the United States. So if you factor out increases in the price level, personal income tax revenues are “only” about three times higher today than they were before the flat tax was implemented.
  • Moreover, a flat tax is not a panacea. Notwithstanding the good results it has delivered, Russia has an unimpressive ranking of #102 from Economic Freedom of the World. In other words, there’s still a long way to go if Russia wants to become a rich nation.

But these caveats don’t change the main conclusion, which is that the Russian flat tax works. Just as it works in Hong Kong. And just as it works in Jersey. It works wherever it is tried.

Let’s look at another example. Writing for Forbes, Fahim Mostafa explains that the Hungarian flat tax also has been a big success.

A fair number of Eastern European nations have…chosen this system of taxation over its progressive counterpart. Among the latest to join this club is Hungary, replacing progressive rates from 17% to 32% with a flat tax of 16% on income effective from 2012 onward… There is reason to believe that the implementation of this system has largely benefited the Eastern European nation. …The results from the following years have been remarkable. Total government revenue in 2015 (the last year for which OECD data is available at this time) stood at 23.8% higher than the maximum prior to the flat tax reform… According to the OECD, public debt in Hungary has been decreasing steadily since 2011. Increased revenues allow for this debt to be paid. …The flat tax has boosted consumption in Hungary, greatly increasing taxes collected from sales. Total tax revenue has shot up despite the massive cuts made to income tax. Politicians seeking to implement this policy in their own nation would do well to point out the example of Hungary.

I’ll add two comments.

First, the same caveats I applied to Russia apply to Hungary. The country is ranked #57 from Economic Freedom of the World, so it’s great that there’s a successful flat tax, but a lot more reform is needed for Hungary to become a role model for overall market-friendly reform.

Second, the author should probably make a change to the column. Instead of writing that “tax revenue has shot up despite the massive cuts,” it might be more accurate to write that “tax revenue has shot up because of the massive cuts.”

Yes, every so often you can find examples of nations being on the downward-sloping portion of the Laffer Curve, either because tax rates are ridiculously high (the U.S. before Reagan) or because a nation is developing or transitioning and needs low tax burdens to boost growth and encourage compliance.

It’s never my goal to boost revenue for governments, of course, but there’s surely a lesson to be learned about the benefits of low tax rates when both taxpayers and the government wind up with more money.

P.S. If we really want to learn from other places about the ideal tax system, we should check out Bermuda, Monaco, and the Cayman Islands.

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On December 24, I wrote that all I wanted for Christmas is a spending cap.

Alas, Santa did not manage to stuff that long-overdue policy down my chimney.

But I’m not surprised. For years, the flat tax was on my Christmas list and that never happened either. I guess I must have been bad. Or maybe Santa is a leftist or socialist.

So instead of simple and fair tax system under the tree, I kept getting lumps of coal in my stocking, which are cleverly disguised as new provisions of a metastasizing internal revenue code.

I’m still allowed to dream, however, so I want to share a new video about the flat tax from Prager University. It’s narrated by Steve Forbes, who (along with Dick Armey) helped popularize the flat tax in the 1990s.

Very compelling. Perhaps even more so than my video on the flat tax.

So what are the chances that we’ll ever get this type of reform?

In a column she wrote last year for Time, Amity Shlaes was somewhat optimistic that a flat tax has untapped support. She cited the fact that most GOP candidates either endorsed some form of flat tax or proposed changes that would move us closer to a flat tax.

The simple levy hasn’t been this popular since 1996, when Steve Forbes campaigned with the promise of a universal 17% income tax rate. Several of this campaign’s flat taxers are actually out-Forbesing Forbes. Ted Cruz is calling for a flat 10%. Ben Carson, Mike Huckabee and Rand Paul also propose some kind of flat rate. Jeb Bush, Marco Rubio and Donald Trump pay their respects with plans that reduce the number of tax brackets.

She explains why the current approach is arbitrary and unfair.

…tinkering is the great weakness of a progressive structure. For if one authority wins license to tinker, so may another. Eventually every interest group convinces others that it is only fair to introduce its ornaments, its exceptions, or its doodads to a tax code. A progressive structure grows organically and disproportionately, becoming a monument to…crony capitalism.

And even though people get tricked when they equate “progressivity” and “progress,” there’s an underlying belief in equal treatment that pushes them in the direction of a flat tax.

In a paper recently presented at the American Accounting Association, scholars Michael and Theresa Roberts report that nearly 8 in 10 business students they polled believe a progressive income tax to be fairer than a flat tax. Still, when asked to actually ascertain a fair amount for a tax payment, the vast majority of the same pollees, even self-identified liberals, picked an amount that correlated to a flat, or even a regressive, rate. This suggests that while Americans like the sound of the word “progressive,” even educated citizens don’t necessarily love progressivity’s effect. Whatever they say at a party, people may quietly prefer proportionality to disproportionality… The Roberts-Roberts paper concludes that “a majority of both liberal and conservative Americans may view a flat income tax rate as fairer than progressive income tax rates.”

Amity’s point about “self-identified liberals” is a natural segue to a Forbes column by Rick Ungar. He approaches the topic from a left-of-center perspective and has considerable sympathy for the flat tax. Not because he likes proportionality, per se, but because he recognizes that the current system has been perverted by special interests.

I’ve long been open to the possibility of trying something new… How can a progressive come to the conclusion that the flat tax might be a better way to go? …American progressives have long had an allergic reaction to the very notion of a flat tax…and with good reason. On it’s face, a flat tax (and the many variations of policy included under the name flat tax) is, indeed, a regressive system more likely than not to benefit the wealthy at the expense of the less wealthy. …However, you have to ask whether or not our current progressive system is truly progressive or, in reality, a system that has been so perverted by special interest tax breaks and benefits as to no longer be legitimately described as progressive. …what do you think is contained in all of those 74,000 plus pages in the United States tax code? …When the higher earner is, in reality, paying at a lower tax rate than her employees who earn far less, thanks to all the special interest perversions built into the tax code, that is very much a regressive tax system. …maybe the time has come to try something new.

Though Ungar isn’t quite willing to embrace the flat tax.

There are, however, some conditions to my willingness to get on board—two to be exact. First, I worry about how the flat tax would impact on those who do not earn much money and have to support their families on a salary that makes both feeding and housing that family a constant, painful challenge. …my second concern…what assurances do we have that this new system will not be corrupted just as the present system was corrupted?

The first concern is easy to address. Every flat tax plan has a generous allowance for all households based on family size. This “zero-bracket amount” would be more generous than the combined standard deduction and personal exemptions in the current tax system. Indeed, because of my concerns about people viewing government as being free, I actually think the amount of tax-free income people would be able to earn is too large. So Mr. Ungar probably can relax on that point.

The second concern, though, is much harder to solve. The risk of a flat tax is that the system somehow will get compromised and degenerate back to the mess we have now. I like to think the American people, after finally being freed from today’s awful system, would vigorously fight to preserve the flat tax. But I also confess there are no guarantees. But here’s the deal. The worst thing that happens is that the current system re-emerges. That obviously would be a big disappointment, but that downside risk is rather tame compared to the downside risk of a national sales tax or value-added tax, which is that politicians would pull a bait and switch, never get rid of the income tax, and then we wind up with a French-style tax system (and the bloated government it finances).

Let’s close by considering a new argument for the flat tax.

Preston Cooper of E21 explains that a single rate protects people in expensive parts of the country from disproportionately harsh taxation.

…data from the Bureau of Economic Analysis (BEA) show that in states such as Arkansas and Mississippi, $100 can buy $115 worth of goods, while in New York and Hawaii, the same dollar value will only get you $86 worth. …This provides yet another argument for a flat tax. …areas with higher prices also tend to have higher incomes, because employers must compensate for their employees’ reduced purchasing power. Therefore, people earning $44,000 in West Virginia can afford the same standard of living as someone earning $58,000 in Hawaii, despite the gap in nominal income. But the federal government does not account for these regional price disparities when setting tax policy. The progressive federal income tax means that those who earn a higher income in nominal terms will pay a higher tax rate. However, the varying cost of living across the United States means that those who earn a higher nominal income may not actually be any richer, yet will still have to pay the taxes for it. This violates an important goal of tax policy known as horizontal equity: people with the same income ought to pay the same amount in taxes.

Using the example of a single adult, Cooper shows that people living in high-cost-of-living states can pay hundreds of dollars in extra tax compared to people with similar levels of purchasing power in low-cost-of-living states.

Looking at this data, I’m temped to say “serves them right” since the list is dominated by blue states that routinely elect politicians who support class-warfare tax policies and lots of redistribution.

But that knee-jerk reaction is misguided. A fundamental libertarian principle is that the law should treat everyone equally.

So how can this work?

A potential solution is to adjust federal tax brackets in different states for differences in purchasing power. But price disparities do not end at the state level: prices also differ by metropolitan area. People in New York City pay higher prices than people in Buffalo. This phenomenon exists even within cities, as anyone who has compared apartment prices in Manhattan and Queens can attest. There are far too many jurisdictions to effectively adjust tax brackets for cost-of-living differences. A better remedy is to apply a flat income tax at the federal level. Under such a tax everyone would pay the same proportion of their income to the federal government, eliminating the interregional redistribution that comes with progressive taxation.

This makes sense.

When I argue for the flat tax, I tend to focus on the economic benefits (low rate, no double taxation, and no loopholes) and the moral benefits (less corruption, more fairness, and better compliance).

Now I can augment that fairness argument because the government shouldn’t arbitrarily penalize people based on where they live.

So, yes, we should have a flat tax. Other nations shouldn’t have all the fun.

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