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Archive for the ‘Income tax’ Category

Every so often, I get asked why I’m so rigidly opposed to tax hikes in general and so vociferously against the imposition of new taxes in particular.

In part, my hostility is an ideological reflex When pressed, though, I’ll confess that there are situations – in theory – where more taxes might be acceptable.

But there’s a giant gap between theory and reality. In the real world, I can’t think of a single instance in which higher taxes led to a fiscally responsible outcome.

That’s true on the national level. And it’s also true at the state level.

Speaking of which, the Wall Street Journal is – to put it mildly – not very happy at the tax-aholic behavior of Connecticut politicians. Here’s some of what was in a recent editorial.

The Census Bureau says Connecticut was one of six states that lost population in fiscal 2013-2014, and a Gallup poll in the second half of 2013 found that about half of Nutmeg Staters would migrate if they could. Now the Democrats who run the state want to drive the other half out too. That’s the best way to explain the frenzy by Governor Dannel Malloy and the legislature to raise taxes again… Mr. Malloy promised last year during his re-election campaign that he wouldn’t raise taxes, but that’s what he also said in 2010. In 2011 he signed a $2.6 billion tax hike promising that it would eliminate a budget deficit. Having won re-election he’s now back seeking another $650 million in tax hikes. But that’s not enough for the legislature, which has floated $1.5 billion in tax increases. Add a state-wide municipal sales tax that some lawmakers want, and the total could hit $2.1 billion over two years.

In other words, higher taxes in recent years have been used to fund more spending.

And now the politicians are hoping to play the same trick another time.

Apparently they don’t care that they’ve turned the Nutmeg State into a New England version of Illinois.

…the state grew a scant 0.9% in 2013, the last year state data are available. That was tied for tenth worst in the U.S. The state’s average compounded annual growth for the last four years is 0.42%. Slow growth means less tax revenue but spending never slows down. Some “40% of the state budget goes to government employee compensation and benefits, including payroll, state pensions, teacher pensions and current and retiree health care,” says Carol Platt Liebau, president of the Hartford-based Yankee Institute. …The Tax Foundation ranks Connecticut as one of the 10 worst states to do business. The state finished last in Gallup’s Job Creation Index in 2014 and now ties with Rhode Island for the worst job creation in the index since 2008.

What’s particularly discouraging is that Connecticut didn’t even have an income tax twenty-five years ago. But once the politicians got a new source of revenue, it’s been one tax hike after another.

Not too many years ago Connecticut was a tax refuge for New York City workers, but since it imposed an income tax in 1991 the rate has kept climbing, as it always does.

There are a couple of lessons from the disaster in Connecticut.

First and foremost, never give politicians a new source of revenue, which has very important implications for the debate in Washington, DC, about a value-added tax.

Unless, of course, you want to enable a bigger burden of government.

And for the states that don’t already have an income tax, the lesson is very clear. Under no circumstances should you allow your politicians to follow Connecticut on the path to fiscal perfidy.

Yet that’s exactly what may be happening in America’s northwest corner. As reported by the Seattle Times, there’s a plan percolating to create an income tax in the state of Washington. It’s being sold as a revenue swap.

State Treasurer Jim McIntire has a “grand bargain” in mind on tax reform and he wants to bend your ear. …the McIntire plan would institute a 5 percent personal-income tax with some exemptions, eliminate the state property tax and reduce business taxes. The plan would raise billions of dollars… The proposal also would lower the state sales tax to 5.5 percent from 6.5 percent.

But taxpayers should be very suspicious, particularly since politicians are talking about the need for more “investment,” which is a common rhetorical trick used by politicians who want to squander more money.

“It is mathematically impossible for us to sustain an adequate investment in education on a shrinking tax base,” he said.

And when you read the fine print, it turns out that the politicians (and the interest groups in the government bureaucracy) want a lot more additional money from taxpayers.

…the plan would raise $7 billion in state revenue but would lower local levies by $3 billion, for an overall increase of about $4 billion.

Advocates of the new tax would prefer to avoid any discussion of big-picture principles.

“We need to have less of an ideological conversation about this,” he said in a news conference.

And their desire to avoid a philosophical discussion is understandable. After all, the big spenders didn’t fare so well the last time voters had a chance to vote on whether the state should impose an income tax.

Voters may not welcome McIntire’s argument, either. In 2010, a proposed income tax on high earners failed by a nearly 30-point margin.

The voters in Washington were very wise back in 2010, so let’s hope they haven’t lost their skepticism about the revenue plans of politicians over the past few years.

There’s every reason to suspect, after all, that the adoption of an income tax would be just as disastrous for the Evergreen State as it was for the Nutmeg State.

To close, I want to share some great advice that was presented by the always sound Professor Richard Vedder. I was at a conference a few years ago where he was also one of the speakers. Asked to comment on whether the Lone Star State should have an income tax, he threw his hands in the air and cried out with passion that, “Texas should give the Alamo to Osama bin Laden before allowing an income tax.”

So if I’m ever asked to speak in Seattle on fiscal policy, I’m going to steal Richard’s approach and and warn that “The state of Washington should give the Space Needle to North Korea before allowing an income tax.”

I doubt I’ll capture Professor Vedder’s rhetorical flair, but there won’t be any doubt that I’ll be 100-percent serious about the dangers of a state income tax.

And what about my home state of Connecticut?

Well, I don’t know of any big landmarks that they could have traded to avoid an income tax. About the only “good” thing to say is that New York’s tax system is probably even worse.

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In my 2012 primer on fundamental tax reform, I explained that the three biggest warts in the current system.

1. High tax rates that penalize productive behavior.

2. Pervasive double taxation that discourages saving and investment.

3. Corrupt loopholes and cronyism that bribe people to make less productive choices.

These problems all need to be addressed, but I also acknowledged additional concerns with the internal revenue code, such as worldwide taxation and erosion of constitutional freedoms an civil liberties.

In a perfect world, we would shrink government to such a small size that there was no need for any sort of broad-based tax (remember, the United States prospered greatly for most of our history when there was no income tax).

In a good world, we could at least replace the corrupt internal revenue code with a simple and fair flat tax.

In today’s Washington, the best we can hope for is incremental reform.

But some incremental reforms can be very positive, and that’s the best way of describing the “Economic Growth and Family Fairness Tax Reform Plan” unveiled today by Senator Marco Rubio of Florida and Senator Mike Lee of Utah.

The two GOP senators have a column in today’s Wall Street Journal, and you can read a more detailed description of their plan by clicking here.

But here are the relevant details.

What’s wrong with Rubio-Lee

In the interest of fairness, I’ll start with the most disappointing feature of the plan. The top tax rate will be 35 percent, only a few percentage points lower than the 39.6 percent top rate that Obama imposed as a result of the fiscal cliff.

Even more troubling, that 35 percent top tax rate will be imposed on any taxable income above $75,000 for single taxpayers and $150,000 for married taxpayers.

Since the 35 percent and 39.6 percent tax rates currently apply only when income climbs above $400,000, that means a significant number of taxpayers will face higher marginal tax rates.

That’s a very disappointing feature in any tax plan, but it’s especially unfortunate in a proposal put forth my lawmakers who wrote in their WSJ column that they want to “lower rates for families and individuals.”

What’s right with Rubio-Lee

This will be a much longer section because there are several very attractive features of the Rubio-Lee plan.

Some households, for instance, will enjoy lower marginal tax rates under the new bracket structure, particularly if those households have lots of children (there’s a very big child tax credit).

But the really attractive features of the Rubio-Lee plan are those that deal with business taxation, double taxation, and international competitiveness.

Here’s a list of the most pro-growth elements of the plan.

A 25 percent tax rate on all business income – This means that the corporate tax rate is being reduced from 35 percent (the highest in the world), but also that there will be a 25 percent maximum rate on all small businesses that file using Schedule C as part of a 1040 tax return.

Sweeping reductions in double taxation – The Rubio-Lee plans eliminates the capital gains tax, the double tax on dividends, and the second layer of tax on interest.

Full expensing of business investment – The proposal gets rid of punitive “depreciation” rules that force businesses to overstate their income in ways that discourage new business investment.

Territorial taxation – Businesses no longer will have to pay a second layer of tax on income that is earned – and already subject to tax – in other nations.

No death tax – Income should not be subject to yet another layer of tax simply because someone dies. The Rubio-Lee plan eliminates this morally offensive form of double taxation.

In addition, it’s worth noting that the Rubio-Lee plan eliminate the state and local tax deduction, which is a perverse part of the tax code that enables higher taxes in states like New York and California.

Many years ago, while working at the Heritage Foundation, I created a matrix to grade competing tax reform plans. I updated that matrix last year to assess the proposal put forth by Congressman Dave Camp, the former Chairman of the House Ways & Means Committee.

Here’s another version of that matrix, this time including the Rubio-Lee plan.

As you can see, the Rubio-Lee plan gets top scores for “saving and investment” and “international competitiveness.”

And since these components have big implications for growth, the proposal would – if enacted – generate big benefits. The economy would grow faster, more jobs would be created, workers would enjoy higher wages, and American companies would be far more competitive.

By the way, if there was (and there probably should be) a “tax burden” grade in my matrix, the Rubio-Lee plan almost surely would get an “A+” score because the overall proposal is a substantial tax cut based on static scoring.

And even with dynamic scoring, this plan will reduce the amount of money going to Washington in the near future.

Of course, faster future growth will lead to more taxable income, so there will be revenue feedback. So the size of the tax cut will shrink over time, but even a curmudgeon like me doesn’t get that upset if politicians get more revenue because more Americans are working and earning higher wages.

That simply means another opportunity to push for more tax relief!

What’s missing in Rubio-Lee

There are a few features of the tax code that aren’t addressed in the plan.

The health care exclusion is left untouched, largely because the two lawmakers understand that phasing out that preference is best handled as part of a combined tax reform/health reform proposal.

Some itemized deductions are left untouched, or simply tweaked.

And I’m not aware of any changes that would strengthen the legal rights of taxpayers when dealing with the IRS.

Let’s close with a reminder of what very good tax policy looks like.

To their credit, Rubio and Lee would move the tax code in the direction of a flat tax, though sometimes in a haphazard fashion.

P.S. There is a big debate on the degree to which the tax code should provide large child credits. As I wrote in the Wall Street Journal last year, I much prefer lower tax rates since faster growth is the most effective long-run way to bolster the economic status of families.

But even the flat tax has a generous family-based allowance, so it’s largely a political judgement on how much tax relief should be dedicated to kids and how much should be used to lower tax rates.

That being said, I think the so-called reform conservatives undermine their case when they argue child-oriented tax relief is good because it might subsidize the creation of future taxpayers to prop up entitlement programs. We need to reform those programs, not give them more money.

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On the issue of so-called progressive taxation, our left-wing friends have conflicting goals. Some of them want to maximize tax revenue in order to finance ever-bigger government.

But others are much more motivated by a desire to punish success. They want high tax rates on the “rich” even if the government collects less revenue.

Some of them simply pretend there isn’t a conflict, as you might imagine. They childishly assert that the Laffer Curve doesn’t exist and that upper-income taxpayers are fiscal pinatas, capable of generating never-ending amounts of tax revenue.

But more rational leftists admit that the Laffer Curve is real. They may argue that the revenue-maximizing rate is up around 70 percent, which is grossly inconsistent with the evidence from the 1980s, but at least they understand that successful taxpayers can and do respond when tax rates increase.

So the question for grown-up leftists is simple: What’s the answer if they have to choose between collecting more revenue and punishing the rich with class-warfare taxation?

And here’s some new research looking at this tradeoff. Authored by economists from the University of Oslo in Norway, École polytechnique de Lausanne in France, and the University of Pennsylvania, they look at “Tax progressivity and the government’s ability to collect additional tax revenue.”

The recent massive expansion of public debt around the world during the Great Recession raises the question how much debt a government can maximally service by raising the level of taxes. Or, to phrase this classic public finance question differently, how much additional tax revenue can the government generate by increasing income taxes?

And since they’re part of the real world (unlike, say, the Joint Committee on Taxation or the Obama Administration), they recognize that higher tax rates impose costs on the economy that lead to feedback effects on tax revenue.

Our research (Holter et al. 2014) investigates how tax progressivity and household heterogeneity impacts the Laffer curve. We argue that a more progressive labour income tax schedule significantly reduces the maximal amount of tax revenues a government can raise…under progressive taxes heterogeneous workers will face different average and marginal tax rates. …the answer to our question is closely connected to the individual (and then properly aggregated) response of labour supply to taxes. The microeconometric literature, as surveyed e.g. by Keane (2011), has found that both the intensive and extensive margins of labour supply (the latter especially for women), life-cycle considerations, and human capital accumulation are important determinants of these individual responses. …households make a consumption–savings choice and decide on whether or not to participate in the labour market (the extensive margin), how many hours to work conditional on participation (the intensive margin), and thus how much labour market experience to accumulate (which in turn partially determines future earnings capacities).

The above passage has a bit of economic jargon, but it’s simply saying that taxpayers respond to incentives.

They also provide estimates of tax progressivity for various developed nations. They’re only looking at the personal income tax, so these numbers don’t include, for instance, the heavy burden of the value-added tax on low-income people in Europe.

The good news (at least relatively speaking) is that the American income tax is not as punitive as it is in many other nations.

But the key thing to consider, at least in the context of this new research, is the degree to which so-called progressivity comes with a high price.

Here is some additional analysis from their research.

Why does the degree of tax progressivity matter for the government’s ability to generate labour income tax revenues…? changes in tax progressivity typically affects hours worked…increasing tax progressivity induces differential income and substitution effects on the workers in different parts of the earnings distribution. …a more progressive tax system may disproportionately reduce labour supply for high earners and lead to a reduction in tax revenue. …more progressive taxes will reduce the incentives for young agents to accumulate labour market experience and become high (and thus more highly taxed) earners.

Now let’s look at some of the results.

Remarkably, they find that the best way of maximizing revenue is to minimize the economic damage of the tax system. And that means…drum roll, please…a flat tax.

For its current choice of progressivity (the green line), the US can sustain a debt burden of about 330% of its benchmark GDP, by increasing the average tax rate to about 42%. Thus, according to our findings the US is currently still nowhere close to its maximally sustainable debt levels…we also observe that larger public debt can be sustained with a less progressive tax system. Converting to a flat tax system (the black line) increases the maximum sustainable debt to more than 350% of benchmark GDP, whereas adopting Danish tax progressivity lowers it to less than 250% of benchmark GDP.

Here are a couple of charts from their study, both of which underscore that punitive tax rates are very counterproductive, assuming the goal is to either maximize revenue or to sustain a larger public sector.

Notice that if you want to punish “the rich” and impose Danish-type levels of progressivity (the dashed line), you’ll get less revenue and won’t be able to sustain as much debt.

Now let’s shift from discussing intellectual quandaries for the left and talk about challenges for believers in limited government.

We like a flat tax because it treats people equally and it raises revenue in a relatively non-destructive manner.

But because it is an “efficient” form of taxation, it’s also an “efficient” way to generate revenues to finance bigger government.

Indeed, this was one of the findings in a 1998 study by Professors Gary Becker and Casey Mulligan.

So does this mean that instead of supporting a flat tax, we should a loophole-riddled system based on high tax rates solely because that system will be so inefficient that it won’t generate revenue?

Of course not. At the risk of stating the obvious, this is why my work on fundamental tax reform is intertwined with my work on constitutional and legal mechanisms to limit the size and scope of government.

And it’s also why Obama’s class-warfare approach is so perversely destructive. If you think I’m exaggerating, watch this video – especially beginning about the 4:30 mark.

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I’ve shared some interested rankings on tax policy, including a map from the Tax Foundation showing which states have the earliest and latest Tax Freedom Days.

There’s also a depressing table showing that the United States “earns” a lowly 94th place in a ranking of business-friendly tax system.

Heck, there’s even a map showing the states with the highest wine taxes, as well as a map showing which states have the lightest and heaviest tax burdens compared to income.

So I was very interested to see this table from the Tax Foundation revealing which countries have the most punitive regimes for penalizing success.

Portugal has the dubious honor of having the most progressive (i.e., discriminatory) tax system in the developed world.

I don’t think anyone is surprised to see France in second place, though I confess that I was not expecting to see pro-reform success stories such as Chile and Canada in the top five.

And I’m totally embarrassed that the United States is #8, worse than such garden spots as Greece, Mexico, and Belgium.

Though it’s important to understand that the Tax Foundation is relying on a narrow definition of progressivity.

One way to measure and compare the progressivity of income tax codes across countries is to express the level of income at which each country’s top tax bracket applies as a multiple of that country’s average income.

That’s a useful bit of information and it shows one aspect of progressivity, but it’s also a bit misleading since it implies that the Swedish tax system (with a top tax rate of 56.7 percent) is less progressive than the Slovakian tax system (with a top tax rate of 21.7 percent).

You won’t be surprised that I think a ranking that purports to show the burden of “progressive” taxation should include the top tax rate.

Speaking of which, this is why I like the Tax Foundation’s measure of progressivity on the state level.

The…table also shows the gap between the top marginal tax rate and the marginal tax rate on $25,000 of taxable income. …Twenty-one states and the District of Columbia have progressive rate structures that rise after $25,000. California, New Jersey, and Vermont have the most progressive rate structures by a wide margin.

Who could have guessed that California would be the worst state, though I’m not surprised to see New Jersey (the worst place to die) and Vermont (worst place for self reliance) have such poor ratings as well.

And is anyone even remotely shocked to see that states with no income taxes manage to avoid any problems with ‘so-called” progressivity? Not surprisingly, they also grow faster and create more jobs.

The moral of the story, at the very least, is that America needs a simple and fair flat tax.

And not the Obama or Hollande version.

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The Tax Foundation in Washington does some great work on fiscal issues, but I also admire their use of maps when they want to show how various states perform on key indicators.

They’re best known for “Tax Freedom Day,” which measures how long people have to work each year before they’ve earned enough to satisfy the tax demands of federal, state, and local government. And they have a map so you can easily see how your state ranks.

But my favorite map from the Tax Foundation is the one showing that the geese with the golden eggs are moving from high-tax states to low-tax states. That’s tax competition in action!

I also like their map showing which states have done the best and worst jobs of controlling the burden of government spending, as well as their map showing which states steal the biggest share of economic output from taxpayers.

So it should go without saying that I’m going to share their new State Business Tax Climate Index. And the accompanying map.

Tax Foundation State Tax Ranking

What are some important takeaways from this ranking? Five things caught my eye.

1. It’s a very good idea for a state to not impose an income tax. The top six states all avoid this punitive levy and every no-income tax state is in the top 15. And you won’t be surprised to learn that these states grow faster and create more jobs.

2. It’s just a matter of time before states such as New York and California are beset by fiscal crisis. When a jurisdiction has something special – like California’s climate or the appeal (to some) of New York City – it can get away with imposing higher tax burdens. But there’s a limit, and migration patterns show that productive people are voting with their feet.

3. Scott Walker and Chris Christie often are mentioned as serious 2016 presidential candidates, and both have become well known for trying to deal with the problem of over-compensated state bureaucrats. But they both preside over states in the bottom 10 of this ranking, and presumably should address this problem if they want to demonstrate that they’re on the side of taxpayers.

4. It’s possible for a state to make a dramatic jump. North Carolina currently is one of the bottom 10, but that will soon change because of reforms – including a flat tax – that were enacted this year. As the Tax Foundation noted: “While the state remains ranked 44th for this edition, it will move to as high as 17th as these reforms take effect in coming years.”

5. States also can move dramatically in the wrong direction. Connecticut is now one of America’s least-competitive states, in large part because politicians managed to push through a state income tax in the early 1990s.

P.S. If you like maps, here are some interesting ones, starting with some international comparisons.

Here are some good state maps with useful information.

There’s even a local map.

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There have been some unfortunate and dark days in American history, but what was the worst day?

Some obvious choices include December 7, when the Japanese bombed Pearl Harbor, and September 11, when the terrorists launched their despicable attack.

Another option (somewhat tongue in cheek) might be January 20 since Republican partisans would say that’s the day that both Jimmy Carter and Barack Obama became President while Democratic partisans would say that’s the day Ronald Reagan became President.

But allow me to suggest that today, October 3, should be a candidate for America’s worst day.

Why? Because on this day in 1913, one of America’s worst Presidents, Woodrow Wilson, signed into law the Revenue Act of 1913, which imposed the income tax.

The law signed that day by President Wilson, to be fair, wasn’t that awful. The top tax rate was only 7 percent, the tax form was only 2 pages, and the entire tax code was only 400 pages. And a big chunk of the revenue actually was used to lower the tax burden on international trade (the basic tariff rate dropped form 40 percent to 25 percent).

But just as tiny acorns become large oak trees, small taxes become big taxes and simple tax codes become complex monstrosities. And that’s exactly what happened in the United States.

We now have a top tax rate of 39.6 percent, and it’s actually much higher than that when you include the impact of other taxes, as well as the pervasive double taxation of saving and investment.

And the relatively simply tax law of 1913 has metastasized into 74,000 pages of Byzantine complexity.

Not to mention that the tax code has become one of the main sources of political corruption in Washington, impoverishing us while enriching the politicians, lobbyists, bureaucrats, and interest groups. Or the oppressive and dishonest IRS.

However, even though I take second place to nobody in my disdain for the income tax, the worst thing about that law is not the tax rates, the double taxation, or the complexity. The worst thing is that the income tax enabled the modern welfare state.

Before the income tax, politicians had no way to finance big government. Their only significant pre-1913 sources of revenue were tariffs and excise taxes, and they couldn’t raise those tax rates too high because of Laffer Curve effects (something that modern-day politicians sometimes still discover).

Once the income tax was adopted, though, it became a lot easier to finance subsidies, handouts, and redistribution. As you can see from the chart, the federal government used to be very small during peacetime.

But as the decades have passed, the Leviathan state in Washington has grown. And in the absence of genuine entitlement reform, it’s just a matter of time before the United States morphs into a bankrupt European-style welfare state.

And as government becomes bigger and bigger, diverting more and more resources from the productive sector of the economy, we can expect more stagnation and misery.

That’s why October 3 is an awful day in American history. All the bad results described above were made possible by the income tax.

P.S. It’s totally off topic, but I don’t think we should commemorate September 11. I’d much rather we celebrate May 1, which is the day that Osama bin Laden became fish food.

P.P.S. If the income tax facilitated today’s bloated government, it should go without saying that giving politicians another big source of revenue would lead to an even bigger burden of government. That’s why the value-added tax is such an awful idea.

P.P.P.S. Government also used to be very small in Western Europe before the income tax. Indeed, it was during that period when European nations became rich.

P.P.P.P.S. One could also argue that February 3 is the worst day in history because that’s when Delaware ratified the 16th Amendment, thus making an income tax constitutional.

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I’m normally reluctant to write about “depreciation” because I imagine eyes glazing around the world. After all, not many people care about the tax treatment of business investment expenses.

But I was surprised by the positive response I received after writing a post about Obama’s demagoguery against “tax loopholes” for corporate jets. So with considerable trepidation let’s take another look at the issue.

First, a bit of background. Every economic theory agrees that investment is a key for long-run growth and higher living standards. Even Marxist and socialist theory agrees with this insight (though they foolishly think government somehow is competent to be in charge of investments).

Let’s look at two remarkable charts, starting with one that shows the very powerful link between total investment and wages for workers.

As you can see (click the chart to see a larger version), if we want people to earn more money, it definitely helps for there to be more investment. More “capital” means that workers have higher productivity, and that’s the primary determinant of wages and salary.

Our second chart shows how the internal revenue code treats income that is consumed compared to how it penalizes income that is saved and invested. Simply stated, the current system is very biased against capital formation because of the combined impact of capital gains taxes, corporate income taxes, double taxes on dividends, and death taxes.

Indeed, one of the reasons why the right kind of tax reform will generate more prosperity is that double taxation of saving and investment is eliminated. With either a flat tax or national sales tax, economic activity is taxed only one time. No death tax, no capital gains tax, no double tax on dividends in either plan.

All of this background information helps underscore why it is especially foolish for the tax code to specifically penalize business investment. And this happens because companies have to “depreciate” rather than “expense” their investments.

Here’s how I described depreciation in my post on corporate jets.

If a company purchases a jet for $20 million, they should be able to deduct – or expense – that $20 million when calculating that year’s taxable income… A sensible tax system defines profit as total revenue minus total costs – including purchases of private jets. But today’s screwy tax code forces them to wait five years before fully deducting the cost of the jet (a process known as depreciation). Given that money today has more value than money in the future, this is a penalty that creates a tax bias against investment (the tax code also requires depreciation for purchases of machines, structures, and other forms of investment).

And I also addressed the issue when writing about the economic illiteracy in one of the Obama-Romney debates.

Now let’s see what some experts on the topic have to say.

Here’s some very sage analysis from Alan Viard of the American Enterprise Institute.

…a deal that cuts the corporate rate could end up doing more harm than good. The problem is that Congress and the Obama administration are thinking of pairing the rate cut with a slow-down of companies’ depreciation deductions. That’s a bad combination. A key goal of corporate tax reform should be to reduce the tax penalty on business investment. Investments in equipment, factories, and other forms of capital help power the long-run economic growth that boosts wages and living standards for American workers. …If depreciation is slowed down enough to offset the full revenue loss from the rate cut, then there’s no reduction in the investment penalty, on balance. The depreciation changes take back with the left hand everything that the rate cut gives with the right hand. …In fact, the policy makes the tax penalty on new investments bigger. …Why is this bad combination being considered? Maybe because the rate cut is easy to understand and the harm of slower depreciation is easy to overlook. …Yes, let’s cut the corporate tax rate. But, let’s not slow down depreciation to pay for it.

Amen. Proposals to lower America’s destructively high corporate tax rate are needed, but I don’t want politicians “paying for” the change with other policies that are similarly harmful to growth and competitiveness.

Margo Thorning of the American Council for Capital Formation adds some wisdom with her column in today’s Wall Street Journal.

…proposals that would increase the tax burden on capital-intensive industries—which are contributing to U.S. economic growth and employment—should be viewed with caution. …stretching out depreciation allowances reduces a company’s annual cash flow and raises the “hurdle rate” that new investments would have to meet before they are approved. For capital-intensive firms in sectors such as energy, manufacturing, utilities and transportation, the trade-off between delayed cash flow and lower corporate income-tax rates may result in cutbacks in capital spending. …Each additional $1 billion in investment is associated with 23,000 new jobs, according to data from the Department of Commerce and the Bureau of Labor Statistics. …Rather than drawing out depreciation schedules, a better, pro-growth approach to corporate tax reform would be to allow all investment to be expensed—in other words, deducted from income in the first year.

I share Margo’s concerns, which is why I’m very suspicious when the President says he wants to lower the corporate tax rate and “reform” the system.

Last but not least, Matt Mitchell (no relation) of the Mercatus Center recently added his two cents to the discussion.

The idea that “accelerated” depreciation is a loophole can be traced back to Stanley Surrey, the Harvard law professor whose work in the 1950s, 60s, and 70s influenced many…, including Senator Bill Bradley. …immediate expensing would mean abandoning “the attempt to tax business income.” That’s because it would essentially turn the corporate income tax into a corporate consumption tax. And that may be a good thing. Capital taxation is notoriously inefficient. This is one reason why Robert Hall and Alvin Rabushka permitted immediate 100 percent expensing in their famous flat consumption tax.

You should realize, by the way, that the distorted view of what’s a loophole doesn’t just apply to depreciation. The Joint Committee on Taxation (the same folks who basically assume that the revenue-maximizing tax rate is 100 percent) also tells lawmakers that it’s a loophole if you don’t double-tax capital gains, or if you allow people to avoid double taxation by utilizing IRAs.

With advice like that, no wonder the tax code is a mess.

Anyhow, congratulations are in order. If you’ve made it this far, you almost surely know more about depreciation than every single politician in Washington. Though, to be sure, that’s not exactly a big achievement.

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Two months ago exactly, I appeared on TV to talk about the concept of eliminating the personal and corporate income tax in Louisiana.

Now Governor Jindal has unveiled a specific proposal.

The plan will eliminate two major tax types: personal income tax and corporate income and franchise tax. Eliminating income taxes in a revenue-neutral manner and improving sales tax administration will dramatically simplify Louisiana’s tax system and reduce administrative problems for families and small businesses. The effective start date of the program is January 1, 2014. …The plan will ensure revenue neutrality by…[b]roadening the state sales tax base and raising the state rate to 5.88%.

This is a superb plan.

Of all the possible ways for a state to generate revenue, the income tax is the most destructive.

My new man crush

That’s why researchers consistently have found that states without this punitive levy grow faster and create more jobs.

It’s also worth noting that jurisdictions such as Monaco, Bermuda, and the Cayman Islands manage to be very prosperous in the absence of an income tax, though the incredible wealth of these places is partly a function of bad policy elsewhere, so the comparison isn’t perfect.

Anyhow, Gov. Jindal expands on this research with some very powerful data.

Over the last ten years, more than 60 percent of the three million new jobs in American were created by the nine states without an income tax. Every year for the past 40 years, states without an income tax had faster growth than states with the highest income taxes.  Economic growth in the nine states without income taxes was 50 percent faster than in the nine states with the highest top income tax rates.  Over the past decade, states without income taxes have seen nearly 60 percent higher population growth than the national average. …While we have reversed the more than two-decade problem of out-migration, we can do more to keep people here. Here are a couple of staggering statistics. Between 1995 and 2010, according to IRS data, Louisiana lost $3 billion in adjusted gross income to Texas.

Amen.

I particularly like that he recognizes the power of tax competition as an argument for better tax policy. Taxpayers win when Texas and Louisiana compete to have less oppressive tax systems.

Indeed, this should help explain why I am so fixated on the importance of making governments compete with each other. Simply stated, governments are very prone to over-tax and over-spend if they think taxpayers have no escape options.

So let’s keep our fingers crossed that Gov. Jindal’s proposal gets a friendly reception from the state legislature.

If he succeeds, I imagine he will vault himself to the top tier of Republicans looking to replace Obama.

And, who knows, maybe he can reinvigorate the argument that we can replace the corrupt internal revenue code with a national sales tax?

P.S. Jindal is good on more than just tax policy. He’s already implemented some good school choice reform, notwithstanding wretched and predictable opposition from the state’s teachers’ union.

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What’s the worst thing about Delaware?

No, not Joe Biden. He’s just a harmless clown and the butt of some good jokes.

Instead, the so-called First State is actually the Worst State because 100 years ago, on this very day, Delaware made the personal income tax possible by ratifying the 16th Amendment.

Though, to be fair, I suppose the 35 states that already had ratified the Amendment were more despicable since they were even more anxious to enable this noxious levy (and Alabama was first in line, which is a further sign that Georgia deserved to win the Southeastern Conference Championship Game, but I digress).

Let’s not get bogged down in details. The purpose of this post is not to re-hash history, but to instead ask what lessons we can learn from the adoption of the income tax.

The most obvious lesson is that politicians can’t be trusted with additional powers. The first income tax had a top tax rate of just 7 percent and the entire tax code was 400 pages long. Now we have a top tax rate of 39.6 percent (even higher if you include additional levies for Medicare and Obamacare) and the tax code has become a 72,000-page monstrosity.

But the main lesson I want to discuss today is that giving politicians a new source of money inevitably leads to much higher spending.

Here’s a chart, based on data from the Office of Management and Budget, showing the burden of federal spending since 1789.

Since OMB only provides aggregate spending data for the 1789-1849 and 1850-190 periods, which would mean completely flat lines on my chart, I took some wild guesses about how much was spent during the War of 1812 and the Civil War in order to make the chart look a bit more realistic.

But that’s not very important. What I want people to notice is that we enjoyed a very tiny federal government for much of our nation’s history. Federal spending would jump during wars, but then it would quickly shrink back to a very modest level – averaging at most 3 percent of economic output.

Federal Spending 1789-2012

So what’s the lesson to learn from this data? Well, you’ll notice that the normal pattern of government shrinking back to its proper size after a war came to an end once the income tax was adopted.

In the pre-income tax days, the federal government had to rely on tariffs and excise taxes, and those revenues were incapable of generating much revenue for the government, both because of political resistance (tariffs were quite unpopular in agricultural states) and Laffer Curve reasons (high tariffs and excise taxes led to smuggling and noncompliance).

But once the politicians had a new source of revenue, they couldn’t resist the temptation to grab more money. And then we got a ratchet effect, with government growing during wartime, but then never shrinking back to its pre-war level once hostilities ended (Robert Higgs wrote a book about this unfortunate phenomenon).

The same thing happened in Europe. The burden of government spending used to be quite modest on the other side of the Atlantic, with outlays consuming only about 10 percent of economic output.

Once European politicians got the income tax, however, that also enabled a big increase is the size of the state.

But Europe also gives us a very good warning about the dangers of giving politicians a second major source of revenue.

Here’s a chart I prepared for a study published when I was at the Heritage Foundation. You’ll notice from 1960-1970 that the overall burden of government spending in Europe was not that different than it was in the United States.

That’s about the time, however, that the European governments began to impose value-added taxes.

The rest, as they say, is history.

VAT and Govt Spending in EU

I’m not claiming, by the way, that the VAT is the only reason why the burden of government spending expanded in Europe. The Europeans also impose harsher payroll taxes and higher energy taxes. And their income taxes tend to be much more onerous for middle-income households.

But I am arguing that the VAT helped enable bigger government in Europe, just like the income tax decades earlier also enabled bigger government in both Europe and the United States.

So ask yourself a simple question: If we allow politicians in Washington to impose a VAT on top of the income tax, do you think they’ll use the money to expand the size and scope of government?

If it takes more than three seconds to answer that question, I suggest you emigrate to France as quickly as possible.

P.S. You probably won’t be surprised to learn that the crazy bureaucrats at the Paris-based OECD think the VAT is good for growth and jobs. Sort of makes you wonder why we’re subsidizing those statists with American tax dollars.

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How do you define a terrible team? No, this isn’t going to be a joke about Notre Dame foolishly thinking it could match up against a team from the Southeastern Conference in college football’s national title game (though the Irish win the contest for prettiest make-believe girlfriends).

I’m asking the question because a winless record is usually a good indication of a team that doesn’t know what it’s doing and is in over its head.

With that in mind, and given the White House’s position that class warfare taxation is good fiscal policy, how should we interpret a recent publication from the Tax Foundation, which reviews the academic research on taxes and growth and doesn’t find a single study supporting the notion that higher tax rates are good for prosperity.

None. Zero. Nada. Zilch.

Twenty-three studies found a negative relationship between taxes and growth, by contrast, while three studies didn’t find any relationship.

For those keeping score at home, that’s a score of 0-23-3 for the view espoused by the Obama Administration.

This new Tax Foundation report is also useful if you want more information to debunk the absurd study from the Congressional Research Service that claimed no relationship between tax policy and growth. Indeed, the TF report even explains that serious methodological flaws made “the CRS study unpublishable in any peer-reviewed academic journal.”

So what do we find in the Tax Foundation report?

…what does the academic literature say about the empirical relationship between taxes and economic growth? While there are a variety of methods and data sources, the results consistently point to significant negative effects of taxes on economic growth even after controlling for various other factors such as government spending, business cycle conditions, and monetary policy. In this review of the literature, I find twenty-six such studies going back to 1983, and all but three of those studies, and every study in the last fifteen years, find a negative effect of taxes on growth.

And what does this mean?

…results support the Neo-classical view that income and wealth must first be produced and then consumed, meaning that taxes on the factors of production, i.e., capital and labor, are particularly disruptive of wealth creation. Corporate and shareholder taxes reduce the incentive to invest and to build capital. Less investment means fewer productive workers and correspondingly lower wages. Taxes on income and wages reduce the incentive to work. Progressive income taxes, where higher income is taxed at higher rates, reduce the returns to education, since high incomes are associated with high levels of education, and so reduce the incentive to build human capital. Progressive taxation also reduces investment, risk taking, and entrepreneurial activity since a disproportionately large share of these activities is done by high income earners.

To be blunt, the report’s findings suggest the Obama White House is clueless about tax policy.

…there are not a lot of dissenting opinions coming from peer-reviewed academic journals. More and more, the consensus among experts is that taxes on corporate and personal income are particularly harmful to economic growth… This is because economic growth ultimately comes from production, innovation, and risk-taking.

Here’s my cut-and-paste copy of the table summarizing all the academic research.

Taxes and growthTaxes and growth 2Taxes and Growth 3Taxes and Growth 4Taxes and Growth 5

So what’s the bottom line? The Tax Foundation report concludes with the following.

In sum, the U.S. tax system is a drag on the economy.  Pro-growth tax reform that reduces the burden of corporate and personal income taxes would generate a more robust economic recovery and put the U.S. on a higher growth trajectory, with more investment, more employment, higher wages, and a higher standard of living.

In other words, America would be more prosperous with a simple and fair system such as the flat tax.

Too bad the political elite is more focused on maintaining (or even exacerbating) a corrupt status quo, even if it means less prosperity for the nation.

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I’m a big fan of the flat tax as a way of neutering the punitive and convoluted internal revenue code in Washington.

But I’m even more aggressive at the state level.

That’s why I’m very excited about a new proposal from Governor Bobby Jindal of Louisiana.

He’s already implemented some good school choice reform, notwithstanding wretched and predictable opposition from the state’s teachers’ union.

Now he wants to get rid of the state’s personal and corporate income taxes.

This would be a big and bold step, and I shared some evidence recently showing that states with no income tax grow faster and create more jobs.

I also discussed Jindal’s proposal last week on Fox Business News.

Some people probably think Jindal is pushing this agenda merely because he may run for President in 2016.

My attitude is “so what?”

Income Tax? The answer is NO

So long as he implements better policy, I don’t care if he’s motivated by a Ouija board.

But since he has a reputation for being a policy wonk, I suspect his motivations are to make Louisiana a more prosperous state.

And if bold reform also happens to increase his national stature, I’m sure he’s more than happy to reap any political benefits.

If he succeeds, Louisiana will enjoy more growth.

Equally important, as I stated in the interview, his success would show that Obama’s class-warfare agenda may have some appeal in basket-case states such as California, but it doesn’t have much support among people who understand that growth is the only effective (and moral) way of achieving a better life.

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One of the key ways of controlling state and local tax burdens, according to this map from the Tax Foundation, is to not have an income tax.

But that’s not too surprising. States have just a couple of ways of generating significant tax revenue, so it stands to reason that states without an income tax would have relatively low tax burdens.

Light-blue states have no broad-based income tax

The more important question is whether this approach leads to better economic performance. The evidence is pretty clear that zero-income-tax states grow faster and create more jobs.

I’ve already shared some important research on this topic, including this review of research in the Cato Journal by Richard Rahn, as well as this summary of similar analysis in Rich States, Poor States by Art Laffer and Steve Moore.

There’s even some evidence that people in low-tax states are happier than those in high-tax states, though I’m not sure that I trust that kind of subjective research since there’s also a study showing people are happier in high-tax nations.  (at least, unlike Brazil, nobody in the U.S. is talking about making happiness a responsibility of government).

Let’s return to the more substantive topic of taxes and economic performance. There’s a column examining this issue in today’s Wall Street Journal. Authored by two experts from the Kansas Policy Institute, it finds that states with no income tax have a lower burden of government spending.

In the midst of a dismal recovery where every job counts, one fact stands out: States that tax less achieve better economic performance. …The secret to having low taxes is controlling spending, and that’s exactly what low-tax-burden states do. States with an income tax spent 42% more per resident in 2011 than the nine states without an income tax. …Every state has public schools, social-service programs, prisons, etc. Some just find ways to provide essentially the same basket of services at lower prices.

They also reveal that lower taxes and lower spending translate into more growth and prosperity.

States that allow taxpayers and employers to keep more of their earnings are reaping the benefits. States without an income tax have significantly better growth in private sector GDP (59% versus 42%) over the last 10 years. They increased the number of jobs by 4.9% while jobs in the rest of the states declined by 2.6%. States without an income tax gained population (+5.5%) from domestic migration (U.S. residents moving in and out of states) while all other states as a whole lost 1.3% of population between 2000 and 2009.

The migration data is particularly powerful, and it’s one of the reasons why California’s class-warfare tax policy is so suicidal and why Texas is growing so rapidly. As I’ve said many times before, tax competition is a critical way of disciplining profligate governments and rewarding jurisdictions with more responsible fiscal policy.

Last but not least, if you want a powerful example of why income taxes are economic poison, read this research showing how Connecticut’s economic performance dropped after imposing a state income tax about 20 years ago.

P.S. Here’s a list of America’s greediest state and local governments, as measured by top income tax rates and most onerous sales tax systems.

P.P.S. Here’s the famous Moocher Index of state dependency, and you’ll notice that states with no income tax are more likely to be near the bottom of the list (with Alaska being a notable – but not surprising – exception).

P.P.P.S. And if you like state fiscal data, the Cato Institute’s Fiscal Policy Report Card on America’s Governors shows which states are moving in the wrong direction and right direction.

P.P.P.P.S. According to this map from a left-wing group, it also seems that states with no income tax do a better job of controlling welfare spending.

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The half-joking response to the question in the title of this post is that policymakers should look at what’s happening in poorly run jurisdictions such as California, France, Illinois, and Greece – and then do just the opposite.

In other words, steer clear of punitive class-warfare tax rates and make sure to control the burden of government spending.

But there’s an even simpler rule that is very correlated with good fiscal policy, at least at the state level. Governments should not impose income taxes.

If you look at this map from the Tax Foundation, you’ll notice that there is a heavy overlap between the 10 states with the lowest overall tax burdens and the 9 states (Alaska, Florida, New Hampshire, Nevada, South Dakota, Tennessee, Texas, Washington, Wyoming) that don’t have income taxes.

More specifically, 7 of the non-income tax states are among the 10 states with the lowest tax burdens. Only Florida and Washington are outside the top 10.

It’s also worth noting that some of the states with the most “progressive” income tax systems are well represented on the list of the 10-worst states – including California, New York, New Jersey, Maine, and Rhode Island.

One important implication of this data is that proponents of limited government should never give politicians a new source of revenue, which is why fighting the value-added tax is one of my main priorities (and why advocates of small government should be worried not just about Obama winning re-election, but also worried about Romney winning).

P.S. New Hampshire and Tennessee impose income taxes on certain forms of capital income, so they are only probationary and tenuous members of the no-income-tax club.

P.P.S. Politicians from Illinois will probably complain that they didn’t make the 10-worst list, but they shouldn’t be too worried. The Tax Foundation was looking at 2010 data and Illinois almost surely will be closer to the bottom when the 2011 data gets released and includes the impact of the midnight, end-of-session, post-2010 election tax hike imposed by the state’s kleptocrat politicians.

P.P.P.S. For a humorous – but accurate – perspective on the VAT, take a look at these clever cartoons (here, here, and here).

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What Do Greece, the United States, and the Cayman Islands Have in Common?

At first, this seems like a trick question. After all, the Cayman Islands are a fiscal paradise, with no personal income tax, no corporate income tax, no capital gains tax, and no death tax.

By contrast, Greece is a bankrupt, high-tax welfare state, and the United States sooner or later will suffer the same fate because of misguided entitlement programs.

But even though there are some important differences, all three of these jurisdictions share a common characteristic in that they face fiscal troubles because government spending has been growing faster than economic output.

I’ve written before that the definition of good fiscal policy is for the private sector to grow faster than the government. I’ve humbly decided to refer to this simple principle as Mitchell’s Golden Rule, and have pointed out that bad things happen when governments violate this common-sense guideline.

In the case of the Cayman Islands, the “bad thing” is that the government is proposing to levy an income tax, which would be akin to committing fiscal suicide.

The Cayman Islands are one of the world’s richest jurisdictions (more prosperous than the United States according to the latest World Bank data), in part because there are no tax penalties on income and production.

So why are the local politicians considering a plan to kill the goose that lays the golden eggs? For the simple reason that they have been promiscuous in spending other people’s money. This chart shows that the burden of government spending in the Cayman Islands has climbed twice as fast as economic output since 2000.

Much of this spending has been to employ and over-compensate a bloated civil service (in this respect, Cayman is sort of a Caribbean version of California).

In other words, the economic problem is that there has been too much spending, and the political problem is that politicians have been trying to buy votes by padding government payrolls (a problem that also exists in America).

The right solution to this problem is to reduce the burden of government spending back to the levels in the early part of last decade. The political class in Cayman, however, hopes it can prop up its costly bureaucracy with a new tax – which euphemistically is being called a “community enhancement fee.”

The politicians claim the tax will only be 10 percent and will only be imposed on the expat community. But it’s worth noting that the U.S. income tax began in 1913 with a top rate of only 7 percent and it affected less than 1 percent of the population. But that supposedly benign tax has since become a monstrous internal revenue code that plagues the nation today.

Except the results will be even worse in Cayman because the thousands of foreigners who are being targeted easily can shift their operations to other zero-income tax jurisdictions such as Bermuda, Monaco, or the Bahamas. Or they can decide that to set up shop in places such as Hong Kong and Singapore, which have very modest income tax burdens (and the ability to out-compete Cayman in other areas).

As a long-time admirer of the Cayman Islands, I desperately hope the government will reconsider this dangerous step. The world already has lots of examples of nations that are following bad policy. We need a few places that are at least being semi-sensible.

By they way, I started this post with a rhetorical question about the similarities of Greece, the United States, and the Cayman Islands. Let’s elaborate on the answer.

Here’s a post that shows how Greece’s fiscal nightmare developed. But let’s show a separate chart for the burden of federal spending in the United States.

What’s remarkable is that the federal government and the Cayman Islands government have followed very similar paths to fiscal trouble. Indeed, Caymanian politicians have achieved the dubious distinction of increasing the burden of government spending at a faster rate than even Bush and Obama. No mean feat.

This data for the U.S. chart doesn’t include the burden of state and local government spending, so the Cayman Islands still has an advantage over the United States, but I’ll close with a prediction.

Cayman’s proposed income tax

If the Cayman Islands adopts an income tax – regardless of whether they call it a community enhancement fee (to misquote Shakespeare, a rotting fish on the beach by any other name would still smell like crap), it will be just a matter of time before the burden of government spending becomes even more onerous and Cayman loses its allure and drops from being one of the world’s 10-richest jurisdictions.

Which will be very sad since I’ll now have to find a different place to go when America suffers its Greek-style fiscal collapse.

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I wrote last week about the destructive and self-defeating impact of high state taxes. Simply stated, when states such as California, Illinois, and New York get too greedy, the geese with the golden eggs fly across the border.

And that was one of my main points in this CNBC debate about state governments and class-warfare tax policy with Jared Bernstein.

Since you never get the opportunity to make all your points in an interview, here are a few additional thoughts.

  • Jared admits that tax rates can get too high, but then he claims that the Laffer Curve only exists “in the heads of people like Dan and Arthur Laffer.” Those are mutually inconsistent statements.
  • Jared seems to think it’s important that big business is siding with big government in Oklahoma and supporting the income tax. But that’s hardly a surprise since large companies often prefer corporatism.
  • Jared actually cited Massachusetts and New Jersey as low-tax states, a point that even the host thought was a bit kooky. I guess this means France is a low-tax country in Jared’s fantasy world.

But I also think I made a mistake. When asked how states can get rid of their income taxes, I mentioned that sales taxes do less damage – per dollar raised – than income taxes. That’s true, but I should have stated first and foremost that states should reduce the burden of government spending.

One final point. This cartoon shows what eventually happens in a tax-and-spend society.

P.S. Jared was the co-author of the infamous study claiming that Obama’s so-called stimulus would keep the unemployment rate below 8 percent. Look at this chart and draw your own conclusions.

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Putting Republicans in charge is never a guarantee of good public policy. It was during the Bush years, for instance, that the nation was saddled with a prescription drug entitlement. The GOPers in the White House and on Capitol Hill also recklessly increased the burden of government spending. And they expanded the “affordable lending requirements” on Fannie Mae and Freddie Mac, thus helping to create the housing crisis.

More recently, a majority of Republicans in the House and Senate voted to expand corporate welfare by increasing the authority of the corrupt Export-Import Bank. And that’s after voting last year to increase housing subsidies!

But this doesn’t mean all Republicans are bad. Ronald Reagan unambiguously was a net plus for freedom, and congressional Republicans mostly tried to do the right thing in the mid-1990s.

The main thing to understand is that there is an ongoing fight inside the Republican Party between those who want to do the right thing and those who see politics as a means of accumulating and exercising power.

The latest example of this battle is taking place in Oklahoma, where the Governor has proposed to eliminate the state income tax and her main opponents are members of the corrupt GOP establishment.

The Wall Street Journal has editorialized on the issue, and makes all the correct points.

Do Republicans stand for economic growth and tax reform, or not? That question is on the table in Oklahoma, where GOP Governor Mary Fallin has a plan to cut and eventually eliminate the income tax. Her main opposition: fellow Republicans in the state Senate. …Ms. Fallin points to decades of evidence that America’s nine no-income tax states have had superior population, income and job growth. The case for a Sooner State tax cut has taken on new urgency because neighboring Texas has no income tax and Missouri, Kansas and Nebraska are working toward or have already enacted rate cuts this year. …A cavalcade of lobbyists, including local Chambers of Commerce, teachers unions and welfare groups are fighting the tax cut. The Tulsa and Oklahoma City Chambers are pleading for corporate welfare that benefits politically connected large corporations, rather than rate cuts for all businesses.

I’m no longer surprised when I read about the Chamber of Commerce supporting bad policy. Big business rarely is a friend of freedom.

But I am very disappointed to read that economists at some of the state universities have climbed into bed with the political elite.

Last week economists on the public payroll from the University of Oklahoma and Oklahoma State came out against the tax cut. Cynthia Rogers of OU said that the evidence on whether income-tax cuts help the economy is “inconclusive.” Maybe in the faculty lounge. But Oklahomans can see the jobs bonanza across the border in Texas, which pays its bills with a sales tax. …Meanwhile, states with some of the highest income-tax rates—California, Maryland and Illinois—have had the toughest time keeping out of the red. New Hampshire, Tennessee, Florida and others that don’t levy an income tax manage to balance their budget nearly every year.

The WSJ makes a very good point about real-world evidence. Texas and California are both role models, and they demonstrate that states with no income taxes kick the you-know-what of states with class-warfare fiscal systems.

Unfortunately, some Oklahoma Republicans care more about political power than the well-being of the people.

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Other than my ongoing adulation for Ronald Reagan, occasional praise for Calvin Coolidge, and one post about John F. Kennedy, I don’t have many nice things to say about previous Presidents.

But I feel the need to rise to the defense of Rutherford B. Hayes, who was mocked recently by the current President. This Mark Steyn column is a deliciously vicious commentary on Obama’s speech, so no need for me to delve into the details.

Instead, I want to jump on the bandwagon and produce some posters comparing the 19th President and the 44th President (if you’re not aware, posters of Pres. Hayes with self-created captions have been all over the Internet).

You won’t be surprised to learn that I’m focused on the policy differences between Hayes and Obama.

Most important, Hayes largely was true to the Founding Fathers’ vision of a limited central government. Government spending averaged only about 6 percent of economic output during his tenure (probably less, the data are not very robust, so I took the worst-case numbers) and America was blessedly free of the income tax.

Obama, on the other hand, is repeating all of Bush’s mistakes and making government an even bigger burden, and then compounding his error by pursuing class warfare tax policy.

So which President would you prefer, Hayes or Obama?

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As a Yankees fan, it was particularly exciting that Derek Jeter became only the second player to get his 3000th hit with a home run.

As a student of human nature, it was remarkable that the fan who caught the ball, Christian Lopez, returned it to Jeter instead of selling it for as much as $300,000.

As a libertarian, it is disgusting that the jackboots at the IRS have now gotten involved by threatening to tax Mr. Lopez because the Yankees repaid his generosity with luxury box seat s and signed memorabilia. Here are some of the details from NBC New York.

The tax man may be on the hunt for the super fan who caught Derek Jeter’s 3,000th hit. Christian Lopez, 23, recovered the prized ball his father fumbled after The Captain hammered it into their section of the stands in the third inning of the Yankees’ win over Tampa Bay on Saturday. The Verizon salesman from Highland Mills, N.Y., gave the ball back to Jeter, whom he called an “icon,” and the Yankees lavished a slew of prizes, including luxury box seats for every remaining home game this season and post-season and some signed memorabilia.  Now the IRS wants a piece. The prizes Lopez received are estimated to be worth more than $32,000 — and, like game show contestants, Lopez may have to pay taxes on the gifts and prizes because the IRS considers them income. Some estimate the IRS will put Lopez on the hook for anywhere between $5,000 and $13,000, reports the Daily News.

The only thing missing from this story is whether the thugs at the IRS also plan to tax Jeter for the value of the ball. Actually, I probably shouldn’t have mentioned that idea. But, then again, it’s highly unlikely that IRS bureaucrats are reading a blog dedicated to liberty.

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Most people fantasize about supermodels (at least most guys, I have no clue about females). But I’m different. I dream about a world with limited government, sort of like what America’s Founding Fathers had in mind.

One of the best things about this fantasy world is that we would not need an income tax. Indeed, with the exception of brief periods during the Civil War and 1894-1895, America did just fine without an income tax all the way ’til 1913.

But even though I like the idea of a society where none of us is burdened by an income tax, it does not automatically follow that I’m happy about the growing number of people that are now exempted from the tax.

My concern revolves around the fact that if government is “free” for a growing number of people, that may lead them to support policies that make government even bigger. More generally, this could be another step toward becoming a failed state like Greece, with too many people riding in the wagon and not enough people pulling the wagon.

Here’s a chart, showing the most-recent breakdown of taxpayers vs. non-taxpayers, from the Ways & Means Committee.

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Read it and weep. Or maybe I should say look at it and weep.

I suppose this is a good time to recycle my flat tax video. I don’t mention this in the video, but Hong Kong’s flat tax system, which has been around for more than 60 years, requires less than 200 pages. Slovakia’s flat tax law is thinner than a magazine.

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My fight for freedom often requires great sacrifice. Last month, I went to Monaco and spoke about financial regulation and bailouts. Today, I’m in Bermuda, where I just gave a speech about tax competition.

Both jurisdictions are remarkable places, among the richest places on the planet. And remarkably scenic, as illustrated by this picture I took from my balcony.

What makes Bermuda’s success especially admirable is that it is a genuinely multiracial society, with blacks comprising a slight majority of the population and playing major roles in both politics and finance.

One would think, therefore, that leftists would see Bermuda as a role model.

But that would be a mistaken assumption. Bermuda actually is a bad place from a left-wing perspective because the jurisdiction is guilty of two unforgivable sins.

First, like Monaco, Bermuda has no income tax. This makes the small island a terrible role model for statists. After all, wouldn’t it be awful if other places learned from Bermuda’s success and abandoned class-warfare tax policy?

Second, Bermuda is (gasp) a tax haven. This means that it attracts jobs and capital from high-tax nations. Not surprisingly, this is even more upsetting to leftists since it makes it difficult for other nations to impose class-warfare tax policy.

In other words, the left wants power for government even more than it wants prosperous multiracial societies. But that’s not exactly a surprise. Prosperous people, after all, generally are not sympathetic to ideological movements based on high tax rates and bloated government.

For folks who want more information, here’s a video that explains the economic benefits of tax havens.

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One of my many frustrations of working in Washington is dealing with perpetual-motion-machine assertions. The classic example is Keynesian economics, which is based on the notion that you magically create additional economic activity by having the government spend money instead of allowing the private sector to decide how it gets spent (in an especially bizarre display of this thinking, Nancy Pelosi actually said that subsidizing unemployment was the best way to create jobs).

Another example of this backwards analysis can be found in the debate over the IRS budget. The President is resisting a GOP proposal to modestly trim the IRS’s gargantuan $12.5 billion budget and his argument is that we should actually boost funding for the tax collection bureaucracy since that will mean more IRS agents squeezing more money out of more taxpayers.

Here are some excerpts from an Associated Press report about the controversy.

Every dollar the Internal Revenue Service spends for audits, liens and seizing property from tax cheats brings in more than $10, a rate of return so good the Obama administration wants to boost the agency’s budget.House Republicans, seeing the heavy hand of a too-big government, beg to differ. They’ve already voted to cut the IRS budget by $600 million this year and want bigger cuts in 2012. …IRS Commissioner Doug Shulman told the committee Tuesday that the $600 million cut in this year’s budget would result in the IRS collecting $4 billion less through tax enforcement programs. The Democrat-controlled Senate is unlikely to pass a budget cut that big. But given the political climate on Capitol Hill, Obama’s plan to increase IRS spending is unlikely to pass, either. Obama has already increased the IRS budget by 10 percent since he took office, to nearly $12.5 billion. The president’s budget proposal for 2012 would increase IRS spending by an additional 9 percent — adding 5,100 employees. …Obama’s 2012 budget proposal for the IRS includes $473 million and 1,269 new positions to start implementing the health care law.

Unlike Keynesian economics, there actually is some truth to Obama’s position. The fantasy estimate of $10 of new revenue for every $1 spent on additional bureaucrats is clearly ludicrous, but it is equally obvious that many Americans would send less money to Washington if they didn’t have to worry about a coercive and powerful tax-collection bureaucracy that had the power to throw them in jail.

This is an empirical question, at least with regards to the narrow issue of whether more IRS agents “pay for themselves” by shaking down sufficient numbers of taxpayers. Reducing the number of IRS bureaucrats by 90 percent, from about 100,000 to 10,000, for instance, surely would be a net loss to the government since the money saved on IRS compensation would be trivial compared to the loss of tax revenue.

But that doesn’t mean that a reduction of 10,000 or 20,000 also would lead to a net loss. And it certainly does not mean that adding 10,000 or 20,000 more IRS agents will result in enough new revenue to compensate for the salaries and benefits of a bigger bureaucracy. Even left-wing economists presumably understand the concept of diminishing returns.

But let’s assume that the White House is correct and that more IRS agents would be a net plus from the government’s perspective. The Administration would like us to reflexively endorse a bigger and more aggressive IRS, but public policy should not be based on what is a “net plus” for the government.

There are two ways to promote better tax compliance. The Obama approach, as we’ve read above, is to expand the size and power of the IRS. Up to a point, this policy can be “successful” in extracting additional money from the productive sector of the economy.

The alternative approach, by contrast, seeks better compliance by lowering tax rates and reforming/simplifying tax systems. This course of action boosts compliance by making evasion and avoidance less attractive. People are much less likely to cheat if the government isn’t being too greedy, and they’re also more likely to comply if they think there is less waste, fraud, corruption, and favoritism in the tax code.

Let’s now put this discussion in context. Obama wants more IRS agents in large part to enforce his new scheme for government-run healthcare. Yet that’s a perfect example of what I modestly call Mitchell’s Law – politicians doing one bad thing (expanding the IRS) only because they did another bad thing (enacting a health care bill that made the tax code even more convoluted and punitive).

So instead of making the IRS bigger in response to a bad healthcare law, why not repeal that bad law and shrink the size of the IRS? Even better, why not junk the entire tax code so we can replace the IRS with a system that is honest and fair?

And if these big steps are not immediately feasible, at least cut the IRS budget so that awful laws are enforced in a less destructive manner.

This Center for Freedom and Prosperity video has additional details about the national nightmare we call the IRS.

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The world is a laboratory and different nations are public policy experiments. Not surprisingly, the evidence from these experiments is that nations with more freedom tend to grow faster and enjoy more prosperity. Nations with big governments, by contrast, are more likely to suffer from stagnation.

The same thing happens inside the United States. The 50 states are experiments, and they generate considerable data showing that small government states enjoy better economic performance. But because migration between states is so easy (whereas migration between nations is more complicated), we also get very good evidence based on people “voting with their feet.” Taxation and jobs are two big factors that drive this process.

Looking at the census data and matching migration data with state tax systems, here’s what Michael Barone wrote. He finds (not that anyone should be surprised) that the absence of a state income tax is correlated with faster growth, which attracts people from high-tax states.

…growth tends to be stronger where taxes are lower. Seven of the nine states that do not levy an income tax grew faster than the national average. The other two, South Dakota and New Hampshire, had the fastest growth in their regions, the Midwest and New England. Altogether, 35 percent of the nation’s total population growth occurred in these nine non-taxing states, which accounted for just 19 percent of total population at the beginning of the decade.

And here’s Diana Furtchtgott-Roth, writing for Realclearmarkets.com. She uses the presence of right-to-work laws (which prohibit union membership as a condition of employment) as a proxy for the degree to which big government and big labor are imposing restrictions on efficient employment markets. Not surprisingly, the states that have a market-friendly approach create more jobs and therefore attract more workers.

The American people have been voting with their feet, the Census Bureau announced on Tuesday, leaving states with heavy union influence and choosing to live in “right-to-work” states with higher job growth where they cannot be forced to join a union as a condition of employment. …As a result of geographic shifts in population uncovered by the 2010 Census, nine congressional seats will move to right-to-work states from forced unionization states. Some winners are Texas, Florida, Arizona, Georgia, and South Carolina, while losers include New York, Ohio, Michigan, Illinois, and New Jersey. Over the past 25 years job growth in right-to-work states has been over twice as high as in unionized states.

This leaves us with one perplexing question. If we know that pro-market policies work for states, why does the crowd in Washington push for more statism?

Welcome, Instapundit readers. Since many of you might not be regular readers of International Liberty, the important lesson to learn from the Census data is that federalism is good because state governments have to compete against each other, and this helps restrain the greed of politicians. The same principle operates at the international level, which is why tax competition is such a powerful force for liberty.

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When all you have is a hammer, everything begins to look like a nail. That old saying makes a lot of sense. As a tax economist, I’m sometimes guilty of looking at all sorts of issues based on their relationship with the tax code. In my defense, however, the tentacles of the IRS now reach into almost every nook and cranny of our society. And greedy tax collectors on the state and local level make a bad situation even worse. Two things from today’s inbox illustrate my point.

First, you may remember that the IRS is going to be a chief enforcer of Obamacare. Well, our friends at the tax collection agency have just released a draft form for the “credit for small employer health insurance premiums.” We already have a tax system that takes up 72,000 pages and requires more than 1,000 different forms and publications, but now we can add 25 more lines of mind-numbing, eye-glazing bureaucratese, all of which doubtlessly will lead to innocent mistakes that cause many more taxpayers to have nightmarish interactions with the IRS. (click here to see a full-size version of the form)

Second, here’s an article on telecommuting which largely focuses on the environmental and quality-of-live advantages of people working from home. What does this have to do with taxes, you ask? It turns out that greedy state politicians have an annoying tendency of trying to tax people who live elsewhere. This form of taxation without representation imposes both bureaucratic and economic barriers that hinder an otherwise desirable development.

Possibly the biggest barrier to telework are state tax laws. Many states implement some form of double taxation on out-of-state teleworkers. For example, New York applies a “convenience of the employer” doctrine on out-of-state teleworkers who work for a New York–based organization, which requires them to pay income tax to New York for telework days outside of the state. All work done outside of New York is subject to New York income tax, unless the work is done outside of New York out of necessity to the employer . In 2005, the New York State Court of Appeals upheld the “convenience of the employer” doctrine in Huckaby vs. New York State Division of Tax Appeals. Thomas Huckaby, a Tennessee resident, worked for a New York–based company, but teleworked 75 percent of the time. On his New York State nonresident tax returns, Huckaby allocated 25 percent of his income to New York, and 75 percent to Tennessee; however, the New York State tax department determined that Huckaby should have paid New York income tax on 100 percent of his income. The court sided with the New York State tax department, stating that the doctrine was constitutionally applied. As many as 35 states have some form of double taxation for teleworkers.

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This is just a rumor, but some of the “stimulus” money has been spent to buy new pencil sharpeners for the IRS. Apparently, the new equipment puts agents in the right frame of mind before auditing taxpayers.

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Being a lazy procrastinator, I filed an extension April 15 and then waited until this weekend to do my tax return. This experience has reinforced my hatred and disdain for our corrupt and punitive tax system. I don’t even have a remotely complicated tax return, just a Cato salary and a few payments for articles and speeches on the income side, along with a standard set of itemized deductions for things like home mortgage interest.

But even dealing with a relatively simple tax return causes lots of angst and makes me long for a simple and fair flat tax. Actually, it makes me long for a limited government, as envisioned by our Founders, in which case we might not need any broad-based tax. And I suppose I shouldn’t blame the IRS. The real villains are the politicians who have spent the past 97 years turning the tax code into a monstrosity.

Now that I’m done venting, I suppose I should include some educational content. In honor of tax day for procrastinators, here are three videos on the flat tax, the IRS, and the global flat tax revolution.

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Caroline Baum of Bloomberg has an excellent column explaining why soak-the-rich taxes don’t work. Simply stated, wealthy people are not like you and me. They have tremendous control over the timing, composition, and level of their income. When the rich are hit with higher tax rates, they adjust their behavior and protect themselves by reducing the amount of taxable income they earn and/or report to the IRS. That usually causes collateral damage for the economy, but the class-warfare crowd is either oblivious or uncaring about real-world effects.

Why, after all this time and an extensive body of data, are we still questioning whether reductions in marginal and capital- gains tax rates increase economic activity enough to generate more revenue for the federal government? “Because they don’t like the answer,” Laffer says of the doubters. “It’s not tax cuts that pay for themselves. Tax cuts on the poor cost you lots of money. Tax cuts on the rich pay for themselves. Rich people can afford lawyers, accountants, and can defer income.” …The rich have the luxury to respond to incentives, to opt for more work and less leisure when the return on work is greater. They are motivated to take risks, maybe start a business, invent something, and get even richer while giving others the opportunity, through hiring, to do the same. The opposite is true for low-income workers. When the government raises taxes, someone struggling to put food on the table for his family may have to go out and get a second job to maintain his level of take-home pay. For this socio-economic group, higher taxes translate to more work. To ignore evidence that the rich behave differently is silly. The government can’t get more blood from a stone, yet it keeps trying. Instead of demagoguing tax cuts for the rich, Democrats should try embracing them for a change. …Academics are busy churning out articles claiming tax cuts for the rich deliver less bang for the buck because the rich save more of the money than the poor. That’s true. It also misses the point. The goal isn’t spending, or distributing other people’s money to create “aggregate demand.” That’s a wealth transfer, not a net stimulus. (Fiscal policy gets its punch from monetary policy, from the increase in the money supply to pay for the spending.) The goal should be to incentivize individuals to work hard, save and invest in the future. It’s about growing the pie. Sound familiar? We’re right back to square one. I, for one, would like to see the debate shift from class warfare over tax rates and targeted tax relief to tax reform. Either scrap the tax code and introduce a simple flat tax with no deductions, or scrap the IRS and move to a consumption tax. If you want to get money out of politics, there’s only one way to do it. Take the tax code out of Congress’s hands.

Baum’s column touches on most of the key issues, but she doesn’t address the political economy of class-warfare taxation. In this video on soak-the-rich tax policy, I provide five reasons why high tax rates are misguided – including the oft-overlooked point that politicians impose punitive taxes on the rich as a prelude to hitting the rest of us with higher taxes.

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I have a column in today’s New York Post about Obama’s plan for higher taxes next year. My main point is that higher tax rates on the so-called rich have a very negative impact on the rest of us because even small reductions in economic growth have a big impact over time. This is a reason, I explain, why middle-income people in Europe have been losing ground compared to their counterparts in the United States. This is an argument I’m still trying to develop (this video is another example), so I’d welcome feedback.

The most important indirect costs are lost economic growth and reduced competitiveness. You don’t have to be a radical supply-sider to recognize that higher tax rates — particularly steeper penalties on investors and entrepreneurs — are likely to slow economic growth. Even if growth only slows a bit, perhaps from 2.7 percent to 2.5 percent, the long-term impact can be big. After 25 years, a worker making $50,000 will make about $5,000 more a year if economic growth is at the slightly higher rate. So if this worker gets hit next year with a $1,000 tax hike, he or she understandably will be upset. In the long run, however, that worker may be hurt even more by weaker growth. …The Obama administration’s approach is to look at tax policy mainly through the prism of class warfare. This means that some of the 2001 and 2003 tax cuts can be extended, but only if there is no direct benefit to anybody making more than $200,000 or $250,000 per year. That’s bad news for the so-called rich, but what about the rest of us? This is why the analysis about direct and indirect costs is so important. The folks at the White House presumably hope that we’ll be happy to have dodged a tax bullet because only upper-income taxpayers will face higher direct costs. But it’s the rest of us who are most likely to suffer indirect costs when higher tax rates on work, saving, investment and entrepreneurship slow economic growth. When the economy slows, that’s bad news for the middle class — and it can create genuine hardship for the working class and poor. Indeed, punitive taxation of the “rich” is one reason why middle-class people in high-tax European welfare states have lost ground in recent decades compared to Americans.

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Supporters of the Cleveland Cavaliers, especially the owner of the team, are upset that basketball superstar LeBron James has decided to sign with the Miami Heat. The anger is especially intense because the Cavaliers offered $4 million more over the next five years. But their anger is misplaced, because more money in Cleveland, Ohio, actually translates into about $1 million less disposable income when the burden of state and local income taxes is added to the equation. Rather than condemn James for making a rational choice, local basketball fans should tar and feather Ohio politicians. This story from CNBC walks through the calculations.
…if you match up what James’ salary would be for the first five years in Cleveland and the five years in Miami, you find that the Cavaliers are only offering him $4 million more. That advantage gets erased — and actually gives the Heat the monetary edge over — when you consider the income tax difference. …Playing in Cleveland, LeBron would face a state income tax of 5.925 percent, plus a Cleveland city tax of two percent. Over the first five years of a new contract with Cleveland, James would give back $3,953,060 combined to the state and city for the 41 games each season he’d play at home. But James would have to pay none of that for home games in Miami since Florida doesn’t have an income tax. Athletes have to pay income taxes to states that they play in on the road, so the games he’ll play away from home — whether he played for Cleveland or Miami — are essentially a wash. But there are, on average, 11 away games per season where James would have to pay Ohio and Cleveland taxes. Why? Because he has to pay when he plays in the six areas – Florida, Texas, Washington D.C., Illinois, Toronto and Tennessee – that have no jock taxes. That’s another $1,061,128 he’ll have to pay in taxes that he wouldn’t have to pay in Miami.
New York basketball fans also should be angry. With some of the highest taxes in the nation, many of which target highly productive people as part of a class-warfare policy, New York is bad news for professional athletes. The New York Post, commenting on the probability that James would sign with the Miami Heat, identified the real villains.
…blame our dysfunctional lawmakers in Albany, who have saddled top-earning New Yorkers with the highest state and city income taxes in the nation, soon to be 12.85 percent on top of the IRS bite. There is no state income tax in Florida. On a five-year contract worth $96 million — what he’d get from the Knicks or the Heat — LeBron would pay $12.34 million in New York taxes. Quite a penalty for the privilege of working in Midtown.
Now let’s look at the big picture. The calculations that LeBron James made when deciding to sign with the Miami Heat are the same calculations that companies make when deciding whether to build factories and create jobs. So when people wonder why high-tax states such as Ohio, California, and New York are losing jobs to zero-income tax states such as Florida and Texas, part of the answer should be obvious. And if we move to the global level, folks should not be too surprised that companies and investors, all other things equal, are likely to avoid the United States, with its punitive 35 percent corporate tax, and instead create jobs and build wealth in places such as Hong Kong, Ireland, and Switzerland.

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I did a post yesterday about the IRS screwing up and sending housing tax credits to prison inmates. Apparently, the 100,000 bureaucrats at the IRS were unable to put 2 and 2 together and realize that jailbirds – by definition – are not buying new homes. I also appeared on MSNBC to talk about the issue, and took the opportunity to explain that much of the blame belongs with politicians who created a tax code that nobody understands.

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