A Simple Choice: Barack Obama or Rutherford Hayes?

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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Baseball, Hot Dogs, Apple Pie, and Chevrolet…and the IRS

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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I Fantasize about a World with No Income Tax, but…

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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A Very Depressing Picture of Tax Complexity and Political Corruption

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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Greetings from Bermuda – a Multiracial Paradise Disliked by the Left

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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Republicans Are Right to Cut the IRS Budget

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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According to Census Data, People Vote with their Feet for Less Government

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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Two More Reasons to Hate Taxes

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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IRS Pencil Sharpener

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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Time for Some IRS Bashing

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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The Destructive Economics of Class-Warfare Taxation

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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Pontificating about Class Warfare Taxation in the New York Post

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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Jilted Basketball Fans Should Blame the Income Tax, not LeBron James

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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Talking About IRS Incompetence on MSNBC

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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Great Moments in Government Stupidity

There really isn’t much I can add to this story in USA Today about the IRS giving money to prisoners. Yes, it is a story about typical government incompetence. But it also shows the inevitable problems that occur when government engages in industrial policy and social engineering via the tax code. Let’s call this argument 1,549,628 in favor of the flat tax.

Despite efforts by the IRS to combat scams, thousands of individuals — including nearly 1,300 prison inmates — have defrauded the government of millions of dollars in home buyer credits, Treasury’s inspector general reported Wednesday. …1,295 prisoners, including 241 serving life sentences, received $9.1 million in credits, even though they were incarcerated at the time they reported that they purchased their home. These prisoners didn’t file joint returns, so their claims could not have been the result of purchases made with or by their spouses, the report said. 2,555 taxpayers received $17.6 million in credits for homes purchased before the dates allowed by law. 10,282 taxpayers received credits for homes that were also used by other taxpayers to claim the credit. In one case, 67 taxpayers used the same home to claim the credit.

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Tax Freedom Day in the U.K. Video

The Taxpayers Alliance has a brief but compelling video, entitled “How long do you work for the tax man?,” which shows how an ordinary worker in the United Kingdom spends more than one-half his day laboring for government. “What will they tax next?” is still the best policy video to come out of the U.K., in my humble opinion, but this one is very much worth watching – especially since America is becoming more like Europe with each passing day.

What makes the video particularly depressing is that it only considers the tax burden. Regulations and government spending also are a burden on average workers, largely because of foregone economic growth.

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Obamacare Means IRS Nightmare for Small Business

We’ve looked at this issue before, but this new CNN article fleshes out the awful IRS rules in the new healthcare bill:

The massive expansion of requirements for businesses to file 1099 tax forms that was hidden in the 2,409-page health reform bill took many by surprise when it came to light last month. …The result: A blizzard of new tax forms that the Internal Revenue Service will begin rolling out next year. …Starting in 2011, financial firms that process credit or debit card payments will be required to send their clients, and the IRS, an annual form documenting the year’s transactions. …The 1099 changes attached to the health care reform bill are another kettle of fish. These massively expand the requirements for filing the “1099-Misc” form, which companies use for recording payments to freelance workers and other individual service providers. Until now, payments to corporations have been exempt from 1099 rules, as have payments for the purchase of goods. Starting in 2012, that changes. All business payments or purchases that exceed $600 in a calendar year will need to be accompanied by a 1099 filing. That means obtaining the taxpayer ID number of the individual or corporation you’re making the payment to — even if it’s a giant retailer like Staples or Best Buy — at the time of the transaction, or else facing IRS penalties. …SMC’s survey found that extending 1099s just to services purchased from corporations would push that number to at least 200 filings per year for a typical small business — adding an estimated $6,000 to the cost of preparing the average tax return. And that’s without even accounting for the requirement that 1099s be filed for purchases of goods, a provision that Henschke’s group didn’t see coming when it conducted its survey last year. “These folks are doing their paperwork in the evenings and on the weekends already,” he says. “This certainly adds to the burden substantially.”

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Greetings from Austria

I spoke yesterday in Vienna on the third stop on the FMRS tour. My speech focused on solutions to the fiscal crisis. I pointed out the need to substantially reduce the burden of government spending and also warned against higher tax rates – in part because higher tax rates discourage much-needed economic growth.

This puts me in direct conflict with many European politicians, many of whom think extracting more money from taxpayers is the answer to the over-spending problem. Some of these politicians try to sound more rational by saying they don’t necessarily want to boost tax rates and instead would be happy to collect more money by more onerous enforcement of existing tax laws.

I don’t think it is reasonable to expect big reductions in the underground (or shadow) economy. In a previous post, I quoted an IMF paper authored by Friedrich Schneider, which noted (with particular reference to Austria):

Macroeconomic and microeconomic modeling studies based on data for several countries suggest that the major driving forces behind the size and growth of the shadow economy are an increasing burden of tax and social security payments… The bigger the difference between the total cost of labor in the official economy and the after-tax earnings from work, the greater the incentive for employers and employees to avoid this difference and participate in the shadow economy. …Several studies have found strong evidence that the tax regime influences the shadow economy. …In Austria, the burden of direct taxes (including social security payments) has been the biggest influence on the growth of the shadow economy… Other studies show similar results for the Scandinavian countries, Germany, and the United States. In the United States, analysis shows that as the marginal federal personal income tax rate increases by one percentage point, other things being equal, the shadow economy grows by 1.4 percentage points. …A study of Quebec City in Canada shows that people are highly mobile between the official and the shadow economy, and that as net wages in the official economy go up, they work less in the shadow economy. This study also emphasizes that where people perceive the tax rate as too high, an increase in the (marginal) tax rate will lead to a decrease in tax revenue.

Interestingly, I just came across a new study from the Bank of Italy that looks at the issue from the perspective of “taxpayer morale.” The study finds that tax compliance also is sensitive to public perceptions about whether taxpayer money is being wasted. This excerpt touches on many of the key issues, and all I could think of when reading the study was bailouts, handouts, and other forms of corrupt and inefficient spending on both sides of the Atlantic:

…our measure of public spending inefficiency enters with the expected negative sign, and it is significant at the 1 percent level. Taxpayers interacting with a more efficient public sector are likely to show a higher level of tax morale. Our result can be interpreted by looking at the interaction between citizens and the government as a contractual relationship, implying duties and rights for each contract partner. If the taxpayer observes that the tax burden is not spent efficiently, he will feel cheated and his willingness to cooperate will fall. …Torgler and Werner (2005) state that greater fiscal autonomy allows regions to spend the tax revenues according to local preferences and this, in turn, might have a positive impact on tax morale. …As expected, the coefficient on the level of public spending per capita enters with a positive sign, and it is significantly different from zero. On the other side, we find a weak positive relationship between fiscal autonomy and tax morale, thus partially confirming the results by Torgler and Werner (2005). At the same time, the coefficient of public spending inefficiency remains negative and highly significant. …We find that tax morale is higher when the taxpayer perceives and observes that the government is efficient; that is, it provides a fair output with respect to the revenues. This evidence can be interpreted in terms of a psychological contract between taxpayer and fiscal authorities in which the former punishes the local government when he observes that resources are not spent well. Therefore, encouraging more efficient spending of public resources has wider consequences and contributes to increasing the citizens’ propensity to pay taxes.

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The Capital Gains Tax Rate Should Be Zero

Every economic theory – even socialism and Marxism – agrees that saving and investment (a.k.a., capital formation) are a key to long-run growth and higher living standards. Yet the tax code penalizes with double taxation those who are willing to forego current consumption to finance future prosperity. This new Center for Freedom and Prosperity video explains why the capital gains tax should be abolished.

Unfortunately, Obama wants to go in the wrong direction. He wants to boost the official capital gains tax rate from 15 percent to 20 percent – and that is after imposing a back-door 3.8 percentage point increase in the tax rate as part of his government-run healthcare scheme.

Share this post with your friends and neighbors. If enough people understand why the capital gains tax is a job killer that reduces American competitiveness, perhaps the wrong thing won’t happen.

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Don’t Give Up on the American People…at Least not Yet

Gloominess and despair are not uncommon traits among supporters of limited government – and with good reason. Government has grown rapidly in recent years and it is expected to get much bigger in the future. To make matters worse, it seems that the deck is stacked against reforms to restrain government. One problem is that 47 percent of Americans are exempt from paying income taxes, which presumably means they no longer have any incentive to resist big government. Mark Steyn recently wrote a very depressing column for National Review Online about this phenomenon, noting that, “By 2012, America could be holding the first federal election in which a majority of the population will be able to vote themselves more government lollipops paid for by the ever shrinking minority of the population still dumb enough to be net contributors to the federal treasury.” Walter Williams, meanwhile, has a new column speculating on whether this cripples the battle for freedom:

According to the Tax Policy Center, a Washington, D.C., research organization, nearly half of U.S. households will pay no federal income taxes for 2009…because their incomes are too low or they have higher income but credits, deductions and exemptions that relieve them of tax liability. This lack of income tax liability stands in stark contrast to the top 10 percent of earners, those households earning an average of $366,400 in 2006, who paid about 73 percent of federal income taxes. …Let’s not dwell on the fairness of such an arrangement for financing the activities of the federal government. Instead, let’s ask what kind of incentives and results such an arrangement produces and ask ourselves whether these results are good for our country. …Having 121 million Americans completely outside the federal income tax system, it’s like throwing chum to political sharks. These Americans become a natural spending constituency for big-spending politicians. After all, if you have no income tax liability, how much do you care about deficits, how much Congress spends and the level of taxation?

Steyn and Williams are right to worry, but the situation is not as grim as it seems for the simple reason that a good portion of the American people know the difference between right and wrong. Consider some of the recent polling data from Rasmussen, which found that “Sixty-six percent (66%) believe that America is overtaxed. Only 25% disagree. Lower income voters are more likely than others to believe the nation is overtaxed” and “75% of voters nationwide say the average American should pay no more than 20% of their income in taxes.” These numbers contradict the hypothesis that 47 percent of Americans (those that don’t pay income tax) are automatic supporters of class-warfare policy.

So why are the supposed free-riders not signing on to the Obama-Reid-Pelosi agenda? There are probably several reasons, including the fact that many Americans believe in upward mobility, so even if their incomes currently are too low to pay income tax, they aspire to earn more in the future and don’t want higher tax rates on the rich to serve as a barrier. I’m not a polling expert, but I also suspect there’s a moral component to these numbers. There’s no way to prove this assertion, but I am quite sure that the vast majority of hard-working Americans with modest incomes would never even contemplate breaking into a rich neighbor’s house and stealing the family jewelry. So it is perfectly logical that they wouldn’t support using the IRS as a middleman to do the same thing.

A few final tax observations:

The hostility to taxation also represents opposition to big government (at least in theory). Rasumssen also recently found that, “Just 23% of U.S. voters say they prefer a more active government with more services and higher taxes over one with fewer services and lower taxes. …Two-thirds (66%) of voters prefer a government with fewer services and lower taxes.” 

There is a giant divide between the political elite and ordinary Americans. Rasmussen’s polling revealed that, “Eighty-one percent (81%) of Mainstream American voters believe the nation is overtaxed, while 74% of those in the Political Class disagree.”

Voters do not want a value-added tax or any other form of national sales tax. They are not against the idea as a theoretical concept, but they wisely recognize the politicians are greedy and untrustworthy. Rasumussen found that “just 26% of all voters think that it is even somewhat likely the government would cut income taxes after implementing a sales tax. Sixty-six percent (66%) believe it’s unlikely to happen.” 

Fiscal restraint is a necessary precondition for any pro-growth tax reform. If given a choice between a flat tax, national sales tax, value-added tax, or the current system, many Americans want reform, but it is very difficult to have a good tax system if the burden of government spending is rising. Likewise, it would be very easy to have a good tax system if we had a federal government that was limited to the duties outlined in Article I, Section VIII, of the Constitution.

Republicans should never acquiesce to higher taxes. All these good numbers and optimistic findings are dependent on voters facing a clear choice between higher taxes and bigger government vs lower taxes and limited government. If Republicans inside the beltway get seduced into a “budget summit” where taxes are “on the table,” that creates a very unhealthy dynamic where voters instinctively try to protect themselves by supporting taxes on somebody else – and the so-called rich are the easiest target.

Last but not least, I can’t resist pointing out that I am part of a debate for U.S. News & World Report on the flat tax vs. the current system. For those of you who have an opinion on this matter, don’t hesitate to cast a vote.

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Current System, Flat Tax, Fair Tax, or Value-Added Tax?

Here are four very short videos produced from an in-office interview I did at the Heartland Institute last week. Which tax system do you prefer?

I talk about the current internal revenue code…

…and the flat tax…

…and the national sales tax (Fair Tax)…

…and the value-added tax.

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International Evidence Shows Spending Restraint Is Best Way to Address Red Ink

Tyler Cowen’s recent New York Times column explains how nations as diverse as Ireland, Sweden, and Canada have successfully solved fiscal problems by limiting the growth of government spending:

America’s long-run fiscal outlook is bleak, mostly because of an aging population and rising health care costs. To close the gap between expenditures and revenue, …we’ll need to focus especially on reducing spending, largely because that taxes on the wealthy can be raised only so high. …Higher income tax rates would discourage hard work and encourage tax avoidance, thereby defeating the purpose of the tax increases. …Higher levels of government spending and taxation would also soak up resources that might otherwise foster innovation and new businesses. And sentiment would most likely turn ever stronger against those immigrants who consume public services and make the deficit higher in the short run. …The macroeconomic evidence also suggests the wisdom of emphasizing spending cuts. In a recent paper, Alberto Alesina and Silvia Ardagna, economics professors at Harvard, found that in developed countries, spending cuts were the key to successful fiscal adjustments — and were generally better for the economy than tax increases. …The received wisdom in the United States is that deep spending cuts are politically impossible. But a number of economically advanced countries, including Sweden, Finland, Canada and, most recently, Ireland, have cut their government budgets when needed. Most relevant, perhaps, is Canada, which cut federal government spending by about 20 percent from 1992 to 1997.

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Yes, High Tax Rates Change Behavior and Discourage Income

I’ve read several places that Ronald Reagan instinctively understood supply-side economics because Hollywood stars sooner or later learned that making more than a couple of movies per year was pointless when marginal tax rates were 90 percent. The same thing happens in sports. I’ve already posted about soccer stars turning down contracts in places where tax rates are high. Now we have a fascinating little story about taxes and the boxing profession:

For a very long time, boxing was the only really big-money sport for athletes. …At a time when Babe Ruth was being razzed for his $80,000 salary (more than the President of the United States, it was pointed out, to which Babe supposedly replied in 1930, “Well, I had a better year than he [President Hoover] did”), heavyweight champion Jack Dempsey made about nine times as much—over $700,000, for his unsuccessful title defense against Gene Tunney in 1926. …The 1950s was the era of the 90 percent top marginal tax rate, and by the end of that decade live gate receipts for top championship fights were supplemented by the proceeds from closed circuit telecasts to movie theaters. A second fight in one tax year would yield very little additional income, hardly worth the risk of losing the title. And so, the three fights between Floyd Patterson and Ingemar Johansson stretched over three years (1959-1961); the two between Patterson and Sonny Liston over two years (1962-1963), as was also true for the two bouts between Liston and Cassius Clay (Muhammad Ali) (1964-1965). Then, the Tax Reform Act of 1964 cut the top marginal tax rate to 70 percent effective in 1965. The result: two heavyweight title fights in 1965, and five in 1966.

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George Will Says No VAT Unless 16th Amendment Is Repealed

As usual, some very sound thoughts – on both the value-added tax and the income tax – from George Will:

When liberals advocate a value-added tax, conservatives should respond: Taxing consumption has merits, so we will consider it — after the 16th Amendment is repealed. A VAT will be rationalized as necessary to restore fiscal equilibrium. But without ending the income tax, a VAT would be just a gargantuan instrument for further subjugating Americans to government. …Because the income tax is not broadly based, it radiates moral hazard: Its incentives are for perverse behavior. The top 1% of earners provide 40% of that tax’s receipts; the top 5% provide 61%; the bottom 50% provide 3%. So the tax makes a substantial majority complacent about government’s growth. Increasingly, the income tax is codified envy. A VAT is the political class’s recourse when the resources of the minority that is targeted by the envious are insufficient to finance ravenous government.

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Awful Tax System Causing a Growing Number of Americans to “Go Galt”

Being an American citizen is an honor in many ways, but it is a huge millstone around the neck for highly successful investors and entrepreneurs because of an oppressive and complex tax system. This is particularly true for those based in and/or competing in global markets. Indeed, because the tax system (and regulatory system) is so onerous and because it is expected to get far worse in the future, a growing number of Americans are actually giving up citizenship and “voting with their feet.” The politicians view these people as “tax traitors” and are trying to erect higher barriers to hinder economic migration, particularly in the form of confiscatory “exit taxes” that are disturbingly reminiscent of the totalitarian practices of some of the world’s most unsavory regimes. The Wall Street Journal recently reported on this issue:

The number of American citizens and green-card holders severing their ties with the U.S. soared in the latter part of 2009, amid looming U.S. tax increases and a more aggressive posture by the Internal Revenue Service toward Americans living overseas. According to public records, just over 500 people world-wide renounced U.S. citizenship or permanent residency in the fourth quarter of 2009, the most recent period for which data are available. That is more people than have cut ties with the U.S. during all of 2007, and more than double the total expatriations in 2008. An Ohio-born entrepreneur, now based in Switzerland, told Dow Jones he is considering turning in his U.S. passport. Mounting U.S. tax and reporting requirements are making potential business partners hesitate to do business with him, he said. “I still do dearly love the U.S., and renouncing my citizenship is not something I take lightly. But more and more it is seeming like being part of a dysfunctional family,” said the businessman, who asked that his name not be used for fear of retribution. “The tax itself is only a small part of the issue,” the Swiss-based entrepreneur said. “It’s the overall regulatory environment.” …”Fifteen or 20 years ago there was a big rush to make sure your kids became U.S. citizens, for access to U.S. schools for example,” said Timothy Burns, a tax lawyer at Withers law firm in Hong Kong. “Now we’re seeing just the opposite.” Last month, the Treasury Department announced more rigorous requirements for Americans living abroad to report information on foreign bank accounts. The reporting requirement has been in place for years, but only in the most recent couple of years has the IRS gotten tough about enforcing penalties. …Others are giving up their U.S. nationality to avoid tax increases in the U.S., as the government struggles under huge budget deficits. The top marginal tax rate is set to rise to 39.6% from 35% at the end of this year. A proposal to tax fund manager pay at ordinary income rates, instead of the 15% capital gains rate, is gaining currency in Congress. “Everybody sees the tax rates are going up. At a certain point, it gets beyond people’s pain threshold,” said Anthony Tong, a tax partner at accounting firm PricewaterhouseCoopers in Hong Kong. Unlike most jurisdictions, the U.S. taxes the income of citizens and green-card holders no matter where in the world it is earned.

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New Video Exposes Nightmare of IRS Complexity

Here’s a new Economics 101 video about the cost of the tax code from the Center for Freedom and Prosperity. I won’t spoil the surprise by giving the details, but you if you’re not angry now, you will be after watching.

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Europe Should Not Copy America’s Imperialist and Anti-Growth Worldwide Tax Regime

The overall fiscal burden in the United States may be lower than it is in Europe, but there are some features of the internal revenue code that are far worse than what can be found on the other side of the Atlantic. America has a “worldwide” tax system, for instance, which means that our government interferes with the sovereignty of other nations by taxing income earned by Americans inside their borders. Good tax policy, by contrast, relies on the “territorial” principle of only taxing income earned inside national borders – and every other developed nation uses this system. Not surprisingly, both the flat tax and national sales tax are based on this common-sense approach. If an American earns income in Hong Kong, it should be up to Hong Kong to decide how that money gets taxed. Likewise, if a German earns money in the United States, then he is fair game for the IRS. There’s an old saying that good fences make good neighbors, and territorial taxation is the fiscal policy equivalent of this sound rule. Not surprisingly, however, other nations want to mimic this horrible feature of the American tax code. The Financial Times is even urging European nations to jointly make that misguided choice. Fortunately, it is almost certain that some nations will refuse to join in such a statist cartel:

The US is unique in using citizenship in determining whether a person’s worldwide income is subject to taxation. Most countries do not impose tax on their citizens who are not resident within their borders – apart from any income that is sourced in that country. But the US system has much to commend it. After all, any citizen of a country enjoys the implicit legal and physical protection it affords. …provision is made to avoid double taxation. Moreover, there is an exit for individuals who do not accept it as they can renounce their citizenship and move elsewhere. But perhaps the best thing about it is that a worldwide system linked to citizenship is simple and easy to understand. Most American citizens do accept it, although more have handed back their passports recently. It would be hard for, say, the UK or Germany to introduce such a system unilaterally. There would be the risk of citizens jurisdiction-hopping by swapping one passport for another within a common economic area. But all European Union states could introduce the same rule. That would not be impossible. After all, EU countries already co-ordinate their policies on savings taxes and their tax authorities exchange information.

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Debating another Neurotic Silver-Spoon Leftist

I’ve always thought it would be nice to inherit a big pile of money, but whenever I debate some trust-fund collectivist, it makes me wonder whether there’s too much risk that unearned wealth causes…well, let’s just say causes strange opinions. Here’s my recent debate on Kudlow’s show with a rich guy who wants to pay more tax to the crooks in Washington.

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Ultra-Rich Leftists Want to Atone for their Guilt by Paying Higher Taxes…And They Want to Impose their Neurotic Views on the Rest of Us

A Washington Post columnist reports on a group of limousine liberals who are lobbying to pay more taxes. Of course, there’s no law that prevents them from writing big checks to the government and voluntarily paying more, so what they’re really lobbying for is higher taxes on the vast majority of investors and entrepreneurs who don’t want more of their income confiscated by the clowns in Washington and squandered on corrupt and inefficient programs. I debated one of these guilt-ridden, silver-spoon, trust-fund rich people on CNN last year and never got an answer when I asked him why he wanted to pull up the ladder of opportunity for the rest of us who would like to become rich some day. Here’s what the Post reported on the issue:

A group of liberals got together Tuesday and proved that they, too, can have a tax rebellion. But theirs is a little bit different: They want to pay more taxes. “I’m in favor of higher taxes on people like me,” declared Eric Schoenberg, who is sitting on an investment banking fortune. He complained about “my absurdly low tax rates.” “We’re calling on other wealthy taxpayers to join us,” said paper-mill heir Mike Lapham, “to send the message to Congress and President Obama that it’s time to roll back the tax cuts on upper-income taxpayers.” …For them, Obama’s plan to “spread the wealth” (by raising taxes on families earning more than $250,000) is too conservative. “The Obama plan we don’t think goes far enough,” Lapham protested. “We think probably more like the top 5 percent should have their taxes raised.” That would be those above $200,000. “Or go beyond that,” he suggested. … They are among 50 families with net assets of more than $1 million to take a “tax fairness” pledge — donating the amount they saved from Bush tax cuts to organizations fighting for the repeal of the Bush tax cuts. According to a study by Spectrem Group, 7.8 million households in the United States have assets of more than $1 million — so that leaves 7,799,950 millionaire households yet to take the pledge. …Of course, if millionaires really want to pay higher taxes, there’s nothing stopping them. The Treasury Department Web site even accepts contributions by credit card to pay the public debt. …His donation will, however, ease the sense of guilt that comes with great wealth, described poignantly by the millionaires: “In 1865, my great-great-grandfather Samuel Pruyn founded a paper mill on the banks of the Hudson River in Glens Falls, New York,” Lapham explained. Judy Pigott, an industrial heiress on the call, added her wish that her income, “mostly unearned income, be taxed at a rate that returns to the common good that I have received by a privilege.” Confessed Hollender, who now runs the Seventh Generation natural products company: “I grew up in Manhattan on Park Avenue in a 10-room apartment.”

P.S. It’s also rather revealing that Massachusetts had (and maybe still has) a portion of the state tax form allowing people to pay extra tax, yet very rich statists like John Kerry decided not to pay that tax while urging higher taxes for mere peasants like you and me.

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Taxing the Rich Won’t Raise Revenue – but Will Hurt the Economy

Writing in the Wall Street Journal, my Cato Institute colleague Alan Reynolds offers a simple economics lesson about pitfalls of class-warfare tax policy:

…the evidence is clear that when marginal tax rates go up, the amount of reported incomes goes down. Economists call that “the elasticity of taxable income” (ETI), and measure it by examining income tax returns before and after marginal tax rates claimed a bigger slice of income reported to the IRS. The evidence is surveyed in a May 2009 paper for the National Bureau of Economic Research by Emmanuel Saez of the University of California at Berkeley, Joel Slemrod of the University of Michigan, and Seth Giertz of the University of Nebraska. They review a number of studies and find that “for an elasticity estimate of 0.5 . . . the fraction of tax revenue lost from behavioral responses would be 43.1%.” That elasticity estimate of 0.5 would whittle the Obama team’s hoped-for $1.2 trillion down to $671 billion. As the authors note, however, “there is much evidence to suggest that the ETI is higher for high-income individuals.” The authors’ illustrative use of a 0.5 figure is a perfectly reasonable approximation for most purposes, but not for tax hikes aimed at the very rich. For incomes above $100,000, a 2008 study by MIT economist Jon Gruber and Mr. Saez found an ETI of 0.57. But for incomes above $350,000 (the top 1%), they estimated the ETI at 0.62. And for incomes above $500,000, Treasury Department economist Bradley Heim recently estimated the ETI at 1.2—which means higher tax rates on the super-rich yield less revenue than lower tax rates. If an accurate ETI estimate for the highest incomes is closer to 1.0 than 0.5, as such studies suggest, the administration’s intended tax hikes on high-income families will raise virtually no revenue at all. Yet the higher tax rates will harm economic growth through reduced labor effort, thwarted entrepreneurship, and diminished investments in physical and human capital. And that, in turn, means a smaller tax base and less revenue in the future.

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