Archive for the ‘Supply-side economics’ Category

Is “supply-side economics” a bad thing or good thing?

It depends on what one means by the phrase. If it means that all tax cuts are self financing or that low tax burdens are the sole key to prosperity, then critics are right about it being a form of “voodoo economics.” See this Kevin Williamson column for more details.

But if the term is simply a shorthand way of saying that low marginal tax rates on productive behavior are a good thing because of better incentives for work, saving, investment, and entrepreneurship (not to mention tax compliance and good government), then supply-side economics should be non-controversial. See this piece by Alan Reynolds for more details.

As you might expect, folks on the left prefer the first definition of supply-side economics and they are instinctively hostile to big tax cuts. Especially during an election cycle.

Here’s the basic argument, from an article by John Cassidy in The New Yorker. He focuses his ire on Governor Bush, but his comments could just as easily been directed against other GOP candidates.

Here’s his basic premise.

…the Republican Party is heading on economic policy: back to the old-time religion of tax cuts. …Jeb Bush, the G.O.P. establishment’s standard-bearer, announced, as the centerpiece of his 2016 campaign, a plan to cut federal income-tax rates across the board. …wouldn’t this plan inflate the deficit, which President Obama and Congress have just spent five years trying to reduce, and also amount to another enormous handout to the one per cent? Not in the make-believe world of “voodoo economics”.

Mr. Cassidy is particularly incensed by the notion that some people believe tax cuts “pay for themselves” by generating sufficiently large amounts of additional taxable income.

The “voodoo” accusation arose from the claim that, because the policies would encourage people to work harder and businesses to invest more, a lot more taxable income would be produced, and the reductions in tax rates wouldn’t lead to a commensurate reduction in the amount of tax revenues that the government collected. Indeed, some early voodoo economists, such as Arthur Laffer, claimed that there wouldn’t be any drop in revenues. By 1988…more than half a decade of gaping budget deficits had discredited the most extreme and foolhardy version of voodoo economics.

For what it’s worth, there are several problems with the above passages.

First, while some GOPers did make exaggerated claims about the power of tax cuts, the Reagan White House never claimed the tax cuts would by self financing and instead made the very reasonable argument that lower tax rates would improve economic performance.

Second, the lower tax rates on upper-income taxpayers did lead to huge increases in taxable income and big increases in tax revenue, so there are a few examples where lower tax rates “pay for themselves.”

Third, the 1980-1982 double-dip recession was the main reason for higher deficits. Once the Reagan tax cuts were implemented, red ink began to shrink and even the Congressional Budget Office projected deficits would continue falling if Reagan’s policies were left on auto-pilot.

But let’s argue about the present rather than the past. Citing the work of some pro-Bush economists, Cassidy argues that tax cuts won’t generate as much growth as Governor Bush says he will deliver.

…the four conservative luminaries whom the Bush campaign rounded up to advise him…said that Bush’s tax plan would raise the growth rate of the economy by 0.5 per cent a year, and that the regulatory changes he is proposing would add another 0.3 per cent to the annual growth rate. But because the annual growth rate over the past five years has been 2.2 per cent, that gets us to three per cent growth, not the four per cent that Bush is promising to deliver.

Since economists are lousy forecasters, I won’t pretend to know how much additional growth the Bush economic plan would produce. But I’ll be the first to admit that Cassidy has found a gap between Bush’s rhetoric and the numbers produced by his advisers.

But does that mean big tax cuts are implausible and unrealistic?

Cassidy certainly would like readers to conclude that Bush’s plan doesn’t add up.

…the economists’ paper…makes the familiar argument that tax cuts, by stimulating growth, will lead to “revenue feedbacks.” On this basis, which is known on Capitol Hill as “dynamic scoring,” the economists reduce the estimated fiscal cost of the Bush tax cuts by two-thirds. But even a third of $3.6 trillion is a lot of red ink.

Though he (sort of) acknowledges that the Bush folks have a counter-argument.

So are the economists actually contradicting Bush and saying that his plan would expand the deficit? Not quite. …they write, “The remaining revenue loss would be offset by reasonable, incremental feedback effects from the tax and regulatory reforms, meaningful spending restraint across the federal budget…” Of course, Bush hasn’t said yet where he would cut spending

I don’t know if Governor Bush intends to produce a detailed list of ways to restrain government spending. Nor do I know whether he would follow through if he got elected (his record in Florida can be interpreted in different ways).

But I know that it’s actually very simple to have large tax cuts along with concomitant spending restraint.

And Bush’s economic advisers also understand. Take a look at these passages from their report. Citing a version of my Golden Rule, they point out that huge savings are possible simply by reducing how fast the government’s budget expands every year.

Budget discipline and economic prosperity go hand in hand. …federal spending restraint is essential to maximizing economic growth. …the Governor’s economic reforms require strong fiscal discipline on the federal budget ledger’s spending side. …the required budget goal can be achieved by reducing the growth in federal outlays from its current upward trajectory by one percentage point per year. From 2017 to 2025, federal expenditures are projected to increase at an annual rate of 4.2 percent. Limiting the increase to 3.2 percent will produce over $400 billion in budget savings in 2025 and $1.4 trillion in savings between 2017 and 2025.

Needless to say, we should have big – and immediate – reductions in government spending.

And if government is allowed to expand, it would be better if the budget grew at the rate of inflation (2 percent) rather than 3.2 percent.

That being said, it’s remarkable that even a little bit of spending restraint is capable of generating huge savings over a 10-year period. And those savings make big tax cuts very plausible. Even for the folks who myopically fixate on red ink when they should be worried about the overall burden of government spending.

So the real issue is not whether sizable tax cuts are plausible. It’s whether advocates of good tax policy are willing to impose accompanying discipline on the spending side of the fiscal ledger.

That means a President like Ronald Reagan or Bill Clinton rather than George Bush or Barack Obama.

Interestingly, Jeb Bush admits spending grew too fast while his brother was in office. Check out what he said toward the end of this interview.

For what it’s worth, I think the Bush White House was just as guilty as the GOP Congress, if not more, but that’s another fight over what happened in the past.

What really matters is that if Jeb Bush (or any other candidate for President) is serious about charting a different path and putting government on a diet, then big tax cuts are very realistic.

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

1. High tax rates that penalize productive behavior such as work and entrepreneurship.

2. Pervasive double taxation that undermines saving and investment.

3. Corrupt loopholes and cronyism that lure people into using resources inefficiently.

These problems all need to be addressed, along with additional problems with the internal revenue code, such as worldwide taxation and erosion of constitutional freedoms and civil liberties.

Based on these criteria, I’ve already reviewed the tax reform plan put forth by Marco Rubio. And I’ve analyzed the proposal introduced by Rand Paul.

Now let’s apply the same treatment to the “Reform and Growth Act of 2017” that former Florida Governor Jeb Bush has unveiled in today’s Wall Street Journal.

Bush identifies three main goals, starting with lower tax rates.

First, I want to lower taxes and make the tax code simple, fair and clear. …We will cut individual rates from seven brackets to three: 28%, 25% and 10%. At 28%, the highest tax bracket would return to where it was when President Ronald Reagan signed into law his monumental and successful 1986 tax reform.

This is a positive step, effectively wiping out the tax-rate increases imposed by Presidents George H.W. Bush, Bill Clinton, and Barack Obama.

Then Governor Bush takes aim at tax loopholes.

Second, I want to eliminate the convoluted, lobbyist-created loopholes in the code. For years, wealthy individuals have deducted a much greater share of their income than everyone else. We will retain the deductibility of charitable contributions but cap the deductions used by the wealthy and Washington special interests, enabling tax-rate cuts across the board for everyone.

This also is a step in the right direction, though it’s unclear what Bush is proposing – if anything – for other big tax loopholes such as the mortgage interest deduction, the healthcare exclusion, the state and local tax deduction, and the municipal bond exemption.

The final big piece of Jeb’s plan deals with America’s punitive treatment of business income.

Third, I believe that the tax code should no longer be an impediment to the nation’s competitiveness with China, Europe and the rest of the world. …To stop American companies from moving out of the country, I will cut the corporate tax rate from 35%—the highest in the industrial world—to 20%, which is five percentage points below China’s. We will end the practice of world-wide taxation on U.S. businesses, which fosters the insidious tactic called corporate “inversions.” …We will also allow businesses to fully and immediately deduct new capital investments—a critical step to increase worker productivity and wages.

All of these reforms are very good for growth.

A lower corporate tax rate, particularly combined with territorial taxation and “expensing” of investment expenditures, will make American companies far more competitive.

More important, these reforms will fix flaws in the tax code that reduce capital formation. And that will mean more investment and higher wages for American workers.

There are other positive features mentioned in the column that are worth celebrating. Governor Bush’s plan eliminates the death tax, which is an especially punitive form of double taxation.

His proposal also gets rid of the alternative minimum tax (AMT), which is a convoluted part of the tax code seemingly designed to grab more money from taxpayers in a very complicated fashion.

Now let’s move to a part of Bush’s plan that seems bad, but arguably is good. He’s proposing to get rid of interest deductibility for companies, which will increase double taxation (remember, investors who buy corporate bonds pay tax on the interest payments they receive from firms).

…we will eliminate most corporate tax deductions—which is where favor-seeking and lobbying are most common—and remove the deduction for borrowing costs. That deduction encourages business models dependent on heavy debt.

So why is this feature arguably good when one of the key goals of tax reform is eliminating double taxation?

For two reasons. First, we already have double taxation of dividends (i.e., equity-financed investment), so imposing double taxation on borrowing (i.e., debt-financed investment) creates a level playing field and addresses the bias for debt in the tax code.

To be sure, it would be best to level the playing field by having no double taxation of any kind, but presumably the Bush team also was paying attention to revenue constraints.

And this is the second reason why this portion of the plan arguably is good. The revenue implications of this change are non-trivial, so one could argue that it is helping to finance pro-growth changes such as a lower corporate tax rate and immediate expensing of business investment.

Let’s close by highlighting some unambiguously worrisome features of the Bush plan.

According to his column, an additional 15 million Americans no longer will have any income tax liability, largely because the plan almost doubles the standard deduction. It’s good for people not to have to pay tax, of course, but we already have a system where almost half of all households are exempt from the income tax. So the concern is that we have a growing share of the population that perceives government as a no-cost dispenser of goodies.

And one of those goodies is the Earned Income Tax Credit, which is a form of income redistribution operated through the tax code. And Bush is proposing to expand the EITC, though there aren’t any details about this part of his plan.

Presumably Bush is including these provisions to somewhat fend off the class-warfare attack that his plan provides big tax cuts for the “rich” while not doing enough for the rest of the population. Yet upper-income taxpayers already pay the lion’s share of the income tax.

Even the IRS has acknowledged that the top 3 percent pay more than half the burden!

So a fair tax cut, by definition, will benefit the rich since they’re the ones who are carrying the load.

In any event, the purpose of good tax policy is to generate faster growth by improving incentives for work, saving, investment, and entrepreneurship, and that’s where you get the big benefits for lower- and middle-income taxpayers.

Simply stated, the close you get to a Hong Kong-style flat tax, the closer you get to robust Hong Kong-type growth rates.

The bottom line is that Bush’s tax plan isn’t a touchdown. Like the Rubio plan and Paul plan, it’s not a Hall-Rabushka flat tax, which is the gold standard for tax reform. But it’s a big step in that direction. Bush takes the ball from the wrong side of the field and puts it on the right side of the field.

If implemented (and accompanied by the spending restraint needed to make the plan sustainable), Bush’s proposal would be a significant boost for the American economy and American taxpayers.

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Every so often, I’ll assert that some statists are so consumed by envy and spite that they favor high tax rates on the “rich” even if the net effect (because of diminished economic output) is less revenue for government.

In other words, they deliberately and openly want to be on the right side (which is definitely the wrong side) of the Laffer Curve.

Critics sometimes accuse me of misrepresenting the left’s ideology, to which I respond by pointing to a poll of left-wing voters who strongly favored soak-the-rich tax hikes even if there was no extra tax collected.

But now I have an even better example.

Writing for Vox, Matthew Yglesias openly argues that we should be on the downward-sloping portion of the Laffer Curve. Just in case you think I’m exaggerating, “the case for confiscatory taxation” is part of the title for his article.

Here’s some of what he wrote.

Maybe at least some taxes should be really high. Maybe even really really high. So high as to useless for revenue-raising purposes — but powerful for achieving other ends. We already accept this principle for tobacco taxes. If all we wanted to do was raise revenue, we might want to slightly cut cigarette taxes. …But we don’t do that because we care about public health. We tax tobacco not to make money but to discourage smoking.

The tobacco tax analogy is very appropriate.

Indeed, one of my favorite arguments is to point out that we have high taxes on cigarettes precisely because politicians want to discourage smoking.

As a good libertarian, I then point out that government shouldn’t be trying to control our private lives, but my bigger point is that the economic arguments about taxes and smoking are the same as those involving taxes on work, saving, investment.

Needless to say, I want people to understand that high tax rates are a penalty, and it’s particularly foolish to impose penalties on productive behavior.

But not according to Matt. He specifically argues for ultra-high tax rates as a “deterrence” to high levels of income.

If we take seriously the idea that endlessly growing inequality can have a cancerous effect on our democracy, we should consider it for top incomes as well. …apply the same principle of taxation-as-deterrence to very high levels of income. …Imagine a world in which we…imposed a 90 percent marginal tax rate on salaries above $10 million. This seems unlikely to raise substantial amounts of revenue.

I suppose we should give him credit for admitting that high tax rates won’t generate revenue. Which means he’s more honest than some of his fellow statists who want us to believe confiscatory tax rates will produce more money.

But honesty isn’t the same as wisdom.

Let’s look at the economic consequences. Yglesias does admit that there might be some behavioral effects because upper-income taxpayers will be discouraged from earning and reporting income.

Maybe…we really would see a reduction of effort, or at least a relaxation of the intensity with which the performers pursue money. But would that be so bad? Imagine the very best hedge fund managers and law firm partners became inclined to quit the field a bit sooner and devote their time to hobbies. What would we lose, as a society? …some would presumably just move to Switzerland or the Cayman Islands to avoid taxes. That would be a real hit to local economies, but hardly a disaster. …Very high taxation of labor income would mean fewer huge compensation packages, not more revenue. Precisely as Laffer pointed out decades ago, imposing a 90 percent tax rate on something is not really a way to tax it at all — it’s a way to make sure it doesn’t happen.

While I suppose it’s good that Yglesias admits that high tax rates have behavioral effects, he clearly underestimates the damaging impact of such a policy.

He presumably doesn’t understand that rich people earn very large shares of their income from business and investment sources. As such, they have considerable ability to alter the timing, level, and composition of their earnings.

But my biggest problem with Yglesias’ proposals is that he seems to believe in the fixed-pie fallacy that public policy doesn’t have any meaningful impact of economic performance. This leads him to conclude that it’s okay to rape and pillage the “rich” since that will simply mean more income and wealth is available for the rest of us.

That’s utter nonsense. The economy is not a fixed pie and there is overwhelming evidence that nations with better policy grow faster and create more prosperity.

In other words, confiscatory taxation will have a negative effect on everyone, not just upper-income taxpayers.

There will be less saving and investment, which translates into lower wages and salaries for ordinary workers.

And as we saw in France, high tax rates drive out highly productive people, and we have good evidence that “super-entrepreneurs” and inventors are quite sensitive to tax policy.

To be fair, I imagine that Yglesias would try to argue that these negative effects are somehow offset by benefits that somehow materialize when there’s more equality of income.

But the only study I’ve seen that tries to make a connection between growth and equality was from the OECD and that report was justly ridiculed for horrible methodology (not to mention that it’s hard to take serious a study that lists France, Spain, and Ireland as success stories).

P.S. This is my favorite bit of real-world evidence showing why there should be low tax rates on the rich (in addition, of course, to low tax rates on the rest of us).

P.P.S. And don’t forget that leftists generally view higher taxes on the rich as a precursor to higher taxes on the rest of the population.

P.P.P.S. In the interests of full disclosure, Yglesias says I’m insane and irrational.

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When I debate class warfare issues, here’s something that happens with depressing regularity.

I’ll cite research from a group like the Tax Foundation on how an overwhelming share of the income tax is borne by upper-income taxpayers.

The statist I’m arguing with will then scoff and say the Tax Foundation is biased, thus implying that I’m sharing bogus data.

I’ll then respond that the group has a very good reputation and that their analysis is directly based on IRS data, but I may as well be talking to a brick wall. It seems leftists immediately close their minds if information doesn’t come directly from a group that they like.

So I was rather happy to see that the Internal Revenue Service, in the Spring 2015 Statistics of Income Bulletin, published a bunch of data on how much of the income tax is paid by different types of taxpayers.

I’ll be very curious to see how they respond when I point out that their favorite government agency admits that the bottom 50 percent of earners only pay 2.8 percent of all income tax. And I’ll be every more curious to see how they react when I point out that more than half of all income taxes are paid by the top 3 percent of taxpayers.

There’s a famous saying, generally attributed to Daniel Patrick Moynihan, that “Everyone is entitled to his own opinion, but not his own facts.”

With this in mind, I’m hoping that this data from the IRS will finally put to rest the silly leftist talking point that the “rich” don’t pay their “fair share.”

This doesn’t mean, by the way, that the debate about policy will be settled.

Getting statists to accept certain facts is just the first step.

But once that happens, we can at least hope that their minds will be opened to subsequent steps, such as understanding the economic impact of punitive tax rates, recognizing that high tax rates won’t necessarily collect more revenue, or realizing that ordinary workers suffer when harsh tax policies reduce economic vitality.

Though I’m not holding my breath and expecting miracles. After all, some leftists openly state that they don’t care if the economic damage of high tax rates is so significant that government doesn’t collect any tax revenue.

You can see an example of one of these spite-motivated people at the 4:20 mark of the video I narrated on class-warfare taxation.

P.S. Shifting to another tax topic, some of you may have heard about the massive data breach at the IRS. Here’s some of what CNN is reporting.

The Internal Revenue Service believes that a major cyber breach that allowed criminals to steal the tax returns of more than 100,000 people originated in Russia, Rep. Peter Roskam confirmed to CNN on Thursday. …The IRS announced Tuesday that organized crime syndicates used personal data obtained elsewhere to access tax information, which they then used to file $50 million in fraudulent tax refunds.

I suppose I could use this opportunity to take a few potshots at the IRS, but there’s a far more important issue to raise.

I’m guessing the IRS probably has the best computer security of any tax bureaucracy in the world. Yet even all the IRS’s expertise couldn’t stop hackers from obtaining sensitive information.

Now let’s contemplate something truly frightening. The Obama Administration wants the United States to be part of an OECD pact that obligates participating nations to promiscuously share information with dozens of other governments, including untrustworthy, hostile, and/or corrupt regimes such as Russia and China, not to mention make information available to jurisdictions that presumably will have very little technical capacity to guard data from hackers and identity thieves. Here’s the list of participating nations on the OECD website, and it includes Azerbaijan, Cameroon, Greece, Indonesia, Mexico, Nigeria, Romania, Saudi Arabia, and Ukraine.

Yet none of this reckless endangerment would be an issue if we had a simple territorial tax system like the flat tax. Under such a simple and fair system, only income inside America’s borders would be taxed (unlike the wretched system of worldwide taxation we have now), so there would be no need to have risky information-swapping deals with dodgy foreign governments.

P.P.S. Senator Rand Paul is one of the few lawmakers fighting to protect Americans from having their information shared with foreign governments.

P.P.P.S. Shifting back to the original topic of class-warfare taxation, here’s a lesson on the Laffer Curve I offered to President Obama.

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In my ultimate fantasy world, Washington wouldn’t need any sort of broad-based tax because we succeeded in shrinking the federal government back to the very limited size and scope envisioned by our Founding Fathers.

In my more realistic fantasy world, we might not be able to restore constitutional limits on Washington, but at least we could reform the tax code so that revenues were generated in a less destructive fashion.

That’s why I’m a big advocate of a simple and fair flat tax, which has several desirable features.

The rate is as low as possible, to minimize penalties on productive behavior.

There’s no double taxation, so no more bias against saving and investment.

And there are no distorting loopholes that bribe people into inefficient choices.

But not everyone is on board, The class-warfare crowd will never like a flat tax. And Washington insiders hate tax reform because it undermines their power.

But there are also sensible people who are hesitant to back fundamental reform.

Consider what Reihan Salam just wrote for National Review. He starts with a reasonably fair description of the proposal.

The original flat tax, championed by the economists Robert Hall and Alvin Rabushka, which formed the basis of Steve Forbes’s flat-tax proposal in 1996, is a single-rate tax on consumption, with a substantial exemption to make the tax progressive at the low end of the household-income distribution.

Though if I want to nit-pick, I could point out that the flat tax has effective progressivity across all incomes because the family-based exemption is available to everyone. As such, a poor household pays nothing. A middle-income household might have an effective tax rate of 12 percent. And the tax rate for Bill Gates would be asymptotically approaching 17 percent (or whatever the statutory rate is).

My far greater concerns arise when Reihan delves into economic analysis.

…the Hall-Rabushka tax would be highly regressive, in part because high-income households tend to consume less of their income than lower-income households and because investment income would not be taxed (or rather double-taxed).

This is a very schizophrenic passage since he makes a claim of regressivity even though he acknowledged that the flat tax has effective progressivity just a few sentences earlier.

And since he admits that the flat tax actually does tax income that is saved and invested (but only one time rather than over and over again, as can happen in the current system), it’s puzzling why he says the system is “highly regressive.”

If he simply said the flat tax was far less progressive (i.e., less discriminatory) than the current system, that would have been fine.

Here’s the next passage that rubbed me the wrong way.

…there is some dispute over whether ending the double taxation of savings would yield significant growth dividends. Chris William Sanchirico of Penn Law School takes a skeptical view in a review of the academic research on the subject, in part because cutting capital-income taxation as part of a revenue-neutral reform would require offsetting increases in labor-income taxation, which would dampen long-term economic growth in their own right.

I’m not even sure where to start. First, Reihan seems to dismiss the role of dynamic scoring in enabling low tax rates on labor. Second, he cites just one professor about growth effects and overlooks the overwhelming evidence from other perspectives. And third, he says the flat tax would be revenue neutral, when virtually every plan that’s been proposed combines tax reform with a tax cut.

On a somewhat more positive note, Reihan then suggests that lawmakers instead embrace “universal savings accounts” as an alternative to sweeping tax reform.

Instead of campaigning for a flat tax, GOP candidates ought to consider backing Universal Savings Accounts (USAs)… The main difference between USAs and Roth IRAs is that “withdrawals could be made at any time for any reason,” a change that would make the accounts far more attractive to far more people. …Unlike a wholesale shift to consumption taxation, USAs with a contribution limit are a modest step in the same general direction, which future reformers can build on.

I have no objection to incremental reform to reduce double taxation, and I’ve previously written about the attractiveness of USAs, so it sounds like we’re on the same page. And if you get rid of all double taxation and keep rates about where they are now, you get the Rubio-Lee tax plan, which I’ve also argued is a positive reform.

But then he closes with an endorsement of more redistribution through the tax code.

Republicans should put Earned Income Tax Credit expansion and other measures to improve work incentives for low-income households at the heart of their tax-reform agenda.

I want to improve work incentives, but it’s important to realize that the EIC is “refundable,” which is simply an inside-the-beltway term for spending that is laundered through the tax code. In other words, the government isn’t refunding taxes to people. It’s giving money to people who don’t owe taxes.

As an economist, I definitely think it’s better to pay people to work instead of subsidizing them for not working. But we also need to understand that this additional spending has two negative tax implications.

  1. When politicians spend more money, that either increases pressure for tax increases or it makes tax cuts more difficult to achieve.
  2. The EIC is supposed to boost labor force participation, but the evidence is mixed on this point, and any possible benefit with regards to the number of people working may be offset by reductions in actual hours worked because the phase out of the EIC’s wage subsidy is akin to a steep increase in marginal tax rates on additional labor supply.

In any event, I don’t want the federal government in the business of redistributing income. We’ll get much better results, both for poor people and taxpayers, if state and local government compete and innovate to figure out the best ways of ending dependency.

The rest of Reihan’s column is more focused on political obstacles to the flat tax. Since I’ve expressed pessimism on getting a flat tax in my lifetime, I can’t really argue too strenuously with those points.

In closing, I used “friendly fight” in the title of this post for a reason. I don’t get the sense that Mr. Salam is opposed to good policy. Indeed, I would be very surprised if he preferred the current convoluted system over the flat tax.

But if there was a spectrum with “prudence” and “caution” on one side and “bold” and “aggressive” on the other side, I suspect we wouldn’t be on the same side. And since it’s good for there to be both types of people in any movement, that’s a good thing.

P.S. I got a special treat this morning. I was at Reagan Airport for a flight to Detroit at the same time as a bunch of America’s World War II vets arrived on an Honor Flight to visit the WWII Memorial.

Here’s my rather pathetic attempt to get a photo of one of the vets being greeted.

Since I’ll never be in demand as a photographer, you should watch this video to learn more about this great private initiative to honor World War II veterans.

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I’m not a fan of the IRS or it’s Commissioner, a partisan Democrat named John Koskinen. The agency has become politicized, interfering with America’s political process. Needless to say, I’m not shedding tears that the bureaucracy is no longer getting big budget increases.

By contrast, I oftentimes applaud Senator Ted Cruz. His shutdown fight against Obamacare was a net plus. He was one of the few 2016 candidates who took a strong stand against cronyism in Iowa. And he manages to retain a sense of humor in the fight against big government.

So it’s with considerable chagrin that I feel compelled to admit that IRS boss made a good point, at least from a technical perspective, when he criticized Senator Cruz on the topic of the flat tax.

Here’s the background. A story in Bloomberg quotes Senator Cruz about his goal for tax reform.

“Instead of a tax code that crushes innovation, that imposes burdens on families struggling to make ends meet, imagine a simple flat tax that lets every American fill out his or her taxes on a post card. Imagine abolishing the IRS,” Cruz said.

Now here’s an excerpt from a Politico report about Mr. Koskinen’s response.

IRS Commissioner John Koskinen poked holes in Republican presidential candidate Ted Cruz’s plan to abolish the IRS and create a simple flat tax so taxpayers could file their taxes on a postcard. Koskinen pointed out that even if taxpayers were to file their taxes on “a small card,” someone would have to collect the money and make sure the numbers filled out are actually correct. “You can call [tax collectors] something else than the IRS if that makes you feel better, but basically someone has to follow through on all of that,” Koskinen told reporters today after a speech at the National Press Club.

Koskinen is right. So long as the federal government intends to extract more than $3 trillion from taxpayers, there will be a tax-collection agency. That’s true even if you have a flat tax or a national sales tax.

Sure, you can rename the IRS, or even require states to collect the revenue instead, but none of that changes the fact that some coercive body will exist to take our money.

That being said, Cruz’s overall point surely is correct. The IRS in a flat tax world would be largely de-fanged. Indeed, the Tax Foundation estimated several years ago that compliance costs would drop by more than 94 percent if we replaced the internal revenue code with a flat tax. And, as pointed out in this video, the tax code today is even more complex, so the savings now presumably would be even larger.

So Koskinen may be technically correct, but only because he is focusing the conversation on the narrow issue of whether government will still have a tax-enforcement body.

But Cruz is correct on the big-picture issue of whether the IRS as it exists today will no longer exist.

Since we’re on the topic of tax reform, Amity Shlaes and Matthew Denhart, both with the Calvin Coolidge Presidential Foundation, have a column in today’s Wall Street Journal that is somewhat critical of the Rubio-Lee tax reform plan.

The authors start by pointing out that the defining characteristic of supply-side economics is lower marginal tax rates on productive behavior (work, saving, investment, risk-taking, entrepreneurship).

Signaling opportunity throughout the tax code has long been the basis of the philosophy known as supply-side economics, or “Reaganomics.” Reaganomics treats even individual wage earners as entrepreneurs. The marginal rate to which a worker is subject under the progressive tax schedule is crucial. A higher rate on the next dollar a worker earns discourages him from working more. The highest tax bracket is especially important as top earners produce the most and innovate the most. …That top marginal rate also functions as a symbol of how society rewards enterprise.

Their unhappiness with Rubio-Lee is due to the fact that their proposal does not contain big rate reductions for labor income to match the very good rate reductions for business and investment income.

…on the personal side their proposal drops the top marginal rate on individual income by a puny 4.6 percentage points, to 35% from 39.6%. …What’s more, Rubio-Lee lowers tax thresholds drastically. Singles with taxable income as low as $75,000 find themselves entering the 35% top bracket; for couples the top rate applies after $150,000. Currently, individuals don’t hit the 35% bracket until $411,501, and the same holds for couples.

So why aren’t there big reductions in tax rates for households to match the very good reforms for businesses? The answer, at least in part, is that “Rubio-Lee also raises the child credit” and this consumes a lot of money, in effect crowding out lower marginal tax rates.

As a result, you get big economic benefits from the reforms to business taxation, but the child credits don’t have any impact on incentives to create wealth, expand jobs, or boost income.

The nonpartisan Tax Foundation recently estimated that Rubio-Lee would increase economic growth so that by 2025 the economy would be 15% larger than otherwise, almost entirely due to business tax cuts. The effect of the child credit on growth is reckoned at zero. 

But imagine if Rubio-Lee took their good tax reform plan and made it better by replacing the child credit with lower rates? And then made it even better by getting rid of additional tax preferences such as the healthcare exclusion?

Shlaes and Denhart quote me in their column as pointing out that if Rubio and Lee made their plan into something akin to the flat tax, the tax rate could be under 20 percent.

Dan Mitchell of the Cato Institute notes that if Rubio-Lee dropped all the preferences it contains, old and new, the plan could drop its top income-tax rate to 20% or lower.

I confess that I don’t have up-to-date estimates to confirm my assertion, but the Clinton Treasury Department back in 1996 estimated that the flat tax rate in a revenue-neutral world would be 20.8 percent.

But since the Rubio-Lee plan is a very large tax cut, amounting to more than $4 trillion over 10 years, combining that amount of tax relief with the flat tax surely would allow the rate to be well below 20 percent.

By the way, none of this should be interpreted to suggest that Rubio-Lee is bad tax policy. It’s a huge improvement over the current system. As I wrote last month, it’s a very good tax reform plan. It is especially good about fixing some of the worst features of the current tax code, such as worldwide taxation, depreciation, and double taxation.

But that doesn’t mean it is as good as the flat tax, which does everything good in Rubio-Lee, but also has a low rate for households and fewer tax preferences.

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I warned just last week about the dangers of letting politicians impose a value-added tax.

Simply stated, unless the 16th Amendment is repealed and replaced with a new provision forever barring the re-imposition of any taxes on income, a VAT inevitably would be a new source of revenue and become a money machine to finance ever-larger government.

Just look at the evidence from Europe if you’re not convinced.

That’s why the VAT is bad in reality.

Now let’s talk about why the VAT (sometimes called a “business transfer tax”) is theoretically appealing.

First and foremost, the VAT doesn’t do nearly as much damage, per dollar raised, as our current income tax. That’s because the VAT is a single-rate tax (i.e., no class warfare) with no double taxation of income that is saved and invested.

In some sense, it’s a version of the national sales tax, except the revenue is collected on the “value added” at each stage of the production process rather than in one fell swoop when consumers make their purchases.

And it’s also conceptually similar to the flat tax. Both have one rate. Both have no double taxation. And both (at least in theory) have no special preferences and loopholes. The difference between a flat tax and the VAT is that the former taxes your income (only one time) when you earn it and the latter taxes your income (only one time) when you spend it.

In other words, the bottom line is that it is good (or, to be more accurate, less bad) to have a tax system with a low rate and no double taxation. And in the strange world of public finance economists, a system with no double taxation is called a “consumption-base tax.” And the flat tax, sales tax, and VAT all fit in that category.

So why, then, if supporters of limited government prefer a consumption-base tax over the internal revenue code, is there so much hostility to a VAT?

The answer is simple. We don’t trust politicians and we’re afraid that a VAT would be an add-on tax rather than a replacement tax.

Which explains why it’s better to simply turn the existing tax code into a consumption-base tax. After all, the worst thing that could happen is that you degenerate back to the current system.

But if you go with a VAT, the downside risk is that America becomes France.

There’s a story in today’s Wall Street Journal that illustrates why consumption-base taxation is both a threat and opportunity. Here are some introductory excerpts.

U.S. lawmakers on both sides of the aisle increasingly are finding appeal in an ambitious concept for overhauling the nation’s income-tax system: a tax based on consumption, a tool long used around the world. …As the name implies, consumption-style taxes hit the money taxpayers spend, rather than income they receive. One prominent feature of consumption systems is that they generally tax savings and investment lightly or not at all. That, in turn, encourages more investment and innovation, and ultimately more growth, many economists contend.

The reporter is wrong about consumption systems, by the way. Income that is saved and invested is taxed. It’s just not taxed over and over again, which can happen with the current system.

But he’s right that there is bipartisan interest. And he correctly points out that some politicians want an add-on tax while others want to fix the current system.

The tax-writing Senate Finance Committee is giving new consideration to the consumption-tax idea with the hope that its promised boost to economic growth would ease the way to a revamp. …Some of these proposals would have consumers pay another tax in addition to existing state and local sales taxes, while others would merely reshape the current system to tilt it more toward consumption. …Enactment of a broad-based federal consumption tax would align the U.S. with a global trend.

A Democratic Senator from Maryland wants to augment the current tax code by imposing the VAT.

Mr. Cardin introduced legislation last year to create a type of consumption tax known as a value-added tax and at the same time lower business taxes and scrap income taxes completely for lower-income Americans.

While some GOP Senators want to modify the current system to get rid of most double taxation.

Republicans on the working group also are interested in the concept, including a proposal put forward recently by GOP Sens. Marco Rubio of Florida and Mike Lee of Utah. That plan would make several changes to the tax code that would move the nation closer to a consumption-based system. …Many GOP members “believe that there are economic benefits to moving away from taxation of income and toward taxation of consumption,” a Senate aide said.

And the story also notes the objections on the left to consumption-base taxation, as well as objections on the right to the VAT.

Some liberals are concerned that consumption taxes affect poor people disproportionately, while unduly benefiting the rich, unless adjustments are made. For their part, conservatives fear that some types of consumption tax—particularly value-added taxes—would make it too easy to dial up government revenue collection.

So what’s the bottom line? Is it true, as the headline of the story says, that “Proposals for a consumption tax gain traction in both parties”?

Yes, that’s correct. But that’s not the same as saying that there is much chance of bipartisan consensus.

There’s a huge gap between those who want a VAT as an add-on tax and those who want to reform the current system to get rid of double taxation.

This doesn’t mean we shouldn’t worry about the prospect of an add-on VAT. As I warned last year, there are some otherwise sensible people who are sympathetic to this pernicious levy.

Which is why I repeatedly share this video about the downside risk of a VAT.

And you get the same message from these amusing VAT cartoons (here, here, and here).

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