Archive for the ‘Tax Reform’ Category

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

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

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


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

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

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

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

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

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

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

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

It’s now time to repeat this exercise.

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

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

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

It includes new taxes.

And it includes increases in existing taxes.

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

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

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

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

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

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

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

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

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

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

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

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Judged by the amount of attention various provisions produced, last year’s fight over tax reform was about reducing the corporate tax rate and limiting the deduction for state and local taxes.

But there were many other important changes, including a a big increase in the standard deduction (i.e., the amount households can protect from the IRS), a shift that will reduce the number of people who utilize itemized deductions.

A report in the Washington Post suggests that this reform could hurt charities.

Many U.S. charities are worried the tax overhaul bill signed by President Trump…could spur a landmark shift in philanthropy, speeding along the decline of middle-class donors… The source of concern is how the tax bill is expected to sharply reduce the number of taxpayers who qualify for the charitable tax deduction — a big driver of gifts to nonprofits. …the number of people who qualify for the charitable deduction is projected to plummet next year from about 30 percent of tax filers to as low as 5 percent. That’s because the new tax bill nearly doubles the standard deduction and limits the value of other deductions, such as for state and local taxes.

Many charities opposed this change.

One study predicts that donations will fall by at least $13 billion, about 4.5 percent, next year. …“The tax code is now poised to de-incentivize the heart of civic action in America,” said Dan Cardinali, president of Independent Sector, a public-policy group for charities, foundations and corporate giving programs. “It’s deeply disturbing.”  The tax bill’s treatment of charities led the Salvation Army to express serious concerns, and it’s why United Way opposed the legislation, as did the U.S. Conference of Catholic Bishops. Cardinali’s group turned its home page — normally a place for a feel-good story — into a call to protest, with the banner headline: “KILL THE TAX REFORM BILL.” …Rep. Kevin Brady (R-Tex.), the main tax bill writer in the House…argued that people would soon have more money to donate because of the economic growth driven by the bill’s tax cuts

As an aside, here’s the part of the story that most irked me.

“The government has always seen fit to reward the goodness of Americans with a tax incentive,” said Lt. Col. Ron Busroe, development secretary at the Salvation Army.

Huh, how is it goodness if people are only doing it because they’re being bribed by the tax code?

But let’s stick with our main topic of whether the tax bill will hurt the non-profit sector.

A Bloomberg column also hypothesized that the GOP tax reform will be bad news for charities.

Will Americans give as generously now that the incentives have completely shifted? Recent research provides little hope for them. …last year’s tax reform…doubled the standard deduction, effectively eliminating most taxpayers’ ability to itemize deductions via contributions to charity…. Tax cost refers to the actual, post-tax price that someone pays when they make a donation. Imagine someone with a marginal tax rate of 25 percent. Every dollar donated only “costs” the taxpayer 75 cents after he or she takes the charitable deduction. …What happens when you change these “tax costs”? …Almost everyone who studied taxpayer behavior found that the charitable deduction encouraged people to donate more than they would if it didn’t exist. But studies yielded very different price elasticity figures ranging from -0.5 (a dollar in lost tax revenue generates an additional 50 cents in donations) to -4.0 (every dollar in forgone tax revenue generates a whopping four dollars of donations). A recent meta-analysis of approximately 70 of these studies yielded a price elasticity a median of -1.2. A recent study by Nicholas Duquette of the University of Southern California…examined how taxpayer contributions changed after the Tax Reform Act of 1986, which increased the tax cost of giving by dramatically lowering marginal tax rates. The result was eye-popping: A 1 percent rise in the tax cost of giving caused charitable donations to drop 4 percent.

I agree that lower tax rates increase the “tax cost” of giving money to charity.

And Reagan’s tax policy (the 1981 tax bill as well as the 1986 tax reform) had a huge impact. In 1980, it only cost 30 cents for a rich person to give a dollar to charity. By 1988, because of much lower tax rates, it cost 72 cents to give a dollar to charity.

Yet I’m a skeptic of Duquette’s research for the simple reason that real-world data shows that charitable contributions rose after Reagan slashed tax rates.

What Duquette overlooks is that charitable giving also is impact by changes in disposable income and net wealth. So the “tax cost” of donations increased, but that was more than offset by a stronger economy.

So our question today is whether we’re going to see a repeat of the 1980s. Will a reduction in the tax incentive for charitable giving be offset by better economic performance?

Some research from the Mercatus Center suggests that the non-profit sector should not fear reform.

…one study by William C. Randolph casts doubt on the claim that the deduction increases giving in the long run. Randolph’s paper analyzes both major tax reforms in the 1980s and follows individuals for 10 years, finding that taxpayers alter the timing of their giving in response to changes in tax policy, but not necessarily the total amount of giving. …lower-income households also donate to charities in large numbers. …However, very few of them benefit in terms of their tax burden, because many lower-income households have no positive tax liability. …For the 80 percent of middle-income filers who do not currently claim the charitable deduction, any cut in marginal tax rates is a pure benefit. Most taxpayers would be better served by eliminating the charitable contributions deduction and using the additional revenue to lower tax rates.

I would put this more bluntly. Only about 30 percent of taxpayers itemize, so 70 percent of taxpayers are completely unaffected by the charitable deduction. Yet many of these people still give to charity.

And they’ll presumably give higher donations if the economy grows faster.

This is one of the reasons the Wall Street Journal opined that tax reform will be beneficial.

…nonprofits…sell Americans short by assuming that most donate mainly because of the tax break, rather than because they believe in a cause or want to share their blessings with others. How little they respect their donors. …Americans don’t need a tax break to give to charities, which should be able to sell themselves on their merits. …The truth is that Americans will donate more if they have more money. And they will have more money if tax reform, including lower rates and simplification, helps the economy and produces broader prosperity. The 1980s were a boom time for charitable giving precisely because so much wealth was created. Like so many on the political left, the charity lobby doesn’t understand that before Americans can give away private wealth they first have to create it.

A column in the Wall Street Journal also augments the key points about generosity and giving patterns.

…a drop in the amount of deductible gifts does not necessarily mean an equivalent drop in actual giving. …recessions aside, Americans have steadily increased their giving despite numerous tax law changes. Individual donations increased by 4% in 2015 and another 4% in 2016. If donations continue to increase at such rates, it won’t take long to make up for changes brought about by tax reform. …Americans have continued to give to charities no matter what benefits the tax code conveys on them for doing so.

Last but not least, Hayden Ludwig, writing for the Washington Examiner, explains that charitable contributions increase as growth increases.

Liberal groups such as the National Council of Nonprofits claim that the plan will be “disastrous” for charities… The thrust of the Left’s argument is that allowing Americans to keep more of their money makes them stingier, and high taxes are needed to force Americans to take advantage of charitable tax write-offs. It’s ironic that anyone in the nonprofit sector, which is built entirely on the generosity of individuals and corporations, can argue that higher taxes encourage charity – or that charity needs to be legislated. …if the Left’s argument about tax incentives is true, we should see sharp declines in charitable donations after every tax cut in U.S. history. We don’t. According to a 2015 report in the Chronicle of Philanthropy, individuals’ charitable giving rose four percent in 1965 and more than two percent in 1966, following the Kennedy and Johnson tax cuts of 1964 and 1965, respectively. Between the Reagan tax cuts in 1981 and 1986, individual giving rose a whopping 21 percent from $119.7 billion to $144.9 billion. By 1989, individual giving grew another 4.7 percent. …The reason is simple: Prosperity and generosity are inextricably linked.

Amen. Make America more prosperous and two things will happen.

Fewer people will need charity and more people will be in a position to help them.

I’ll conclude by noting that the charitable deduction is the itemized deduction I would abolish last. Not because it is necessary, but because it doesn’t cause macroeconomic harm. The state and local tax deduction, by contrast, is odious and misguided because it subsidizes bad policy and the home mortgage interest deduction is harmful since it is part of a tax code that tilts the playing field and artificially lures capital from business investment to residential real estate.

Things to keep in mind for the next round of tax reform.

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

Bad government policy deserves much of the blame.

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

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

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

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

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

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

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

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

Even the IMF thinks pro-market reforms are needed.

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

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

Bloomberg has some of the details.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Ugh. Basic income is a very troubling idea.

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

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

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

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

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

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During the Obamacare bill-signing ceremony, Vice President Biden had a “hot mic” incident when he was overheard telling Obama that “this is a big f***ing deal.”

And he was telling the truth. It was a big deal (albeit a wrong deal) from a fiscal perspective and a health perspective. And it also was a very costly deal for Democrats, costing them the House in 2010 and the Senate in 2014. But it definitely was consequential.

Well, there’s another “big f***ing deal” in Washington, and it’s what just happened to the state and local tax deduction. It wasn’t totally repealed, as I would have preferred, but there’s now going to be a $10,000 limit on the amount of state and local taxes that can be deducted.

I’ve already explained why this is going to reverberate around the nation, putting pressure on governors and state legislators for better tax policy, and I augment that argument in this clip from a recent interview with Trish Regan.

The bottom line is that high-tax states no longer will be able to jack up taxes, using federal deductibility to spread some of the burden to low-tax states.

Let’s look at what this means, starting with a superb column in today’s Wall Street Journal by Alfredo Ortiz.

The great American migration out of high-tax states like New York and Illinois may be about to accelerate. The tax reform enacted last month caps the deduction for state and local taxes, known as SALT, at $10,000. …between July 1, 2016, and July 1, 2017, …high-tax states like New York, New Jersey, Connecticut, Illinois and Rhode Island either lost residents or stagnated. …When people move, they take their money with them. The five high-tax states listed above have lost more than $200 billion of combined adjusted gross income since 1992… In contrast, Nevada, Washington, Florida and Texas gained roughly the same amount. If politicians in high-tax states want to prevent this migration from becoming a stampede, they will have to deliver fiscal discipline.

Mr. Ortiz shows how some state politicians already seem to realize higher taxes won’t be an easy option anymore.

New Jersey’s Gov.-elect Phil Murphy campaigned on a promise to impose a “millionaires’ tax.” But the Democratic president of the state Senate, Steve Sweeney, said in November that New Jersey needs to “hit the pause button” because “we can’t afford to lose thousands of people.” His next words could have come from a Republican: “You know, 1% of the people in the state of New Jersey pay about 42% of its tax base. And you know, they can leave.” New York City Mayor Bill de Blasio may need to rethink his proposed millionaires’ tax. George Sweeting, deputy director of the city’s Independent Budget Office, told Politico in November that eliminating the SALT deduction would “make it a tougher challenge if the city or the state wanted to raise their taxes.” New York state Comptroller Thomas DiNapoli added: “If you lose that deductibility, I worry about more middle-class families leaving.” …the limit on the SALT deduction is a gift that will keep on giving. In the years to come it will spur additional tax cuts and forestall tax increases at the state and local level.

Though the politicians from high-tax states are definitely whining about the new system.

The Governor of New Jersey is even fantasizing about a lawsuit to reverse reform.

Murphy, a Democrat, said he has spoken with leadership in New York and California and with legal scholars about doing “whatever it takes”… Asked if that included a joint lawsuit with other states, Murphy said “emphatically, yes.” …Murphy said. “This is a complete and utter outrage. And I don’t know how else to say it. We ain’t gonna stand for it.”

Here’s a story from New York Times that warmed my heart last month.

…while Mr. Cuomo and his counterparts from California and New Jersey seemed dead-certain about the tax bill’s intent — Mr. Brown called it “evil in the extreme” — there were still an array of questions about how states would respond. None of the three Democrats offered concrete plans on what action their states might take.

They haven’t offered any concrete plans because the only sensible policy – lower tax rates and streamlined government – is anathema to politicians who like buying votes with other people’s money.

California will be hard-hit, but a columnist for the L.A. Times correctly observes tax reform will serve as a much-need wake-up call for state lawmakers.

…let’s be intellectually honest. There’s no credible justification for the federal government subsidizing California’s highest-in-the-nation state income tax — or, for that matter, any local levy like the property tax. Why should federal tax money from people in other states be spent on partially rebating Californians for their state and local tax payments? Some of those states don’t even have their own income tax, including Nevada and Washington. Neither do Texas and Florida. …federal subsidies just encourage the high-tax states to rake in more money and spend it. And they numb the states’ taxpayers. …Republican state Sen. Jeff Stone of Temecula put it this way after Trump unveiled his proposal last week: “For years, the Democrats who raise our taxes in California have said, ‘Don’t worry. The increase won’t matter all that much because tax increases are deductible.’” Trump’s plan, Stone continued, “seems to finally force states to be transparent about how much they actually tax their own residents.”

He also makes a very wise point about the built-in instability of California’s class-warfare system – similar to a point I made years ago.

Our archaic system is way too volatile. The nonpartisan Legislative Analyst’s Office reported last week that income tax revenue is five times as volatile as personal income itself. The “unpredictable revenue swings complicate budgetary planning and contributed to the state’s boom-and-bust budgeting of the 2000s,” the analyst wrote. During the recession in 2008, for example, a 3.7% dip in the California economy resulted in a 23% nosedive in state revenue. The revenue stream has become unreliable because it depends too heavily on high-income earners, especially their capital gains. During an economic downturn, capital gains go bust and revenue slows to a trickle. In 2015, the top 1% of California earners paid about 48% of the total state income tax while drawing 24% of the taxable income.

Let’s close with some sage analysis from Deroy Murdock.

“Taxes should hurt,” Ronald Reagan once said. He referred to withholding taxes, which empower politicians to siphon workers’ money stealthily, before it reaches their paychecks. Writing the IRS a check each month, like covering the rent, would help taxpayers feel the public sector’s true cost. This would boost demand for tax relief and fuel scrutiny of big government. Like withholding taxes, SALT keeps high state-and-local taxes from hurting. In that sense, SALT is the opiate of the overtaxed masses. The heavy levies that liberal Democrats (and, inexcusably, some statist Republicans) impose from New York’s city hall to statehouses in Albany, Trenton, and Sacramento lack their full sting, since SALT soothes their pain. Just wait: Once social-justice warriors from Malibu to Manhattan feel the entire weight of their Democrat overlords’ yokes around their necks, they will squeal. Some will join the stampede to income-tax-free states, including Texas and Florida. …A conservative, the saying goes, is a liberal who has been mugged by reality. Dumping SALT into the Potomac should inspire a similar epiphany among the Democratic coastal elite.

He’s right. This reform could cause a political shake-up in blue states.

P.S. Since I started this column with some observations about the political consequences of Obamacare, this is a good time to mention some recent academic research about the impact of that law on the 2016 race.

We combine administrative records from the federal health care exchange with aggregate- and individual-level data on vote choice in the 2016 election. We show that personal experiences with the Affordable Care Act informed voting behavior and that these effects could have altered the election outcome in pivotal states… We also offer evidence that consumers purchasing coverage through the exchange were sensitive to premium price hikes publicized shortly before the election… Placebo tests using survey responses collected before the premium information became public suggest that these relationships are indeed causal.

Wow. Obamacare there’s a strong case that Obamacare delivered the House to the GOP, the Senate to the GOP, and also the White House to the GOP. Hopefully the Democrats will be less likely to do something really bad or really crazy the next time they hold power.

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Since it’s the last day of the year, let’s look back on 2017 and highlight the biggest victories and losses for liberty.

For last year’s column, we had an impressive list of overseas victories in 2016, including the United Kingdom’s Brexit from the European Union, the vote against basic income in Switzerland, the adoption of constitutional spending caps in Brazil, and even the abolition of the income tax in Antigua and Barbuda.

The only good policies I could find in the United States, by contrast, were food stamp reforms in Maine, Wisconsin, and Kansas.

This year has a depressingly small list of victories. Indeed, the only good thing I had on my initial list was the tax bill. So to make 2017 appear better, I’m turning that victory into three victories.

  • A lower corporate tax rate – Dropping the federal corporate tax rate from 35 percent to 21 percent will boost investment, wages, and competitiveness, while also pressuring other nations to drop their corporate rates in a virtuous cycle of tax competition. An unambiguous victory.
  • Limits on the deductibility of state and local taxes – It would have been preferable to totally abolish the deduction for state and local taxes, but a $10,000 cap will substantially curtail the federal tax subsidy for higher taxes by state and local government. The provision is only temporary, so it’s not an unambiguous win, but the whining and complaining from class-warfare politicians in New York and California is music to my ears.
  • No border-adjustment tax – Early in 2017, I was worried that tax reform was going to be tax deform. House Republicans may have had good intentions, but their proposed border-adjustment tax would have set the stage for a value-added tax. I like to think I played at least a small role in killing this bad idea.
  • Regulatory Rollback – The other bit of (modest) good news is that the Trump Administration has taken some steps to curtail and limit red tape. A journey of a thousand miles begins with a first step.

Now let’s look elsewhere in the world for a victory. Once again, there’s not much.

  • Macron’s election in France – As I scoured my archives for some good foreign news, the only thing I could find was that a socialist beat a socialist in the French presidential election. But since I have some vague hope that Emanuel Macron will cut red tape and reduce the fiscal burden in France, I’m going to list this as good news. Yes, I’m grading on a curve.

Now let’s look at the bad news.

Last year, my list included growing GOP support for a VAT, eroding support for open trade, and the leftward shift of the Democratic Party.

Here are five examples of policy defeats in 2017.

  • Illinois tax increase – If there was a contest for bad state fiscal policy, Illinois would be a strong contender. That was true even before 2017. And now that the state legislature rammed through a big tax increase, Illinois is trying even harder to be the nation’s most uncompetitive state.
  • Kansas tax clawback – The big-government wing of the Kansas Republican Party joined forces with Democrats to undo a significant portion of the Brownback tax cuts. Since this was really a fight over whether there would be spending restraint or business-as-usual in Kansas, this was a double defeat.
  • Botched Obamacare repeal – After winning numerous elections by promising to repeal Obamacare, Republicans finally got total control of Washington and then proceeded to produce a bill that repealed only portions. And even that effort flopped. This was a very sad confirmation of my Second Theorem of Government.
  • Failure to control spending – I pointed out early in the year that it would be easy to cut taxes, control spending, and balance the budget. And I did the same thing late in the year. Unfortunately, there is no desire in Washington to restrain the growth of Leviathan. Sooner or later, this is going to generate very bad economic and political developments.
  • Venezuela’s tyrannical regime is still standing – Since I had hoped the awful socialist government would collapse, the fact that nothing has changed in Venezuela counts as bad news. Actually, some things have changed. The economy is getting worse and worse.
  • The Export-Import Bank is still alive – With total GOP control of Washington, one would hope this egregious dispenser of corporate welfare would be gone. Sadly, the swamp is winning this battle.

Tomorrow, I’ll do a new version of my annual hopes-and-fears column.

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Now that we have a final bill rather than a mere “agreement in principle,” let’s step back and consider some implications of tax reform.

There are three reasons to be pleased and one reason to worry.

Win: Less-destructive federal tax code

There are several provisions of the tax bill that will boost the economy, most notably dropping the federal corporate tax rate from 35 percent to 21 percent. Slightly lower individual tax rates will also help growth, as will provisions such as the expanded death tax exemption and the mitigation of the alternative minimum tax.

How much faster will the economy perform? There are several estimates, with microeconomic-based models predicting better outcomes that Keynesian-based models. Here are some findings from two market-based models.

From the Tax Foundation:

…we estimate that the plan would increase long-run GDP by 1.7 percent. The larger economy would translate into 1.5 percent higher wages and result in an additional 339,000 full-time equivalent jobs. Due to the larger economy and the broader tax base, the plan would generate $600 billion in additional permanent revenue over the next decade on a dynamic basis. Overall, the plan would decrease federal revenues by $1.47 trillion on a static basis and by $448 billion on a dynamic basis.

From the Heritage Foundations:

We project that the final bill will increase the level of gross domestic product (GDP) in the long run by 2.2 percent. To put that number in perspective, the increase in GDP translates into an increase of just under $3,000 per household. Though we only estimate the change in GDP over the long run, most of the increase in GDP would likely occur within the 10-year budget window. …the final bill would increase the capital stock related to equipment by 4.5 percent, and the capital stock related to structures by 9.4 percent. We also estimate that the number of hours worked would increase by 0.5 percent.

And here is an estimate from a partially market-based model at the Joint Committee on Taxation:

We estimate that this proposal would increase the level of output (as measured by real Gross Domestic Product (“GDP”) by about 0.7 percent on average over the 10-year budget window. That increase in output would increase revenues, relative to the conventional estimate of a loss of $1,436.8 billion by about $483 billion over that period. This budget effect would be partially offset by an increase in interest payments on the Federal debt of about $55 billion over the budget period. We expect that both an increase in GDP and resulting additional revenues would continue in the second decade after enactment, although at a lower level.*

And here is an estimate from a Keynesian-oriented model at the Tax Policy Center:

We find the legislation would boost US gross domestic product (GDP) 0.8 percent in 2018 and would have little effect on GDP in 2027 or 2037. The resulting increase in taxable incomes would reduce the revenue loss arising from the legislation by $186 billion from 2018 to 2027 (around 13 percent).

For what it’s worth, the market-based (or microeconomic-based) models are more accurate since they are based on the impact of tax-rate changes on incentives to engage in productive behavior.

That being said, proponents of tax reform should not expect Hong Kong-style growth. First, this is only a modest version of tax reform, not a game-changing step such as a simple and fair flat tax. As George Will opined today, “On a scale of importance from one (negligible) to 10 (stupendous), the legislation might be a three.”

Second, keep in mind that fiscal policy only accounts for about 20 percent of a nation’s economic performance. And if taxes and spending each account for half of that grade, policymakers in Washington have positively impacted a variable that determines 10 percent of America’s prosperity.

That may sound discouraging, but even small differences in economic growth make a big difference if sustained over time. As I noted in 2014:

…very modest changes in annual growth, if sustained over time, can yield big increases in household income. … long-run growth will average only 2.3% over the next 75 years. If good tax policy simply raised annual growth to 2.5%, it would mean about $4,500 of additional income for the average household within 25 years.

Win: Pressure for better tax policy in other nations

I consider myself to be the world’s bigger cheerleader and advocate of tax competition. I’ve even risked getting thrown in jail to promote fiscal rivalry between nations. And I’ve written several times about how this tax reform package is good because it will encourage better tax policy abroad (see here, here, and here).

I’ll bolster my argument today by sharing some excerpts from a Wall Street Journal editorial.

German economists at the Center for European Economic Research (ZEW) released a study last week finding that U.S. corporate tax reform will sharply improve incentives for foreigners to invest in America—at the expense of high-tax countries such as Germany. …In the ZEW model, U.S. firms needed a return of around 7.6% for an investment to be profitable under pre-reform tax law, compared to an EU average of 6%, and 5.7% in low-tax Ireland. The U.S. reform changes all this. America’s statutory and effective corporate rates will both be near the EU average, essentially even with Britain and the Netherlands and well below France (a 39% headline rate) and Germany (31%). …Companies from low-tax Ireland, high-tax Germany and the EU as a whole would all see their effective tax rates and their cost of capital for U.S. investment plummet under the reform.

Another German think tank reached a similar conclusion.

US administrations have refrained from any major corporate tax reform since that implemented by Reagan in 1986. This passivity has been remarkable in the sense that most industrial countries have put forward considerable corporate tax cuts in the last decades. This long period of inaction has now come to an end. …Without doubt, this far reaching corporate tax reform of the largest economy will change the setting of international tax competition.

And how will it change the setting?

First, a caveat. The German study looked at the likely impact of a 20-percent corporate rate, so keep in mind that updated numbers to reflect the 21-percent rate in the final deal would look slightly different.

Second, the corporate tax burden in the United States is still going to higher than the European average, even after the 21-percent rate is implemented. Here’s a chart from the German study and I’ve highlighted the current U.S. position and the post-tax reform position (“US_20%_Dep” is where we would be if “expensing” had been included).

Third, even though the reduction in the corporate rate is just a modest step in the right direction, it’s going to yield major benefits.

The US tax reform will affect the net-of-tax profitability of both inbound and outbound FDI as well as domestic investments. …in the case of Germany the reduction in the tax burden for German FDI in the US outweighs the reduction of the tax burden for US outbound FDI in Germany by almost factor 3. …FDI stocks in a country increases by 2.49% if the tax rate is reduced by one percentage point. … despite the overall expansion after the US tax reform which is expected to foster FDI in all countries, the US will benefit disproportionally by additional inward FDI. This comes at the cost of European countries which will face increasing outbound FDI flows to the US which are not accompanied with inbound FDI flows from the US in the same amount. …After the implementation of the US corporate tax reform, manufacturing FDI be particularly expanded. The US will attract additional inbound FDI of 113.5 billion EUR from investors located in the EU28. … European high-tax jurisdictions such as Germany will most likely be confronted with a higher net outflow of investments than European low-tax jurisdictions such as Ireland. Ultimately, the European high-tax jurisdictions will lose ground in the competition for FDI.

And here’s another chart from the study. It shows that it will be somewhat more profitable for U.S. companies to compete abroad, and a lot more profitable for foreign investors to put money in America.

Win: Pressure for better state tax policy

As I’ve repeatedly argued, getting rid of the deduction for state and local taxes is a very desirable policy. On the federal level, it’s good because that reform frees up some revenue that can be used to offset lower tax rates. On the state level, it’s good because politicians in high-tax areas will now feel a lot of pressure to lower tax rates.

Or, if you look at the glass being half empty, they’ll feel pressure not to further increase tax rates.

The Wall Street Journal has a new editorial on this topic, asking “how much will they have to cut income-tax rates to retain and attract the high-income earners who finance so much of their state budgets?”

The mere possibility is caused great angst in some circles.

New York Gov. Andrew Cuomo last weekend declared that the GOP bill’s limit on the state-and-local tax deduction will trigger “an economic civil war” between high- and low-tax states. California Governor Jerry Brown has likened Republicans to “mafia thugs” while Mr. Cuomo calls the bill a “dagger at the economic heart of New York.”

Though only a select slice of taxpayers will be impacted, and some of them are in red states.

…the tax math will be tricky for many high-earners in states with the highest tax rates. …high earners in states with top rates exceeding 6.56% could see their tax bills increase. The nearby table shows the 17 states with top income-tax rates exceeding 6.56%. The four with the highest income tax rates have Democratic Governors—California, New York, Oregon and Minnesota—and liberal political cultures heavily influenced by public unions. …Iowa ranks fifth with a top rate of 8.98% that hits at a mere $70,785 for married couples, which is more punitive than even New Jersey’s 8.87% that hits households making more than $500,000. Wisconsin (7.65%), Idaho (7.4%), South Carolina (7%), Arkansas (6.9%) and Nebraska (6.84%) are among Donald Trump -voting states that also make the high-tax list. …This ought to put pressure on high-tax Midwestern states such as Wisconsin, Iowa and Minnesota to reduce their rates.

But the ultra-high-tax blue states are the ones that will really feel the squeeze to lower tax rates.

…limiting the deduction will increase the existing rate divide between high- and low-tax states. New York, New Jersey and Connecticut have been losing billions of dollars each year in adjusted gross income from high earners fleeing to lower tax climes like Florida. Nevada will become an even more attractive tax haven for wealthy Californians. The problem is more acute when you consider that the top 1% of earners pay nearly 50% of state income taxes in California and New York, and 37% in New Jersey. States may experience significant budget carnage if more high earners defect. To head off a high-earner revolt, Mr. Cuomo could seek to eliminate the millionaire’s tax he campaigned against in 2010 but has repeatedly extended. Mr. Brown could campaign to repeal the 3% surcharge on millionaires he championed in 2012.

Loss: Failure to restrain federal spending puts tax reform at risk

Now that we’ve looked at three reasons to be optimistic about tax reform, let’s close with some grim news.

Republicans could have produced a far bolder tax reform plan had they been willing to restrain spending. That didn’t happen.

Instead, they only were able to produce a tax bill that featured a very modest – and temporary – amount of tax relief.

And because they were constrained by the budget numbers, many of the provisions impacting individuals are sunset at the end of 2025.

It’s not just a question of not doing the right thing. Republicans are actually making matters worse on the spending side of the budget. They are busting the budget caps and doing a lot of so-called emergency spending.

All this will come back to bite them when it’s time extend (or, better yet, make permanent) the provisions that are scheduled to expire. The bottom line if that it’s impossible to have a good tax code with an ever-growing burden of government spending.

* The Joint Committee on Taxation estimate is for the House-passed version of tax reform. An estimate of the final bill hasn’t been released, though it presumably will be similar.

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I don’t focus much on media bias because journalists generally aren’t dishonest. Instead, they choose which stories to highlight or downplay based on what advances their political agenda. Though every so often I’ll highlight an example of where bias leads to an egregious (maybe even deliberately dishonest) mistake.

Now we have an addition to that collection from a WonkBlog column in the Washington Post. The piece starts with an accurate observation that the tax plan on Capitol Hill isn’t a long-run tax cut.

Senate rules require the Tax Cuts and Jobs Act not to add to the federal deficit after 10 years. …The bill aims to cut corporate taxes in perpetuity…but they actually need to raise money to offset the permanent corporate tax reduction.

Yes, as I wrote two weeks ago, the long-run tax cuts have to be offset by long-run revenue increases. So that part of the column is fine.

We then get this rather dubious assertion.

Republicans are paying for a permanent cut for corporations with an under-the-radar tax increase on individuals.

In part, it’s a dodgy claim because there are provisions in the bill that collect more revenue from companies, such as the partial loss of interest deductibility and various base erosion rules. So if he wanted to be accurate, the author should have begun that sentence with “Republicans are partially paying for…”

But that’s only part of the problem. As you can see from this next excerpt, he cites a former Democrat staffer and doubles down on the allegation that individual taxpayers will be coughing up more money to Uncle Sam because of the legislation.

This chart, playing off what the Senate’s former top tax aide and New York University professor Lily Batchelder pointed out on Twitter on Friday evening, makes vividly clear where Republicans ultimately raise that money. …we know it’s individual taxpayers who ultimately bear the cost of the tax bill.

And here’s the chart that ostensibly shows that you and me are going to pay more money so evil corporations can enjoy a tax cut.

Notice, however, the part I circled in green. It shows that Republicans are repealing Obamacare’s individual mandate as part of their tax reform plan, and it also shows that repeal has budgetary effects.

So how is this a tax increase (the pink portion of the bar chart), as the Washington Post wants us to believe?

Needless to say, the honest answer is that it isn’t a tax hike. Getting rid of the mandate means people won’t get “fined” by the IRS if they choose not to buy health insurance. If anything, that should count as a tax cut.

But that’s not what’s represented by the pink part of the bar chart. Instead, it shows that when you get rid of the mandate and consumers choose not to get Obamacare policies, that automatically means that insurance companies will get fewer subsidies from Uncle Sam (getting access to that cash was one of the reasons the big insurance companies lobbied for Obamacare).

In other words, the chart actually is showing that corporate rate reduction is partially financed by a reduction in spending, which is a win-win from my perspective.

By the way, you don’t have to believe me. On page 9 of the Joint Committee on Taxation’s revenue estimate (which presumably will be posted on the JCT website at some point), you find this footnote about the “outlay effect” of repealing the mandate.

At the risk of stating the obvious, an “outlay effect” is when a change in law causes a shift in government spending. That’s what’s happening, not a tax increase on individuals.

By the way, the author sort of admits this is true in a passage buried near the bottom of the column.

…a number of analysts argue that it’s wrong to consider the loss of insurance related to the end of the ACA mandate a tax increase, because it reflects individuals’ choice not to get insurance.

That’s a pathetic attempt at justifying a dishonest article.

Here’s the bottom line.

  1. Individuals will be paying less money to the IRS because of this provision, not more.
  2. The fiscal impact of the provision is less spending, not more tax revenue.

Sadly, most readers will have no idea that they were deliberately misled.

P.S. The “alternative inflation measure” in the bill (the red portion of the bar chart) arguably is a tax increase. Or, for those who persuasively argue that it’s a more accurate measure, it’s a provision that will result in individual taxpayers sending more money to Uncle Sam compared to current law since the new measure (chained CPI) will result in smaller inflation adjustments to tax brackets and the standard deduction.

P.P.S. If repealing just one small piece of Obamacare will save about $300 billion over the next decade, imagine how much money we could save if the entire law was repealed.

P.P.P.S. Since I’ve previously explained how politicians use alchemy to turn spending increases into tax cuts, I guess it’s not surprising that some folks are using the same magic to turn spending cuts into tax increases.

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