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Archive for the ‘Tax Reform’ Category

The Trump tax plan, which was signed into law right before Christmas in 2017, had two very good features.

The former was important because the federal tax code was subsidizing high tax burdens in states such as New Jersey, Illinois, and California.

The latter was important because the United States, with a 35 percent corporate rate, had the highest tax burden on businesses among developed nations.

The 21 percent rate we have today doesn’t make us a low-tax nation, but at least the U.S. corporate tax burden is now near the world average.

There were many other provisions in the Trump tax plan, most of which moved tax policy in the right direction.

Now that a couple of years have passed, what’s been the net effect?

In a column for today’s Wall Street Journal, former Trump officials Gary Cohn and Kevin Hassett make the case that the tax plan has produced good results.

…the tax cut reduced the cost of installing new plant and machinery by about 10%, suggesting that capital spending would jump by the same amount. This would increase the amount of capital per worker and drive up productivity and wages. …This predicted increase in capital has materialized, and has translated into additional economic growth. …Capital spending was 4.5% higher in 2018 than pre-TCJA blue-chip forecasts, and this trend continued in 2019. This extra capital improved productivity and wages… Over the past year, nominal wages for the lowest 10% of American workers jumped 7%. The growth rate for those without a high-school diploma was 9%. …when President Obama hiked marginal tax rates, …labor-force participation dropping 0.7% after the tax increase for workers 35 to 44, but dropping 1.5% for workers over 55. After passage of the TCJA, the opposite pattern emerged, with labor-force participation for those between 35 and 44 increasing 0.4%, and labor-force participation for those over 55 increasing 1.3%. … Before Mr. Trump took office in January 2017, the Congressional Budget Office forecast the creation of only two million jobs by this point. The economy has in fact created seven million jobs since January 2017. …the U.S. is the only Group of Seven country that will post growth above 2% this year.

And the White House has been publicizing some positive numbers.

Such as an increase in investment.

I suppose one can argue that the Blue Chip consensus forecast was wrong and that the Trump tax plan had no effect, but that seems like an after-the-fact rationalization.

The White House also has been touting an increase in prime-age labor force participation.

These are impressive numbers. I’ve argued, for instance, that the employment/population ratio may now be a more important variable than the unemployment rate.

Regardless, the best numbers I’ve seen aren’t from the White House.

Andy Puzder recently shared this chart showing that workers in low-wage industries (the blue line) are enjoying the biggest gains.

I want everyone’s wages to increase, which is why I’m a big supporter of reforms that boost investment and productivity.

But I especially applaud when those reforms increase wages for those with modest incomes.

I’ll close with three caveats.

  1. Because Trump has been very weak on the issue of government spending, it’s quite likely that his tax cuts eventually will be repealed or offset by other tax increases.
  2. Trump obviously was talking nonsense when he claimed his tax plan would produce annual growth of 4 percent or higher. That being said, even more-modest increases in growth are very desirable.
  3. Trump’s tax increases on trade are bad for prosperity and therefore are offsetting some of the benefits of his tax reductions on corporate and household income.

The bottom line is that Trump has made tax policy better (or less worse), but always remember that tax policy is just one piece of a large puzzle when looking at economic policy.

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Whenever I review a tax proposal, I automatically check whether it is consistent with the “Holy Trinity” of good policy.

  1. Low marginal tax rates on productive activity such as work and entrepreneurship.
  2. No tax bias (i.e., extra layers of tax) penalizing saving and investment.
  3. No complicating preferences and loopholes that encourage inefficient economic choices.

A good proposal satisfies one of these three principles. A great proposals satisfies all of them.

And that’s a good way of introducing today’s topic, which is about whether we should replace “depreciation” with “expensing.” Or, for those who aren’t familiar with technical tax terminology, this issue revolves around whether there should be a tax penalty on new investment.

Erica York of the Tax Foundation has a nice summary of the issue.

While tax rates matter to businesses, so too does the measure of income to which those tax rates apply. The corporate income tax is a tax on profits, normally defined as revenue minus costs. However, under the current tax code, businesses are unable to deduct the full cost of certain expenses—their capital investments—meaning the tax code is not neutral and actually increases the cost of investment. …Typically, when businesses incur capital investment costs, they must deduct them over several years according to preset depreciation schedules, instead of deducting them immediately in the year the investment occurs. …the delay in taking deductions means the present value of the write-offs (adjusted for inflation and the time value of money) is smaller than the original cost. …The delay effectively shifts the tax burden forward in time as businesses face a higher tax burden today because they cannot fully deduct their costs, and it decreases the after-tax return on the investment. …Ultimately, this means that the corporate income tax is biased against investment in capital assets to the extent that it makes the investor wait years or decades to claim the cost of machines, equipment, or factories on their tax returns.

Here’s a visual depiction of how the current system works.

The key thing to understand is that businesses are forced to overstate their income, which basically means a higher tax rate on actual income (thus violating principle #1).

Back in 2017, Adam Michel and Salim Furth wrote about this topic for the Heritage Foundation.

Here is their main argument.

The current system gives companies a partial deduction for each dollar invested in the economy. The real value of the deduction depends on the vagaries of the tax code, future inflation, and the company’s cost of borrowing. The classification of investments by type and the somewhat arbitrary assignment of the number of years over which each investment must be written off are called depreciation schedules. The imperfect design of these schedules creates unequal tax rates on investment across industries. …Adopting full expensing would reduce effective tax rates everywhere, but especially in industries disfavored under the current system. The result would be more economically efficient: The tax code would no longer be steering investment to arbitrarily favored industries. …Expensing lowers the cost of capital investments. …Both the U.S. capital stock and the demand for labor to operate and service the new investments would be permanently larger. A larger capital stock and higher labor demand would increase the number of jobs and place upward pressure on wages.

A key takeaway is that the tax bias created by the current system is a penalty on new investment (thus violating principle #2).

And the current approach of depreciation also is incredibly complicated (thus violating principle #3).

Expensing can also significantly cut compliance costs. According to IRS research, business tax compliance costs are over $100 billion per year, representing a massive waste of money and effort. Other estimates place the cost of complying with depreciation schedules alone at over $23 billion annually, or 448 million hours each year. Considering that the total compliance cost for traditional C corporations is equal to 14 percent of their taxes paid, expensing could make major inroads toward simplifying business taxpaying and lowering compliance costs.

Unsurprisingly, some politicians are on the wrong side.

Not only are they against a neutral system based on expensing, Erica York explains that they want to make the current system even more biased against new investment.

…proposals to stretch deductions over longer periods of time, such as those from Senators Warren (D-MA) and Sanders (I-VT)…would increase the cost of capital, bias the tax code against investment, and lead to less capital accumulation and lower productivity, output, and wages.

Yes, I know readers are shocked to learn that “Crazy Bernie” and “Looney Liz” want to make a bad situation even worse.

Returning to the policy discussion, the fight over depreciation vs. expensing also matters for national competitiveness.

In another study for the Tax Foundation, Amir El-Sibaie looks at how the U.S. compares to other developed nations.

Currently, the U.S. tax code only allows businesses to recover an average of 67.7 percent of a capital investment (e.g., an investment in buildings, machinery, intangibles, etc.). This is slightly higher than the Organisation for Economic Co-operation and Development’s (OECD) average capital allowance of 67.2 percent. …Since 1979, overall treatment of capital assets has worsened in the U.S., dropping from an average capital allowance of 75.8 percent in the 1980s to an average capital allowance of 67.7 percent in 2018. Capital allowances across the OECD have also declined, but by a lesser extent over the same period: 72.4 percent in the 1980s to 67.2 percent in 2018. …The countries with the best average treatment of capital assets are Estonia (100 percent), Latvia (100 percent), and Slovakia (78.2 percent). Countries with the worst treatment of capital assets are Chile (41.7 percent), the United Kingdom (45.7 percent), and Spain (54.5 percent).

The bad news is that the United States is much worse than Estonia (the gold standard for neutral business taxation).

The good news is that we’re not in last place. Here’s a comparison of the United States to the average of other developed nations.

By the way, there are folks in the United Kingdom who want to improve that nation’s next-to-last score.

Here are some excerpts from a column in CapX by Eamonn Ives.

…successive governments have…cut the headline rate of corporation tax. …That said, some of the positive effects of the cuts to corporation tax were blunted by changes to the tax code which allow businesses to write off the cost of capital expenditure… Typically, corporate tax systems let firms deduct day to day expenses – like labour and materials – right away. However, the cost of longer-term investments – such as those in machinery and industrial premises – can only be deducted in a piecemeal manner, over a set period of time. …this creates a problem for businesses, because the more a tax deduction for capital investment is spread out, the less valuable it becomes to a firm. This is not only because of inflationary effects, but also due to what economists would call the time value of money… Thankfully, however, a solution is at hand to iron out this peculiarity. ‘Full expensing’ allows firms to immediately and entirely deduct the cost of any investment they undertake from their corporation tax bill.

He cites some of the research on the topic.

A 2017 study, from Eric Ohrn, found that in parts of America, full expensing has increased investment by 17.5%, and has increased wages by 2.5%. Employment also rose, by 7.7% after five years, as did production, by 10.5%. If the same results were replicated in the UK, the average worker could stand to earn a staggering additional £700 a year. Another academic study, this time from the UK itself, found that access to more generous capital allowances for small and medium sized enterprises which were offered prior to fiscal year 2008/09 increased the investment rate by 11%.

Let’s conclude.

When I discuss this issue, I usually start by asking an audience for a definition of profit.

That part is easy. Everyone agrees that profit is the difference between cost and revenue.

To show why depreciation should be replaced by expensing, I then use the very simple example of a lemonade stand.

In the start-up year for this hypothetical lemonade stand, our entrepreneur has total costs of $25 (investment costs for the actual stand and operating costs for the lemons) and total revenue of $30. I then explain the different tax implications of expensing and depreciation.

As you can see, our budding entrepreneur faces a much higher tax burden when forced to depreciate the cost of the lemonade stand.

For all intents and purposes, depreciation mandates that businesses overstate profits.

This is unfair. And it’s also bad economic policy because some people will respond to these perverse incentives by deciding not to invest or be entrepreneurial.

To be fair, businesses eventually are allowed to deduct the full cost of investments. But this process can take as long as 39 years.

Here’s another comparison, which shows the difference over time between expensing and a five-year deprecation schedule. I’ve also made it more realistic by showing a loss in the first year.

In both examples, our entrepreneur’s five-year tax bill is $3.

But the timing of the tax matters, both because of inflation and the “time value” of money. That’s why, in a good system, there should only be a tax when there’s an actual profit.

Needless to say, good tax reform plans such as the flat tax are based on expensing rather than depreciation.

P.S. This principle applies even if businesses are investing in private jets.

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In my libertarian fantasies, we dramatically shrink the size of the federal government and return to pre-1913 policy by getting rid of the income tax.

But if I’m forced to be at least vaguely realistic, the second-best option is scrapping the current tax code and replacing it with a simple and fair flat tax based on the “Holy Trinity” of good policy.

The third-best option (i.e., the best we can hope for in the real world) is to adopt incremental reforms that move the tax code in the right direction.

That happened in 2017. I’ve written many times about why it was a very good idea to reduce the tax rate on corporate income. And I’ve also lauded the 2017 law’s limitation on the state and local tax deduction.

Today, let’s focus on the changes in that law that reduced the tax preference for residential real estate.

The housing lobby (especially builders and realtors) tried to scare lawmakers that any reduction in their privileged tax status would cause a large amount of damage.

Yet, as reported last year by the New York Times, there was no adverse effect in the first year of the new tax law.

It wasn’t supposed to take long for the Trump tax cuts to hobble housing prices… Nearly nine months later, those warnings have not materialized. …Economists see only faint effects from the new law so far in housing data. They’re small, and they’re contained to a few high-priced, highly taxed ZIP codes, largely in blue states. They’re nothing close to the carnage that real estate groups warned about when the law was under debate last fall. …the tax law has unquestionably diminished the value of several federal subsidies for homeowners. It limits deductions for state and local taxes, including property taxes, to $10,000 per household, which hurts owners of expensive homes in high-tax states. It lowers the cap on the mortgage interest deduction, which raises housing prices by allowing homeowners to write off the interest payments from their loans, to $750,000 for new loans, down from $1 million.

To the extent the impact could even be measured, it was a net plus for the economy.

After the law passed, ZIP codes in the Boston area saw a 0.6 percentage point slowdown in home appreciation on the Massachusetts side — and a 0.1 percent acceleration on the New Hampshire side. The effect there is “not huge, it’s small,”… Experts say several forces are helping to counteract the diminished federal home-buying subsidies. …said Kevin Hassett, “…if you’re getting a lot of income growth, the income growth increases the demand for housing, and the mortgage interest deduction reduces it. And the effects offset.”

This chart from the story is particularly persuasive. If anything, it appears housing values rose faster after the law was changed (though presumably due to bad policies such as building restrictions and zoning laws, not just the faster growth caused by a a shift in tax policy).

There’s also no negative effect one year later. A report from today’s New York Times finds that the hysterical predictions of the housing lobby haven’t materialized.

Even though the tax preference was significantly reduced.

The mortgage-interest deduction, a beloved tax break bound tightly to the American dream of homeownership, once seemed politically invincible. Then it nearly vanished in middle-class neighborhoods across the country, and it appears that hardly anyone noticed. …The 2017 law nearly doubled the standard deduction — to $24,000 for a couple filing jointly — on federal income taxes, giving millions of households an incentive to stop claiming itemized deductions. As a result, far fewer families — and, in particular, far fewer middle-class families — are claiming the itemized deduction for mortgage interest. In 2018, about one in five taxpayers claimed the deduction, Internal Revenue Service statistics show. This year, that number fell to less than one in 10. The benefit, as it remains, is largely for high earners, and more limited than it once was: The 2017 law capped the maximum value of new mortgage debt eligible for the deduction at $750,000, down from $1 million.

Once again, the evidence shows good news.

…housing professionals, home buyers and sellers — and detailed statistics about the housing market — show no signs that the drop in the use of the tax break is weighing on prices or activity. …Such reactions challenge a longstanding American political consensus. For decades, the mortgage-interest deduction has been alternately hailed as a linchpin of support for homeownership (by the real estate industry)…. most economists on the left and the right…argued that the mortgage-interest deduction violated every rule of good policymaking. It was regressive, benefiting wealthy families… Studies repeatedly found that the deduction actually reduced ownership rates by helping to inflate home prices, making homes less affordable to first-time buyers. …In the debate over the tax law in 2017, the industry warned that the legislation could cause house prices to fall 10 percent or more in some parts of the country. …Places where a large share of middle-class taxpayers took the mortgage-interest deduction, for example, have not seen any meaningful difference in price increases from less-affected areas.

Incidentally, here’s a chart from the story. It shows that the rich have always been the biggest beneficiaries of the tax preference.

And now the deduction that remains is even more skewed toward upper-income households.

As far as I’m concerned, the tax code shouldn’t punish people simply because they earn a lot of money.

But neither should it give them special goodies.

For what it’s worth, the mortgage interest deduction is not a left-vs-right or statism-vs-libertarian issue.

I’ve crossed swords on a few occasions with Bill Gale of the Brooking Institute, but his column a few months ago in the Wall Street Journal wisely calls for full repeal of this tax preference.

With any luck, the 2017 tax overhaul will prove to be only the first step toward eventually replacing the century-old housing subsidy… This is a welcome change. The mortgage-interest deduction has existed since the income tax was created in 1913, but it has never been easy to justify. …Canada, the United Kingdom, and Australia have no mortgage-debt subsidies, yet their homeownership rates are slightly higher than in the U.S. A large reduction in the mortgage-interest deduction in Denmark in 1987 had virtually no effect on homeownership rates. …The next step should be to eliminate the deduction altogether. The phaseout should be gradual but complete.

Here’s another example.

Nobody would ever accuse the folks at Slate of being market friendly, so this article is another sign that there’s a consensus against using the tax code to tilt the playing field in favor of residential real estate.

One of the most remarkable things about the tax bill Republicans passed last year was how it took a rotary saw to the mortgage interest deduction. The benefit for homeowners was once considered a politically untouchable upper-middle-class entitlement, but the GOP aggressively curtailed it in order to pay for cuts elsewhere in the tax code. …just 13.8 million households will subtract mortgage interest from their 2018 returns, down from 32.3 million in 2017. …if Democrats ever get a chance to kill off the vestigial remains of the mortgage interest deduction down the line, they might as well. …any negative effect of the tax law seems to have been drowned out by a healthy economy.

I’ll close by digging into the archives at the Heritage Foundation and dusting off one of my studies from 1996.

Analyzing the flat tax and home values, I pointed out that rising levels of personal income were the key to a strong housing market, not the value of the tax deduction.

Everything that’s happened over the past 23 years – and especially the past two years – confirms my analysis.

Simply stated, economic growth is how we get more good things in society. That’s true for housing, as explained above, and it’s also true for charitable giving.

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The crown jewel of the 2017 tax plan was the lower corporate tax rate.

I appeared on CNBC yesterday to debate that reform, squaring off against Jason Furman, who served as Chairman of Obama’s Council of Economic Advisers.

Here are a couple of observations on our discussion.

  • Jason Furman thinks it would be crazy to raise the corporate tax rate back to 35 percent. Yes, he wants to rate to be higher, but rational folks on the left know it would be very misguided to fully undo that part of the tax plan. That signifies a permanent victory.
  • Based on his comments about expensing and interest deductibility, he also seems to have a sensible view on properly and neutrally defining corporate income. These are boring and technical issues, but they have very important economic implications.
  • Critics say the lower corporate rate is responsible for big increases in red ink, but it’s noteworthy that the corporate rate was reduced by 40 percent and revenue is down by only 8.7 percent (a possible Laffer-Curve effect?). Here’s the relevant chart from the latest Monthly Budget Report from the Congressional Budget Office.

  • There’s a multi-factor recipe that determines prosperity, so it’s extremely unlikely that any specific reform will have a giant effect on growth, but even a small, sustained uptick in growth can be hugely beneficial for a nation.
  • There’s a big difference between a pro-market Democrat like Bill Clinton and some of the extreme statists currently seeking the Democratic nomination (just like there’s a big difference between Ronald Reagan and some of today’s big-government Republicans).
  • I close the discussion by explaining why “double taxation” is a profound problem with the current tax code. For all intents and purposes, we are punishing the savers and investors who generate future growth.

P.S. This wasn’t addressed in the interview, but I can’t resist pointing out that overall revenues for the current fiscal year have increased 2.2 percent, which is faster than needed to keep pace with inflation. So why has the deficit increased? Because spending has jumped by 5.8 percent. We have a spending problem in America, not a deficit problem. Fortunately, there’s a very practical solution.

P.P.S. It also wasn’t mentioned, but the other crown jewel of tax reform was the restriction on the state and local tax deduction.

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Welcome Instapundit readers! Thanks, Glenn

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Earlier today at the Friedman Conference in Australia, I spoke on the proper design of a tax system.

My goal was to explain the problem of double taxation.

I’ve repeatedly shared a flowchart to illustrate the pervasive double taxation in the current system (my example is for the United States, but many other nations make the same mistake).

And to help explain why this is economically misguided, I developed a (hopefully) compelling visual based on how to harvest apples.

But I’ve always wondered if I was presenting the information in an accessible and understandable manner. So for today’s presentation, I decided to experiment with some different visuals.

Here’s how I illustrated the current system.

As you can see, there are several additional layers of tax on people who save and invest their after-tax income.

And I explained to the crowd that this is very foolish since every economic theory agrees that saving and investment are key to long-run growth.

Even socialism. Even Marxism. (Socialists and Marxists are foolish to think government can be in charge of allocating capital, but at least they realize that future growth requires saving and investment.)

In other words, you don’t achieve good tax policy solely by having a low tax rate.

Yes, that’

s important, but genuine tax reform also means no bias against saving and investment.

Here’s another visual. This one shows the difference between the current system and the flat tax. As you can see, all the added layers of tax on saving and investment are jettisoned under true tax reform.

By the way, there are some people who prefer a national sales tax over a flat tax.

I question the political viability of that approach, but I’ve always defended the sales tax.

Why? Because it’s conceptually identical to the flat tax.

As you can see from this next visual, the difference between the two systems is that the flat tax grabs a bit of money when income is earned and the sales tax grabs a bit of money when income is spent (either today or in the future).

Remember, the goal is to eliminate the bias against saving and investing.

To economists who specialize in public finance, this is known as shifting to a “consumption base” system.

But I’ve never liked that language. What really happens under true tax reform is that we tax income, but using the right definition.

The current system, by contrast, is known as a “comprehensive income tax” with a “Haig-Simons” tax base. But that simply means a system that taxes some forms of income over and over again.

Time for one final point.

Some people like a value-added tax because it avoids the problem of double taxation.

That’s certainly true.

But this final visual shows that adding a VAT to the current system doesn’t solve the problem. All that happens is that politicians have a new source of revenue to expand the welfare state.

If a VAT was used to replace the current tax system, that might be a very worthwhile approach.

But that’s about as likely as me playing the outfield later this year for the New York Yankees.

P.S. The VAT visual is overly simplified and it sidesteps the logistical issue of whether politicians would go for a credit-invoice VAT or a subtraction-method VAT. But the visual is correct in terms of how a VAT would interact with the current system.

P.P.S. All you need to know about the VAT is that Reagan was against it and Nixon was for it.

 

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I recently appeared on CNBC to talk about everyone’s favorite government agency, those warm and cuddly folks at the IRS.

Our tax system is a dysfunctional mess, but you’ll notice that I mostly blamed politicians. After all, they are the ones who have unceasingly made the internal revenue code more complex, starting on that dark day in 1913 when the income tax was approved.

But I don’t want to give the IRS a free pass.

I’ve cited IRS incompetence and misbehavior in the past, most notably when discussing political bias, targeted harassment, and other shenanigans.

And, as illustrated by these five examples, we can always cite new evidence.

Such as lack of accountability.

…a new report from the Cause of Action Institute reveals that the IRS has been evading numerous oversight mechanisms, and it refuses to comply with laws requiring it to measure the economic impact of its rules. Congress has passed several laws, including the Regulatory Flexibility Act and the Congressional Review Act, that require agencies to report on their rules’ economic impact to lawmakers and the public. …These good-government measures are meant to ensure unelected bureaucrats can be checked by the public. …the IRS has made up a series of exemptions that allow it to avoid basic scrutiny. The agency takes the position that its rules have no economic effect because any impact is attributable to the underlying law that authorized the rule.

Such as inefficiency.

Private debt collectors cost the Internal Revenue Service $20 million in the last fiscal year, but brought in only $6.7 million in back taxes, the agency’s taxpayer advocate reported Wednesday. That was less than 1 percent of the amount assigned for collection. What’s more, private contractors in some cases were paid 25 percent commissions on collections that the I.R.S. made without their help…the report stated, “the I.R.S. has implemented the program in a manner that causes excessive financial harm to taxpayers and constitutes an end run around taxpayer rights protections.”

Such as rewarding scandal.

The Internal Revenue Service (IRS) issued more than $1.7 million in awards in fiscal 2016 and early fiscal 2017 to employees who had been disciplined by the agency, a Treasury Department watchdog said. “Some of these employees had serious misconduct, such as unauthorized access to tax return information, substance abuse and sexual misconduct,” the Treasury Inspector General for Tax Administration (TIGTA) said in a report made public this week. …in fiscal 2016 and early fiscal 2017, the IRS had given awards to nearly 2,000 employees who were disciplined in the 12 months prior to receiving the bonus.

By the way, the IRS has a pattern of rewarding bad behavior.

Such as pursuing bad policy.

…for 35 years the Internal Revenue Service has exempted itself from the most basic regulatory oversight. …Tax regulations (like all regulations) have exploded in recent decades, and of course IRS bureaucrats impose their own policy judgments. The IRS has in recent years unilaterally decided when and how to enforce ObamaCare tax provisions, often dependent on political winds. In 2016 it proposed a rule to force more business owners to pay estate and gift taxes via a complicated new reading of the law. …Secretary Steve Mnuchin’s Treasury…department is inexplicably backing IRS lawlessness with a string of excuses.

Again, this is not the first time the IRS has interfered with congressional policy.

Such as stifling political speech.

The Internal Revenue Service infamously targeted dissenters during President Obama’s re-election campaign. Now the IRS is at it again. Earlier this year it issued a rule suppressing huge swaths of First Amendment protected speech. …The innocuously named Revenue Procedure 2018-5 contains a well-hidden provision enabling the Service to withhold tax-exempt status from organizations seeking to improve “business conditions . . . relating to an activity involving controlled substances…” The rule does not apply to all speech dealing with the listed substances, only that involving an “improvement” in “business conditions,” such as legalization or deregulation. …This is constitutionally pernicious viewpoint discrimination.

In other words, the bureaucrats didn’t learn from the Lois Lerner scandal.

Now that I’ve hopefully convinced people that I’m not going soft on IRS malfeasance, let’s look at the budgetary issue that was the focus of the CNBC interview.

Is the IRS budget too small? Should it be increased so that more agents can conduct more audits and extract more money?

Both the host and my fellow guest started from the assumption that the IRS budget has been gutted. But that relies on cherry-picked data, starting when the IRS budget was at a peak level in 2011 thanks in part to all the money sloshing around Washington following Obama’s failed stimulus legislation.

Here are the more relevant numbers, taken from lines 2564-2609 of this massive database in the OMB’s supplemental materials on the budget. As you can see, IRS spending – adjusted for inflation – has nearly doubled since the early 1980s.

In other words, we shouldn’t feel sorry for the IRS and give it more money.

To augment these numbers, I made two simple points in the above interview.

  • First, we should demand more efficiency from the bureaucracy.
  • Second, we should reform the tax code to eliminate complexity.

The latter point is especially important because we could dramatically improve compliance while also shrinking the IRS if we had a simple and fair system such as the flat tax.

Last but not least, here’s a clip from another recent interview. I explained that the recent shutdown will be used as an excuse for any problems that occur in the near future.

Standard operating procedure for any bureaucracy.

P.S. My archive of IRS humor features a new Obama 1040 form, a death tax cartoon, a list of tax day tips from David Letterman, a Reason video, a cartoon of how GPS would work if operated by the IRS, an IRS-designed pencil sharpener, two Obamacare/IRS cartoons (here and here), a collection of IRS jokes, a sale on 1040-form toilet paper (a real product), a song about the tax agency, the IRS’s version of the quadratic formula, and (my favorite) a joke about a Rabbi and an IRS agent.

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Since I’m a proponent of tax reform, I don’t like special favors in the tax code.

Deductions, exemptions, credits, exclusions, and other preferences are back-door forms of cronyism and government intervention.

Indeed, they basically exist to lure people into making decisions that otherwise aren’t economically rational.

These distortionary provisions help to explain why we have a hopelessly convoluted and deeply corrupt tax code of more than 75,000 pages.

And they also encourage higher tax rates as greedy politicians seek alternative sources of revenue.

This current debate over “tax extenders” is a sad illustration of why the system is such a mess.

Writing for Reason, Veronique de Rugy explains how special interests work the system.

Tax extenders are temporary and narrowly targeted tax provisions for individuals and businesses. Examples include the deductibility of mortgage-insurance premiums and tax credits for coal produced from reserves owned by Native American tribes. …These tax provisions were last authorized as part of the Bipartisan Budget Act of 2018, which retroactively extended them through the end of 2017, after which they have thus far been left to remain expired. If Congress indeed takes up extenders during the current lame-duck session, any extended provisions are likely to once again apply retroactively through the end of 2018, or perhaps longer. There are several problems with this approach to tax policy. Frequently allowing tax provisions to expire before retroactively reauthorizing them creates uncertainty that undermines any potential benefits from incentivizing particular behaviors.

To make matters more complicated, a few of the extenders are good policy because they seek to limit double taxation (a pervasive problem in the U.S. tax system).

…not all tax extenders are a problem. Some are meant to avoid or limit the double taxation of income that’s common in our tax code. Those extenders should be preserved. Yet others are straightforward giveaways to special interests. Those should be eliminated.

Veronique suggests a sensible approach.

It’s time for a new approach under which tax extenders are evaluated and debated on their individual merits. The emphasis should be on eliminating special-interest handouts or provisions that otherwise represent bad policy. Conversely, any and all worthy provisions should be made permanent features of the tax code. …The dire need to fix the federal budget, along with the dysfunctional effects from extenders, should provide the additional motivation needed to end this practice once and for all.

Needless to say, Washington is very resistant to sensible policies.

In part, that’s for the typical “public choice” reasons (i.e., special interests getting into bed with politicians to manipulate the system).

But the debate over extenders is even sleazier than that.

As Howard Gleckman explained for Forbes, lobbyists, politicians, and other insiders relish temporary provisions because they offer more than one bite at the shakedown apple.

If you are a lobbyist, this history represents scalps on your belt (and client fees in your pocket). If you are a member of Congress, it is the gift that keeps on giving—countless Washington reps and their clients attending endless fundraisers, all filling your campaign coffers, election after election. An indelible image: It is pre-dawn in September, 1986. House and Senate tax writers have just completed their work on the Tax Reform Act.  A lobbyist friend sits forlornly in the corner of the majestic Ways & Means Committee hearing room. “What’s wrong,” I naively ask, “Did you lose some stuff?” Oh no, he replies, he got three client amendments in the bill. And that was the problem. After years of billable hours, his gravy train had abruptly derailed. The client got what it wanted. Permanently. And it no longer needed him. Few make that mistake now. Lawmakers, staffs, and lobbyists have figured out how to keep milking the cash cow. There are now five dozen temporary provisions, all of which need to be renewed every few years. To add to the drama, Congress often lets them expire so it can step in at the last minute to retroactively resurrect the seemingly lifeless subsidies.

In other words, the temporary nature of extenders is a feature, not a bug.

This is a perfect (albeit depressing) example of how the federal government is largely a racket. It enriches insiders (as I noted a few days ago) and the rest of us bear the cost.

All of which reinforces my wish that we could rip up the tax code and replace it with a simple and fair flat tax. Not only would we get more growth, we would eliminate a major avenue for D.C. corruption.

P.S. I focused today on the perverse process, but I can’t help but single out the special tax break for electric vehicles, which unquestionably is one of the most egregious tax extenders.

EV tax credits…subsidize the wealthy at the expense of the lower and middle classes. Recent research by Dr. Wayne Winegarden of the Pacific Research Institute shows that 79 percent of EV tax credits were claimed by households with adjusted gross incomes greater than $100,000. Asking struggling Americans to subsidize the lifestyles of America’s wealthiest is perverse… Voters also shouldn’t be fooled by the promise of large environmental benefits. Modern internal combustion engines emit very little pollution compared to older models. Electric vehicles are also only as clean as the electricity that powers them, which in the United States primarily comes from fossil fuels.

I was hoping that provisions such as the EV tax credit would get wiped out as part of tax reform. Alas, it survived.

I don’t like when politicians mistreat rich people, but I get far more upset when they do things that impose disproportionate costs on poor people. This is one of the reasons I especially dislike government flood insuranceSocial Security, government-run lotteries, the Export-Import Bank, the mortgage interest deduction, or the National Endowment for the Arts. Let’s add the EV tax credit to this shameful list.

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