(Even Better) State Tax Rankings

There’s been great progress in recent years with regards to state tax policy.

When I put together my first ranking back in 2018, there were 9 states with flat taxes and and 3 states with low-rate graduated tax systems.

Today, there are 11 (soon to be 13) states with flat taxes and 6 states with low-rate graduated systems.

But one thing has not changed.

The ideal state tax policy is to have no income tax and the 9 states in that category have not changed. Indeed, things may even be moving in the wrong direction since politicians in the state of Washington recently imposed a capital gains tax and they hope that the state’s top court somehow will decide it is constitutional.

But there’s now a glimmer of hope that a few states will jettison their income taxes.

We’ll start with an editorial in the Wall Street Journal about tax reform in North Dakota, where the state is about to join the flat tax club and might even phase out the income tax altogether.

The state has five brackets that range from 1.1% to 2.9%. That’s low compared with the 9.85% top rate in big-city Minnesota, but South Dakota doesn’t tax income at all. In the competition to be the best Dakota, this matters… The bill “would put us on a path toward eventually zeroing out our individual income tax,” Mr. Burgum told the House finance committee in January. “We compete for energy workers. Alaska, Texas and Wyoming are three of those eight states that already have zero income tax, and of course our neighbor right next to us in South Dakota.” …Zeroing out North Dakota’s income tax could finally be accomplished via a third bill, also passed by the state House. This plan would automatically cut income taxes by 0.5 percentage point if the state’s revenue targets are exceeded. If the rate starts at 1.5%, as the Governor hopes, the best case scenario is that the income tax could disappear entirely by 2028.

Iowa already has made great progress on tax policy, but may go even further according to this story in the Des Moines Register.

Iowa senators are advancing a bill that would eventually eliminate the state’s income tax. …Sen. Dan Dawson..said economic data since last year’s tax cuts show the state can afford to be even more aggressive. And, he said, Iowa needs to keep cutting taxes to compete with other states that are also lowering their own rates. …[Governor] Reynolds has said she’d like to eliminate the income tax by the end of her current term in office, which would be 2027. …”My goal is to get to zero individual income tax rate by the end of this second term,” she said. …Senate Study Bill 1126 would lower Iowa’s income tax rate to 3.55% in 2026, 2.95% in 2027 and 2.5% in 2028. Beginning in 2030, the bill would transform Iowa’s taxpayer relief fund into an “individual income tax elimination fund” and use the money in the fund to eventually lower the individual income tax rate further until it is eliminated entirely.

There’s also interest in Mississippi, as reported by Michael Goldberg for the Associated Press.

Gov. Tate Reeves promised to push for a full elimination of the state’s income tax during the 2023 legislative session. The move would make Mississippi the 10th state with no income tax. …Mississippi’s Republican-controlled legislature passed legislation in 2022 that will eliminate the state’s 4% income tax bracket starting in 2023. In the following three years, the 5% bracket will be reduced to 4%. …Mississippi’s population has dwindled in the past decade, even as other Sun Belt states are bustling with new residents. Tax-cut proposals are a direct effort to compete with states that don’t tax earnings, including Texas, Florida and Tennessee. “You don’t have to be a geography expert to look at a map and recognize that we have Texas to our west, Florida to our east and Tennessee to the north,” Reeves said. “All three of those states have no income tax, and therefore all three of those states have a competitive advantage when we are recruiting for both businesses and individual talent.”

Last but not least, the Democratic Governor of Colorado wants to abolish his state’s flat tax. Here are some details from a report by Ben Murrey in National Review.

…during his state of the state address last month, Governor Jared Polis suggested using TABOR refunds to decrease the state’s income-tax rate. The address marked the first time Polis had explicitly proposed using TABOR-refund dollars — which come out of state revenue surpluses — to lower the income-tax rate as part of his push to eliminate the state’s income tax altogether. …Discussing tax reform during his address, Polis said, “I was proud to have supported two successful income-tax cuts at the ballot and since I took office our income-tax rate has gone from 4.63 percent to 4.44 percent, helping produce strong economic growth and low unemployment.” …“It’s no secret that I, and most economists, despise the income tax,” Polis added. “I don’t expect that we can fully eliminate the income tax by our 150th anniversary [in 2026], but let’s continue to make progress.” …Polis’s willingness to stand by his support of TABOR refunds and light a path forward for his zero-income-tax agenda in the face of opposition from his own party is laudable.

By the way, “TABOR” refers to the Taxpayer Bill of Rights, which is a spending cap that requires automatic refunds to taxpayers when tax revenues increase faster than inflation plus population.

Leftists in Colorado fantasize about being able to spend those extra revenues, so kudos to Gov. Polis for instead wanting to use them to gradually phase out the income tax.

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Should America Copy Estonia’s Pro-Growth Flat Tax?

The Baltic nation of Estonia is an improbable success.

After breaking free from the horror of Soviet communism, leaders adopted pro-market reforms.

• Including a low-rate flat tax for households.
• Including a pro-growth tax system for companies.
• Including widespread economic deregulation.
• Including periodic episodes of spending restraint.

Is Estonia a laissez-faire paradise? No. But it ranks #8 in the world for economic liberty.

And having decent policy means poverty has plummeted and it has been quickly closing the gap with European nations that did not suffer from decades of communist enslavement.

Estonia’s experience with regards to tax policy may provide some lessons for the United States. The Tax Foundation has a new report that measures the potential benefits of replacing America’s nightmarish income tax with the Estonian system.

Other countries have proven that sufficient tax revenue can be collected in a less frustrating and more efficient manner. A particularly compelling example is Estonia’s tax system, where taxes are so simple they are typically filed online in about five minutes. …Drawing on the Estonian experience and building on ideas from our initial study on reform options, we present here a plan for reforming the U.S. tax code… The reforms include: A flat tax of 20 percent on individual income combined with a generous family allowance to protect low-income households. …A distributed profits tax of 20 percent… Elimination of taxes at death and simplified treatment of capital gains.

Here’s how the U.S. would benefit.

By simplifying the federal tax code, the reform would substantially reduce compliance costs, potentially saving U.S. taxpayers more than $100 billion annually. By improving work and investment incentives and eliminating the double taxation of business income, we estimate the reform would boost long-run GDP by 2.3 percent, grow wages by 1.3 percent, and add 1.3 million full-time equivalent jobs. The plan would increase average after-tax incomes by 0.3 percent in the long run on a conventional basis. When including the benefit of higher economic output, average after-tax incomes would rise by 2.1 percent in the long run.

A bigger economy, more investment, higher wages, and more jobs.

Hard to argue with these results.

Though, to be fair, you can argue with these results. The Tax Foundation’s analysis assumes that government should collect as much money with an Estonian-style flat tax as it does with the current internal revenue code.

That means poor people benefit (generous exemptions) and rich people benefit (lower tax rates) but middle-class people would wind up with less after-tax income.

That’s not a recipe for political success.

Which allows me to re-emphasize what I wrote in 2021, which is that you can’t have a good tax system without spending restraint.

That’s true for the flat tax. That’s true for the national sales tax. And it’s true for anybody and everybody who does not want massive future tax increases.

P.S. You can click here to read about Paul Krugman’s big mistake about Estonia.

P.P.S. And you can click here to read about the OECD’s campaign to undermine Estonian prosperity.

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The Political Argument Against the Fair Tax

I have repeatedly defended the national sales tax for the simple reason that it has the same desirable attributes as a flat tax.

• The tax rate is low.
• There is no double taxation.
• There are no loopholes.

Indeed, the flat tax and a national sales tax (such as the Fair Tax) are basically different sides of the same coin.

The only big difference is the collection point. A flat tax takes a piece of your income as you earn it while a national sales tax grabs a piece of your income as you spend it.

Using the jargon of public-finance economists, both the flat tax and national sales tax are “consumption base” systems.

But that does not mean a tax that is collected at the cash register. Instead, it simply means a system where there is no double taxation of saving and investment (i.e., a system where all saving and investment receives IRA/401(k)-type protection).

But just because two tax plans are economically similar does not mean that they have the same political appeal.

Over the past few decades, I’ve explained to many politicians the best arguments for both the flat tax and national sales tax. I’ve also warned them about the most likely attacks and how to respond.

Suffice to say that it’s much easier to sell the flat tax and defend it from demagoguery (usually revolving around class warfare or itemized deductions).

Which is why some pro-tax reform folks are trying to discourage House Republicans from supporting the Fair Tax.

Here are excerpts from a Wall Street Journal editorial.

House Republicans may be…set to vote on a national sales tax that won’t become law but will give Democrats a potent campaign issue. The plan is called the Fair Tax and its premise is simple: Replace every existing federal tax with a new national tax on sales. …the true rate would be about 30%. The Fair Tax rate would be on top of state sales taxes. …It would also eliminate the Internal Revenue Service, but…replace it with a new Sales Tax Bureau and Excise Tax Bureau. …The Fair Tax is based on the reasonable theory that levies on consumption distort the economy less than our current taxes on work and investment. Killing the income tax also sounds good until you realize that a future Congress could restore it if the Constitution’s 16th Amendment isn’t repealed. …The point is that a consumption tax might make sense if Congress were writing the tax code from scratch. But it isn’t, and we could end up with both a national income and sales tax, the later of which could evolve over time into a value-added tax. …the Fair Tax has hurt GOP candidates before. When tea party Republicans ran on the idea in 2010, Democratic groups ran ads that blasted the sales tax… Few voters listen to a second sentence after they hear about a 30% tax on everything they buy.

Opining for National Review, Ramesh Ponnuru is even more critical.

Any House Republican who backs this bill can accurately be accused of voting for the following things: raising the price of everything by a huge amount at a time when inflation is already high; shifting more of the tax burden to the middle class; instituting a large new wealth tax on senior citizens; increasing federal spending by a massive amount; increasing the deficit; and creating large black markets. …FairTax supporters have answers for most of these charges. They are not…persuasive answers. But even if they were right, Republicans who vote for the bill would be taking on a formidable amount of defensive work. Those in competitive seats, especially, should know what they are getting themselves into.

Last but not least, Grover Norquist of Americans for Tax Reform argues against the Fair Tax in an article for the Atlantic.

The bill proposes to abolish the Internal Revenue Service and eliminate the federal income tax. So far, so good. Unfortunately, the bill would replace the income tax with a 30 percent national sales tax on all goods and services and establish a giant new entitlement program. …Under the bill’s plan, all households would receive a monthly check from the federal government regardless of earned income. …In all but name, in fact, the Fair Tax’s “prebate” system would establish a universal basic income, one of the left’s favorite policies. …Fair Tax proponents make two good points. They understand the need to end the double taxation of savings and investment in the present system, and they want to depoliticize the IRS workforce… None of this has stopped Democrats from seizing the opportunity to claim that Republicans now want to raise taxes on the poor and middle class. …the Fair Tax Act has a long record of proving politically toxic.

P.S. While I recognize that a national sales tax has political vulnerabilities, I actually think its biggest problem is the risk that politicians would not actually get rid of the income tax. Or, maybe they would get rid of the income tax, but then reinstate that awful levy after a few years. This is why, in this video, I explain that a national sales tax only should be considered after the 16th Amendment is repealed and replaced with something that unambiguously prohibits the income tax from ever again plaguing the nation.

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The Political Argument for the Fair Tax

I’m a long-time proponent of tax reform and I mostly focus on the flat tax, but as I wrote last month, a national sales tax also is a good option.

Here’s some of what I said on the topic back in 2007.

The key thing to understand is that the flat tax and sales tax are different sides of the same coin.

What differs is the collection point. A flat tax takes a slice of your income when you earn it while a sales tax gets a slice of your income when you spend it.

But otherwise the two plans have a lot of similarities. Both tax at a low rate. Both get rid of double taxation (in the jargon of economists, this means a “consumption base” system). And both eliminate corrupt and distorting loopholes.

Those are the main economic arguments, though it’s also worth noting that either version of tax reform would allow a dramatic downsizing of the IRS.

I don’t know whether that should be a victory over bureaucracy or a victory for civil liberties, but it would be a good outcome.

In a column for today’s Wall Street Journal, Professor John Cochrane of the Hoover Institution makes the economic case for reform. Here are some excerpts.

…t“Fair Tax” bill…eliminates the personal and corporate income tax, estate and gift tax, payroll (Social Security and Medicare) tax and the Internal Revenue Service. It replaces them with a single national sales tax. Business investment is exempt, so it is effectively a consumption tax. Each household would get a check each month, so that purchases up to the poverty line are effectively not taxed. …our income and estate tax system is broken. It has high statutory rates with a Swiss cheese of exemptions, immense cost, unfairness and distortion. …A consumption tax, with none of the absurd complexity of our current taxes, is the answer. It funds the government with the least economic distortion. …A range of implicit subsidies will disappear. Good. Subsidies should be transparent. Money for electric cars, health insurance, housing, and so forth should be appropriated and sent as checks, not hidden as tax deductions or credits.

The bottom line is that we would have a much less destructive system with a national sales tax.

That being said, there is a very relevant debate about whether a sales tax is the politically smart way of trying to fix tax code.

In the video above, Bruce Bartlett argued that incremental reforms could solve almost all of the problems in the current system. That’s technically true, but tinkering with the tax code over the past 110 years is what’s produced the current mess.

So is it realistic to think that tinkering in the future will yield good results?

Regardless of our strategy, the odds of a good outcome are not favorable, but my two cents is that our best bet is to advocate for big changes like either a flat tax or national sales tax.

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The Boring but Important Issue of “Tax Expenditures”

It’s fun to write about big-picture tax issues such as tax reform (for instance, should we have a flat tax or national sales tax?).

It’s also fun to write about contentious issues such as whether there should be tax increases or whether the tax code should be based on class warfare.

Many tax topics, however, are tedious and boring. But they nonetheless involve important issues.

1. Depreciation vs. expensing for new business investment.
2. International tax rules and the choice of worldwide taxation vs territorial taxation.
3. The debate on consumption-base taxation vs. Haig-Simons taxation.
4. Choosing the right way of treating prior-years business losses.
5. The fight over whether border-adjustable taxation should be part of tax reform.

Building on that list, today we’re going to wade into the boring topic of “tax expenditures.”

For those unfamiliar with the term, tax expenditures are special preferences in the tax code. In other words, tax loopholes.

But here’s the challenge: In order to figure out what’s a loophole, you first need to define a neutral tax system. And that means the debate over tax expenditures is actually a fight over consumption-base taxation vs. Haig-Simons taxation (the third item in the above list).

At the risk of over-simplifying, here’s what both sides believe:

• Proponents of consumption-base tax believe you get a neutral system by taxing all income one time, but only one time (i.e., there should be no discriminatory extra layers of taxation on income that is saved and invested).
• Proponents of Haig-Simons taxation, by contrast, believe that a neutral tax system also requires double taxation of income that is saved and invested (for all intents and purposes, taxing income and changes in net worth).

I’m motivated to write about this topic because the Committee for a Responsible Federal Budget put out a report last year entitled, “Addressing Tax Expenditures Could Raise Substantial Revenue.”

Since I don’t think our fiscal problem of excessive spending can be solved by giving politicians more revenue, I obviously disagree with the folks at CRFB about whether it would be desirable to “raise substantial revenue.”

For what it’s worth, I want to get rid of tax loopholes, but only if we use the revenues to facilitate lower tax rates. Indeed, that’s the goal of reforms such as the flat tax.

But let’s set aside that fight over tax increases and instead look at CRFB’s list of supposed tax expenditures. They rely on the Haig-Simons approach and thus include items (circled in red) that are not actually loopholes.

In a neutral tax system with no double taxation, there is no capital gains tax, no death tax, and no double taxation of dividends. In a neutral tax system, all savings is treated like IRAs and 401(k)s, which means the provisions circled above should be viewed as mitigations of penalties rather than loopholes.

Adam Michel of the Heritage Foundation illustrated the differences between consumption-base and Haig-Smons taxation in a 2019 report.

Here’s his table looking at what’s a loophole under both systems and the bottom part of the visual is where you will see the stark difference in how both systems treat saving and investment.

I’ll close by observing that my friends on the left generally support double taxation because they view such policies as a way of getting rich people to pay more (or as a way of punishing success, regardless of whether more revenue is collected).

I try to remind them that saving and investment is what leads to higher productivity, which means it is the most effective way of boosting wages for those of us who are not rich.

Sadly, it’s not easy to get them to understand that labor and capital are complementary factors of production (apologies for the economic jargon).

P.S. While CRFB uses the wrong definition when measuring tax loopholes, they are not alone. The Joint Committee on Taxation,  the Government Accountability Office, and the Congressional Budget Office make the same mistake. Heck, you even see Republicans foolishly use this flawed benchmark.

P.P.S. Here’s my award for the strangest tax loophole.

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National Sales Tax Update: Test Vote for the Fair Tax

Fundamental tax reform is back on the agenda, with House Republicans promising a vote this year on a national sales tax, so I dug into C-Span’s archives so I could share a few of my thoughts from 2007 on the Fair Tax.

As you might suspect, the principles I believed in back in 2007 and the principles I still support in 2023.

If anything, I have even greater disdain for the IRS and our awful tax system.

Politicians have combined the worst of two worlds, giving us a tax code that simultaneously is filled with class-warfare provisions that punish success while also containing thousands of special tax breaks that benefit the well-heeled friends of politicians.

As I said in the video, it would be nice to toss the current tax code in the trash and replace it with something that collects revenue is a less-damaging and less-corrupt fashion.

For what it’s worth, I’ve always preferred the flat tax over a national sales tax.

Not because one is theoretically better than the other, but because of two political reasons.

1. As noted in the above clip, I’m very worried about giving untrustworthy politicians a new source of tax revenue without unambiguously and permanently getting rid of the income tax (so that we don’t repeat the European mistake of giving politicians a way of expanding government).
2. I also worry that a Fair Tax is vulnerable to demagoguery since lawmakers will get hit with election-year ads stating they want a big 30 percent tax on everything people buy (while overlooking that our paychecks will be much bigger once income taxes and payroll taxes are abolished).

Indeed, many sympathizers openly admit that the Fair Tax has vulnerabilities.

And there’s plenty of less-friendly opposition. In an article for the Bulwark, Jim Swift pours cold water on the idea.

…nobody has ever taken the Fair Tax seriously. Not in the years after the Tea Party wave… Not in 2011, when Texas Gov. Rick Perry briefly campaigned in support of the Fair Tax, only to quietly walk back his support and switch to a flat tax proposal.Not in 2017, when the Republican-controlled Congress passed the Tax Cuts and Jobs Act. …Do moderate House Republicans really want to be forced to vote on the Fair Tax? …In light of all this, why promise a vote on such a loser? Going straight to the floor poses risks, given the slim GOP majority. It’s a lose-lose situation: Vote yes, and the House Republican Conference looks frivolous, to say nothing of the messaging gift they would give Democratic speechwriters in 2024 (“Republicans want to instate a 30-plus percent federal sales tax!”). Vote no, and invite primaries by far-right candidates who will accuse you of siding with Democrats when given a chance to abolish the IRS. …It’s possible that McCarthy agreed to a floor vote expecting moderates to break ranks and the bill to fail by a spectacular margin. That would drive a stake through the heart of the Fair Tax. …What’s likelier is that McCarthy knew this was a promise he could break. He never said anything about when he would bring the bill to the floor.

While I do worry about the political blowback against a Fair Tax, I hope Speaker McCarthy keeps his promise and there is a floor vote.

Not because I’m deluded about something good getting through the Senate or surviving a sure-veto from Biden.

But if tax reform becomes a big issue this year, that may set the stage for a bigger debate in 2024 and maybe one of my fantasies will come true and we’ll get something good in 2025.

P.S. Here’s another video from the archives, in which I discuss the flat tax and national sales tax.

P.P.S. Speaking of archives, here are my brief thoughts from 2011 about the various proposals for tax reform.

P.P.P.S. And click here, here, here, or here if you want to peruse my arguments for the flat tax.

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Addressing IRS Dysfunction

I’m not a big fan of the Internal Revenue Service, but our awful (and anti-growth) tax system is mostly the fault of politicians.

Ever since that dark day in 1913 when the income tax was enacted, presidents and members of Congress have been making the system more and more complicated.

The net result is that we now have a tax system that – according to the IRS website – requires more than 2,700 separate forms, instructions, or publications (a huge increase over the past two decades).

In my fantasy world, we would throw all those forms in the trash and replace today’s convoluted tax system with a simple and fair flat tax.

Instead of 2,700-plus forms, we would have one simple postcard-sized tax return for households and another simple postcard-sized tax form for businesses.

Yes, there would be a few other forms for instructions and things like that, but compliance costs would drop by more than 90 percent.

Seems like a win-win approach, but the Washington Post has a different perspective, editorializing instead in favor of simply giving the IRS more money and power.

For the past three years, the IRS has failed to do its most basic job: processing tax returns in a timely manner. There are many reasons. The pandemic upended almost everything for a while. …Ancient computer systems hampered operations. And Congress kept asking the IRS to do more: implement the sweeping 2017 GOP tax code overhaul, then send stimulus checks — three times — to the vast majority of Americans during the pandemic. …Yet House Republicans made it their first priority this year to pass legislation slashing IRS funding, which would worsen the agency’s problems — and the service it provides Americans. …Congress’s priority should be modernizing the IRS and getting it back to full functionality. That’s why Democrats passed $80 billion in extra funding for the agency… This isn’t the time to cut. It’s the time to resuscitate.

By the way, “slashing” is a very inaccurate word when describing the GOP plan to cancel a giant budget increase for the IRS. Indeed, the IRS budget (adjusted for inflation) has dramatically expanded in recent decades.

But we should expect misleading analysis from the Washington Post.

So let’s conclude by instead asking a fundamental question: Is it better to continue on the current path (an ever-more-complex tax system requiring ever-more-money for the IRS) or is it better to have a clean tax system?

The answer should be obvious.

P.S. I’m sure that not every additional form on the IRS website represents additional complexity. But I’m also sure that the tax code is far worse than it was in the past. Perhaps the most compelling evidence is the huge increase in the number of pages needed for the instruction manual for the 1040 tax form.

P.P.S. Also keep in mind that there is a lot of evidence that tax complexity is a major source of political corruption.

P.P.P.S. If you like gallows humor, click here.

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Best and Worst News of 2022

Continuing a tradition that began back in 2013, let’s look at the best and worst developments of the past year.

Since I try to be optimistic (notwithstanding forces and evidence to the contrary), let’s start with the good news.

I’ll start by mentioning that we will now have gridlock in Washington. That’s probably a positive development, but I’ll explore that issue tomorrow as part of my “Hopes and Fears” column for 2023.

For today, let’s focus on three concrete developments from 2022 that unambiguously are positive.

States cutting tax rates and enacting tax reform – Since I’m a long-time advocate for better tax policy, I’m very pleased that more states are moving in the right direction. I especially like that the flat tax club is expanding. I’m also amused that a bad thing (massive handouts from Washington) backfired on the left (because many states decided to cut taxes rather than squander the money on new spending).

Chileans vote against a statist constitution – There was horrible news in 2021 when Chileans voted a hard-core leftist into the presidency. But we got very good news this year when the same voters overwhelmingly rejected a proposed constitution that would have dramatically expanded the power of government.

More families have school choice – Just like last year, we can celebrate that there was more progress on education this year. In 2021, West Virginia led the way. In 2022, Arizona was the best example. And we’ll discuss tomorrow why there are reasons to be optimistic about 2023.

Now let’s shift to the bad news of 2022.

I thought about listing inflation, which definitely caused a lot of economic damage this year. But the bad monetary policy actually occurred in 2020 and 2021 when central bankers overreacted to the pandemic.

So I’m going to write instead about bad things that specifically happened in 2022.

Biden semi-successfully expands the burden of government – The president was able to push through several bad proposals, such as the so-called Inflation Reduction Act and some cronyist subsidies for the tech industry. Nothing nearly as bad as his original “build back better” scheme, but nonetheless steps in the wrong direction.

The collapse of small-government conservatism in the United Kingdom – Just as today’s Republicans have deviated from Reaganism, the Conservatives in the United Kingdom have deviated from Thatcherism. Except even worse. Republicans in the USA acquiesce to higher spending. Tories in the UK acquiesce to higher spending and higher taxes.

Massachusetts voters opt for class warfare – Starting tomorrow, Massachusetts no longer will have a flat tax of 5 percent. That’s because voters narrowly approved a class-warfare based referendum to replace the flat tax with a new “progressive” system with a top rate of 9 percent. Though bad news for the state’s economy will be offset by good news for moving companies.

P.S. I almost forget to mention that the best thing about 2022 occurred on January 10 when the Georgia Bulldogs defeated Alabama to win the national championship of college football.

P.P.S. While 2022 was a mixed bag, history buffs may be interested in knowing that it was the 100th anniversary of a big tax rate reduction (top rate lowered from 73 percent to 58 percent) implemented in 1922 during the under-appreciated presidency of Warren Harding.

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Time to Resuscitate the Flat Tax

It is economically foolish to have high tax rates, double taxation, and corrupt loopholes.

The answer, as Steve Forbes explains in this video, is the flat tax.

He makes excellent points, similar to the analysis I shared in my 2010 video.

Though there’s one difference. He got to share the good news about the wave of tax reform taking place at the state level.

In my video, by contrast, I got to share the good news about the tax reform that was taking place in Eastern Europe.

And what happened in Eastern Europe is our topic for today.

A new study by Brian Wheaton, a professor at UCLA who examined what happened after those nations adopted flat tax systems after the breakup of the Soviet Empire.

Here’s a map from the study, showing the nations that adopted the flat tax.

What were the economic results?

Here are some excerpts from Prof. Wheaton’s study.

Would a flat income tax substantially improve…incentives? To answer these questions, I study the experience of twenty post-Communist countries, which introduced flat taxation on income. I find that the flat tax reforms increase annual per-capita GDP growth by 1.38 percentage points for a transitionary period of approximately one decade. …Further, I find that the growth effect primarily operates through increases in investment and, to a lesser extent, labor supply. It is driven by the reductions in progressivity resulting from the reforms rather than merely the reductions in the average marginal tax rate.

And here’s a chart showing the pro-growth impact.

I wrote a column about this study yesterday for Townhall.

Here’s some of my analysis.

Starting about 30 years ago, there was serious interest in replacing the internal revenue code with a simple and fair flat tax. What motivated the desire to adopt a system based on one low rate, no double taxation of saving and investment, and no special loopholes? In part, it may have been because lawmakers at the time had a decent understanding of fiscal policy, having spent much of the 1980s lowering tax rates and seeing how that led to better economic performance. …With Bill Clinton in the White House, however, it was not possible to turn enthusiasm into reality. And in the following few decades, tax reform has fallen off the radar. …That’s unfortunate. America’s tax system has punitive features that reduce incentives for productive behavior. ..it would be a very good idea to resuscitate tax reform.

I explain that Professor Wheaton’s growth estimates are very important.

By the way, 1.38 percentage points of additional annual growth may not sound like much to some people, but the net effect is that flat tax nations wound up with about 15 percent more economic output after a decade. And that’s in addition to whatever growth they would have experienced without tax reform. A similar boost in growth in the United States would means several thousand dollars of additional economic output for every man, woman, and child.

And I close with a political observation.

It will be interesting to see whether some of the potential 2024 presidential hopefuls decide to battle these people and make tax reform part of their campaigns. Combined with other good ideas such as spending caps and federalism, there might be a winning message for the right candidate.

By the way, I’m not the only person to write about resuscitating tax reform.

Here are some excerpts from a column earlier this year by Cal Thomas for Jewish World Review.

The next time Republicans control all three branches of government they may wish to visit an old idea – the flat tax. …The Tax Code is a foreign language to many. As of 2018, it comprised 60 thousand pages in 54 volumes. According to The Tax Foundation, …the U.S. ranks 21st out of 37 nations in tax simplicity. Estonia has been first for eight straight years. Maybe we could learn from them. Look at states with no state taxes to see their prosperity. It is a major reason so many Americans are moving from high tax states to those with lower, or no state taxes. Unfortunately, one cannot escape the long arm of the IRS. A flat tax and the elimination of the IRS might help reduce the anger many people have about Washington and big spending politicians.

Since I’m a policy wonk, I mostly care about tax reform in hopes of reducing what economists refer to as “deadweight loss” in the economy.

But let’s also remember what Steve Forbes said in the video about the current system being corrupt.

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Applauding Governor Ducey of Arizona

Because politicians have built-in incentives to expand the size and scope of government, it is very rare to find elected officials who actually deliver more liberty.

Some of them will offer rhetoric, of course, but very few of them produce results.

That’s true nationally (with limited exceptions), and it’s true internationally (with limited exceptions).

And it’s almost certainly true at the state level.

Though I found an exception, and that is the topic of today’s column.

The outgoing governor of Arizona, Doug Ducey, deserves praise from libertarians and small-government conservatives.

George Will is especially impressed with Ducey’s education reforms (and I agree).

Here are some excerpts from his Washington Post column.

With two trenchant sentences, the nation’s most successful governor of the 21st century defines the significance of his signature achievement: “Fifty years ago, politicians stood in the schoolhouse door and wouldn’t let minorities in. Today, union-backed politicians stand in the schoolhouse door and won’t let minorities out.” Hence Gov. Doug Ducey’s Empowerment Scholarship Account program, which was enacted this year to provide universal school choice in grades K-12. Every Arizona family is eligible to receive about $7,000 per student per year to pay for private school tuition, home schooling, tutoring, textbooks, online courses, programs for special-needs pupils and more. …ESA was ferociously opposed by the teachers’ unions, whose confidence in the quality of their schools can be gauged by their fear of competition. A union attempt to repeal ESA by referendum failed to get enough signatures to qualify for the ballot, partly because of a group (Decline to Sign) in which, Ducey said here last week, Black leaders were disproportionately active.

The Wall Street Journal is impressed with his tax reform (and I agree).

Arizonans who fled California for sunnier tax climes can breathe easier after a court ruling that has saved the day from a punitive 8% top state tax rate. A state judge…struck down Arizona’s Proposition 208, which placed a 3.5% surtax on incomes above $250,000, or $500,000 for joint filers. …Nixing the surtax means Arizona will soon have a flat tax of 2.5% on individual incomes, the lowest flat rate among states with an income tax. Gov. Doug Ducey slashed the previous 4.5% top rate in his 2022 budget… Tax competition has helped Arizona draw residents and businesses from neighbors like California, but the surtax would have sent the Grand Canyon State down a Golden State path. The tax’s $250,000 income threshold made it a particular burden on small businesses that pay taxes under the individual code. The episode is a reminder of the value of constitutional guardrails on state taxes and spending. Arizona voters in 1980 placed limits on school spending through a ballot initiative, preventing unrestrained budget bloat.

In a column for National Affairs, James Glassman mentions school choice and the flat tax, but also a few of his other accomplishments.

Since Arizona’s governor is limited to eight years in office, Ducey’s second term — which ends in January — will be his last. This makes it an opportune time to consider Ducey’s legacy… This past January, Ducey told the state legislature, “[l]et’s think big and find more ways to get kids into the school of their parents’ choice…” In July, he did just that. The Empowerment Scholarship Account program — the most expansive school-choice program in America — is a pure choice-based system that provides $6,500 per student to any family that prefers an alternative to public schools. …When he entered office, he announced that he wanted the state’s personal income tax rate, which stood at 4.5%, to be “as close to zero as possible.” He started by indexing brackets to inflation, then chipped away at the rate with dozens of specific reductions. Finally, last year, he signed into law the largest tax cut in the state’s history, which will achieve a flat tax of 2.5% within three years. On regulatory policy, …he axed or modified more than 3,000 regulations. …he signed the first universal occupational-licensing law in the nation: Arizona now automatically recognizes occupational licenses issued by any other state. He also eliminated initial licensing fees for applicants from families making less than 200% of the federal poverty level.

Ducey’s licensing reform is especially impressive. For all intents and purposes, he adopted an approach based on “mutual recognition,” and that makes it much easier for people in other states to shift economic activity to Arizona.

P.S. George Will’s column also notes that Ducey is not a fan of Republicans who want to surrender to bigger government.

During a September speech at the Ronald Reagan Presidential Library in California, Ducey deplored the fact that “a dangerous strain of big-government activism has taken hold” in the Republican Party, and “for liberty’s sake we need to fight it with every fiber in our beings”.

Amen. Whether it is called national conservatism, compassionate conservatism, kinder-and-gentler conservatism, common-good capitalism, reform conservatism, or anything else, bigger government is bad news for ordinary citizens.

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The Feel-Good Map of 2022

I’ve already shared the “feel-good story” for 2022, so today I’m going to share this year’s feel-good map.

Courtesy of the Tax Foundation, here are the states that have lowered personal income tax rates and/or corporate income tax rates in 2021 and 2022. I’ve previously written about these reforms (both this year and last year), but more and more states and lowering tax burdens, giving us a new reason to write about this topic.

The map is actually even better than it looks because there are several states that don’t have any income taxes, so it’s impossible for them to lower rates. I’ve labelled them with a red zero.

And when you add together the states with no income tax with the states that are reducing income tax rates, more than half of them are either at the right destination (zero) or moving in that direction.

That’s very good news.

And here’s more good news from the Tax Foundation. The flat tax club is expanding.

I prefer the states with no income taxes, but low-rate flat taxes are the next best approach.

P.S. According to the Tax Foundation, New York and Washington, D.C. have moved in the wrong direction. Both increased income tax burdens in 2021. No wonder people are moving away.

P.P.S. If I had to pick the states with the best reforms, I think Iowa and Arizona belong at the top of the list.

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Is It Time to Resuscitate the National Sales Tax?

About 14 years ago, I narrated this video about the flat tax and national sales tax (sometimes referred to as a “Fair Tax”).

I used the video as an opportunity to explain that both plans effectively rip up the current internal revenue code. And both would solve the major problems that plague today’s income tax.

• No more punitive tax rates on productive behavior.
• No more double taxation of saving and investment
• No more corrupt, complex, and inefficient loopholes.

As I stated in the video, the only big difference between a flat tax and national sales tax is the collection point.

A flat tax is collected as income is earned. A sales tax, or Fair Tax, is collected as income is spent.

But the economic benefits of both plans are identical because the core features of both plans are identical.

Sadly, big-picture tax reform no longer is a major issue. Proponents of good policy are mostly focused today on stopping plans that would make a bad tax code even worse.

But maybe it is time to think about going on offense.

In a column for the New York Sun, John Childs makes the case for replacing the current mess with the national sales tax.

There is a better way — replace the entire income tax monstrosity with a national consumption tax, i.e. a national sales tax. Let Walmart and Amazon be the tax collectors. Odds are they will be vastly more efficient than the IRS, which at this point can’t even return the phone calls of bewildered taxpayers. All retailers already perform sales tax collection services for state governments. So it is hardly a leap of faith to ask them to do it for the Feds. …This would be bad news for tax lawyers and accountants. As some of the brightest minds in the country now devote themselves to crafting fiendishly clever tax avoidance schemes, though, imagine what an unexpected dividend would flow from redirecting all of that creativity to productive activities.

I agree that a national sales tax would be much better than the current system.

That’s why I’ve promoted the idea on many occasions.

But always with the very big caveat that I mentioned in the video, which is that any sort of direct consumption tax (sales tax, Fair Tax, value-added tax) has to be a total replacement for the income tax.

However, that’s just one must-have requirement. Since politicians are untrustworthy, we also should not allow a direct consumption tax until and unless the 16th Amendment is repealed and replaced with a new amendment that unambiguously prohibits any future Congress from reinstating an income tax.

The bad news is that I don’t think either of these requirements will be met. And this is why I am more focused on supporting the flat tax.

After all, the worst thing that happens with a flat tax is that future politicians reinstate the current system.

But the worst thing that happens with a national sales tax is that future politicians have a new source of revenue to fuel bigger government (sort of what happened in Europe when value-added taxes financed a major expansion in the burden of government spending).

P.S. The same principles apply at the state level. Policymakers should use consumption taxes to help finance the repeal of income taxes.

P.P.S. A Fair Tax (or any form of national sales tax) will reduce the underground economy, but not by a greater amount than the flat tax.

P.P.P.S. Here are very succinct explanations of major tax reforms proposals.

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Iowa Joins the Flat Tax Club

At the state level, we have another victory for good tax policy.

I wrote last month that Iowa might replace its discriminatory tax regime with a simple and fair flat tax.

And I pointed out that this reform would help the state jump several spots in my ranking of state tax systems.

Well, the proposed reform has been approved by the state legislature and Iowa will now have a much better (i.e., less destructive) tax system.

Here are some details of the new law, as reported by Stephen Gruber-Miller and Ian Richardson for the Des Moines Register.

Iowa will move to a 3.9% flat income tax rate under a compromise between legislative Republicans and Gov. Kim Reynolds… …It would also exempt retirement income such as 401(k)s, pensions and IRAs from state taxes… Along the way, the bill would eliminate Iowa’s progressive income tax system, where wealthier Iowans pay higher rates than lower-income Iowans. Iowa would join 10 other states with some form of flat income tax. …The new proposal would build upon a series of tax cuts that were previously set to start for Iowans in 2023, meaning multiple new tax laws would take effect during the same year. Iowa is already set to reduce the number of tax brackets from nine to four starting in 2023. …It will drop the corporate tax rate to a 5.5% flat rate over time.

I could end today’s column at this point.

After all, what happened in Iowa is a triumph for tax reform and another case study on the benefits of tax competition (just like we’ve seen in states such as Kentucky and North Carolina).

But I want to take this opportunity to address another big-picture issue.

Earlier this month, James Lynch wrote a column for the Des Moines Register on the potential impact of tax reform in the state.

He contrasted the views of both proponents and opponents.

Flattening state income tax rates and exempting retirement income would either lead to growth in businesses and jobs and increase Iowans wealth, or simply make wealthy Iowans wealthier, according to speakers at a public hearing…speakers at the Monday evening public hearing were divided between those who said a flatter tax rate would make Iowa a more attractive place for businesses to locate and expand — as well as a more attractive place for employees to live and work — and those who said the plan largely benefits the wealthy while doing little to help lower-income workers.

At the risk of sounding mushy, both supporters and critics are right.

Iowa’s tax reform will encourage more growth. And it’s also true that the rich will benefit.

But opponents are guilty of a sin of omission. That’s because tax reform will benefit lower-income and middle-class taxpayers as well.

And I think “sin of omission” is the right term. That’s because a big moral shortcoming among our friends on the left is that they are sometimes tempted to go along with policies that will hurt the less fortunate so long as they impose even greater damage on upper-income taxpayers.

P.S. Adopting a flat tax is progress, but the ultimate goal should be abolishing the state income tax.

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Iowa Adopting a Flat Tax?

I wrote last year about an encouraging trend of lower tax rates at the state level.

As you can see from this map, one of the states moving in the right direction is Iowa.

But Governor Kim Reynolds isn’t satisfied with just lowering tax rates, which is a worthy goal, of course.

She is now proposing to get rid of the state’s so-called progressive tax and replace it with a flat tax.

This would be very good news for Iowa’s economy and Iowa’s taxpayers.

An article in the Quad-City Times explains Governor Reynolds’ proposal.

In four years, every Iowan’s income would be taxed at 4% by the state under a new proposal from Gov. Kim Reynolds. Reynolds introduced her flat income tax proposal during last week’s annual Condition of the State address to the Iowa Legislature, encouraging the lawmakers to pass her idea.“Flat and fair,” Reynolds proclaimed during the speech. …Ten states currently have a flat state income tax, including Iowa’s eastern neighbor, Illinois. The list includes more blue states like Michigan and Massachusetts, but also red states like Kentucky and Utah. …Under Reynolds’ new plan, top state income tax rate would be eliminated each year over the next four years, until in 2026 every Iowa worker, regardless of income level, pays 4 percent. …The plan would reduce state revenue by $226 million in the first year, and by $1.6 billion at full implementation… Reynolds said during her speech. “Yes, we’ll have less to spend once a year at the Capitol, but we’ll see it spent every single day on Main Streets, in grocery stores, and at restaurants across Iowa. We’ll see it spent in businesses instead of on bureaucracies.” …Republican legislative leaders praised Reynolds’ proposal and said they are eager to begin working on legislation.

The article also explains the previous tax reform, which focused on lowering marginal tax rates.

In 2021, Iowa had nine state income tax rates, tied for the second-most in the country. Most Iowa workers’ income was taxed at between 4.14%, with rates increasing as income increased, up to a top rate of 8.53% for those earning over $78,435 of taxable income. As a result of tax reform passed by the Iowa Legislature and signed into law by Reynolds in 2018, the number of tax brackets will be reduced to four, ranging between 4.4 and 6.5%.

I showed last year how that legislation moved Iowa up one level in a ranking of state income taxes.

Well, here’s an updated look at the state’s total improvement if the governor’s plan for a flat tax is enacted.

Iowa jumps from the worst column to the next-to-best column.

And if I ranked states by the rate of their flat tax, Iowa’s 4 percent rate would be lower than the rates in North Carolina, Kentucky, Illinois, Michigan, Utah, and Massachusetts.

Not as good as the states with no income taxes, but still impressive.

P.S. I’ll be curious to see how much Iowa will improve in the Tax Foundation’s rankings if the proposed flat tax gets approved.

 

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Ranking State Income Taxes

Motivated in part by an excellent graphic that I shared in 2016, I put together a five-column ranking of state personal income tax systems in 2018.

Given some changes that have since occurred, it’s time for a new version. The first two columns are self explanatory and columns 3 and 5 are based on whether the top tax rate on households is less than 5 percent (“Low Rate”) or more than 8 percent (“Class Warfare”).

Column 4, needless to say, is for states where the top tax rate in between 5-8 percent.

The good news is that the above table is better than the one I created in 2018. Thanks to tax competition between states, there have been some improvements in tax policy.

I recently wrote about Louisiana’s shift in the right direction.

Now we have some good news from the Tarheel state. The Wall Street Journal opined today about a new tax reform in North Carolina.

The deal phases out the state’s 2.5% corporate income tax between 2025 and 2031. …The deal also cuts the state’s flat 5.25% personal income tax rate in stages to 3.99% by July 1, 2027. …North Carolina ranks tenth on the Tax Foundation’s 2021 state business tax climate index, and these reforms will make it even more competitive. …North Carolina has an unreserved cash balance of $8.55 billion, and legislators are wisely returning some of it to taxpayers.

What’s especially noteworthy is that North Carolina has been moving in the right direction for almost 10 years.

P.S. Arizona almost moved from column 3 to column 5, but that big decline was averted.

P.P.S. There are efforts in Mississippi and Nebraska to get rid of state income taxes.

P.P.P.S. Kansas tried for a big improvement a few years ago, but ultimately settled for a modest improvement.

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Another Good Election Result for Taxpayers

Immediately after election day in early November, I applauded voters in the (very blue) state of Washington. They wisely expressed their opposition to a plan by state politicians to impose a capital gains tax.

And it wasn’t even close. Voters said no by a landslide margin in a state that went heavily for Biden.

Today, we’re going to look at more good news from a statewide initiative.

Voters in Louisiana last Saturday had a chance to vote for some pro-growth tax reform. And, as reported by KPVI, they made a wise choice.

Louisiana voters approved a constitutional amendment that decreases the maximum individual income tax rate from 6% to 4.75% beginning next year. …fifty-four percent of voters agreed to Amendment 2, which affects taxpayers making more than $50,000 and couples making more than $100,000 annually. …The free market Pelican Institute also supported Amendment 2. “For too long Louisiana has been lagging behind our neighbors, but the people of Louisiana voted to start our comeback story by passing amendment 2 to simplify our tax code and lower our income tax rates to the lowest in the Southeast of states that levy the tax,” Pelican Institute CEO Daniel Erspamer said in a statement.

The good news gets even better.

Voters imposed a cap on income tax rates, with a maximum of 4.75 percent.

But the legislature is putting the rate down to 4.25, as noted by the Tax Foundation.

Let’s close by looking at some excerpts from an editorial by the Wall Street Journal.

…voters on Saturday approved a constitutional amendment that will reduce corporate and individual income tax rates while simplifying the code. …The tax reform, approved with 54% of the vote, eliminates the deductibility for federal taxes while reducing the top income tax rate on individuals making more than $50,000 to 4.25% from 6%. Rates will also decline for lower earners. The current five corporate tax brackets would be consolidated into three with the top rate falling to 7.5% from 8%. Most Louisianans will get a small net tax cut, and the implementing legislation includes triggers that would reduce rates more if revenues meet growth goals.

For what it’s worth, allowing state deductibility of federal taxes is almost as misguided as federal deductibility of state and local taxes.

So Louisiana voters opted for a win-win situation of lower rates and getting rid of a loophole.

P.S. In a payoff to their wealthy constituents (and to make life easier for profligate governors, state lawmakers, and local officials), Democrats in Congress are pushing to re-create a big deduction for state and local tax payments.

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Pro-Growth Tax Reform in Arizona

The best referendum result of 2020 (indeed, the best policy development of the year) was when the people of Illinois voted to preserve their flat tax, thus delivering a crushing defeat to the Prairie State’s hypocritical governor, J.B. Pritzker.

The worst referendum result of 2020 was when the people of Arizona voted for a class-warfare tax scheme that boosted the state’s top tax rate from 4.5 percent to 8 percent.

In one fell swoop, Arizona became a high-tax state for investors, entrepreneurs, innovators, and business owners. That was a very dumb choice, especially since there are zero-income tax states in the region (Nevada, Texas, and Wyoming), as well as two flat-tax states (Utah and Colorado).

You can see Arizona’s problem in this map from the Tax Foundation. It’s great to be grey and good to be yellow, but bad to be orange (like Arizona), red, or maroon.

That’s the bad news.

The good news is that lawmakers in have just approved a plan that will significantly lower tax rates and restore the state’s competitiveness.

The Wall Street Journal opined this morning about this positive development.

Arizona currently taxes income under a progressive rate structure, starting at 2.59% up to 4.5%. The ballot last November carried an initiative to add a 3.5% surtax on earnings above $250,000 for single filers. It narrowly passed, meaning the combined top rate was set to hit 8%, higher than all of Arizona’s neighbors except California. …Mr. Ducey’s budget will cut rates for all taxpayers. The Legislature can’t repeal the voter-approved surtax, so above the 2.5% flat rate, there will still be a second bracket on income over $250,000. But the budget also has a provision adjusting the flat tax downward for those Arizonans, so no one will pay a top rate above 4.5%. …the same as today. …No Arizonan will have to pay the threatened 8% rate, since the provisions forestalling it are immediate. …“Every Arizonan—no matter how much they make—wins with this legislation,” Mr. Ducey said. “It will protect small businesses from a devastating 77 percent tax increase…and it will help our state stay competitive so we can continue to attract good-paying jobs.” That’s worth celebrating.

A story from the Associated Press gave the development a much more negative spin.

After slashing $1.9 billion in income taxes mainly benefiting upper-income taxpayers and shielding them from higher taxes approved by voters in an initiative last year, the Republican-controlled House returned Friday and passed more legislation targeting Proposition 208. The House approved the creation of a new tax category for small business, trusts and estates that will eliminate even more of the money that the measure approved by voters in November was designed to raise for schools. The proposal passed despite unified opposition from minority Democrats. …The governor has expressed disdain for the voter-approved tax, saying it would hurt the state’s economy and vowing in March to see it gutted either though Legislation or the courts. …The budget-approved tax cuts set a flat 2.5% tax on all income levels that will be phased in over several years once revenue projections are met, with those subject to the new education tax paying 4.5% at most.

If nothing else, an amusing example of bias from AP.

I have two modest contributions to this discussion.

First, it’s not accurate to say that Arizona adopted a flat tax. Maybe I’m old fashioned, but a flat tax has to have only one rate. Arizona’s reform is praiseworthy, but it doesn’t fulfill that key equality principle.

Second, the main takeaway is not that lawmakers did something good. It’s more accurate to say that they protected the state from something bad.

I’ve updated this 2018 visual to show how the referendum would have pushed Arizona into Column 5, which is the worst category, but the reform keeps the state in column 3.

P.S. North Carolina made the biggest shift in the right direction in recent years, followed by Kentucky, while Kansas flirted with a big improvement and settled for a modest improvement. Meanwhile, Mississippi is thinking about making a huge positive jump.

P.P.S. Since Arizona voters made a bad choice and Arizona lawmakers made a wise choice, this is evidence for Prof. Garett Jones’ hypothesis that too much democracy is a bad thing.

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The Boring but Important Topic of Carry Forwards and Net Operating Losses

In the world of tax policy, big-picture issues such as tax reform can capture the public’s attention (should we junk the IRS, instance, and adopt a flat tax?).

People also get very interested if politicians are threatening to grab more of their money.

But many tax issues are tedious and boring, even if they involve important issues.

• Depreciation vs. expensing for new business investment.
• International tax rules and the choice of worldwide taxation vs territorial taxation.
• The debate on consumption-base taxation vs. Haig-Simons taxation.

Today, we’re going to discuss another one of the sleep-inducing tax issues – how to account for business losses.

This arcane issues has been attracting a bit of attention because the big coronavirus-driven emergency package included some changes to the tax treatment of such losses (making it easier to reduce overall tax liabilities by balancing losses in some years with profits in other years).

That upset two left-leaning members of Congress, Rep. Lloyd Doggett (D-TX) and Sen. Sheldon Whitehouse (D-RI), who editorialized in USA Today about the changes.

…tucked into its 880 pages were Republican-inserted tax provisions…that..allow certain investors…to cut their tax bills by shifting losses to prior tax years. …Large corporations were also authorized to convert losses from two years before the pandemic into immediate tax refunds. Businesses with losses when the economy was growing are rewarded for poor management or adverse market conditions that had absolutely nothing to do with the pandemic. …let’s reverse the damage. We are offering legislation to unwind this massive tax giveaway, to recover the lost revenues… Giant special interest tax breaks were not needed before and certainly have no place during a pandemic.

Is this right? Did a handful of GOP politicians insert a special favor for their friends in the business community?

For what it’s worth, I’m sure the answer to both questions is yes. Politicians are a very self-interested group and I’m sure there were dozens of provisions in the legislation that qualified for that type of criticism.

I’m interested, however, in whether the provisions moved policy in the right direction or the wrong direction.

Kyle Pomerleau with the American Enterprise Institute explains why the changes were desirable.

The liberalized treatment of losses is not a bailout and does not provide special treatment of certain industries. Loss deductions are an essential part of a well-functioning income tax. Businesses typically make multi-year investments. Those investments may lose money in some years make money in other years. The ability to either carry back losses to offset previous years’ taxes or carry forward losses to offset future taxes ensures that the tax system accurately measures income. Without loss deductions, a tax system would be biased against risky investment. …In the future, lawmakers should consider permanently liberalizing the treatment of losses.

Nicole Kaeding made similar arguments for the National Taxpayers Union.

The provision at hand, a loosening of net operating loss rules, isn’t cronyism. Instead, it reflects Congress’s priority of helping affected individuals and businesses weather our economic crisis by smoothing out “lumpy” tax burdens over time. Net operating losses (NOLs) are key features of the tax code. Tax years, calendar years, and business profitability don’t always align. Net operating loss provisions help smooth profits and losses across tax years to ensure that businesses are taxed on their economic income, not an accounting byproduct. …many have argued that it made little sense for Congress to revise loss rules for 2018 and 2019, when the virus wasn’t a consideration. In the abstract, that concern makes sense but policymakers were concerned about providing immediate liquidity to firms. A 2020 NOL doesn’t help a firm until they file their 2020 tax return in 2021. But allowing carrybacks for 2018 or 2019 allows firms to access capital quickly by amending their previous returns and claiming a refund.

For what it’s worth, I addressed this topic back in 2016 because it became a controversy in that year’s presidential campaign.

I didn’t pretend to know whether Trump was doing the right thing or wrong thing with his tax returns, but I made the argument that a fair and neutral tax system should have carry-forward rules.

Indeed, the business side of the flat tax expressly includes such provisions.

For what it’s worth, households used to have the option for “income-averaging,” which basically meant they could lower their overall tax rate by spreading a spike in income over several years.

A difference between households and businesses, though, is that businesses can suffer losses, while the worst thing that happens to a household is when income drops to zero.

The bottom line is that income averaging for people would be a helpful provision in the tax code, but carry-forward rules for businesses are a necessary provision.

P.S. That last sentence assumes goal is a tax system that is designed to extract money while imposing the smallest-possible amount of damage on economic efficiency.

At the risk of stating the obvious, a simple and fair tax system is not the goal of most politicians. In public, they prefer using the tax code as a tool for class-war demagoguery, and in private, they use it as a vehicle for auctioning off special provisions to their cronies.

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The Right Way to Adopt a Consumption Tax

I’ve written dozens of columns explaining why it would be a terrible idea for the United States to enact a value-added tax.

But that’s not because I think consumption taxes are worse than income taxes. Indeed, sales taxes and VATs are less destructive because tax rates tend to be reasonable and there’s no double taxation of saving and investment.

My opposition is solely based on the fact that we shouldn’t give politicians an extra source of revenue to finance bigger government. That would effectively guarantee that the United States would morph into a stagnant European-style welfare state.

In other words, I’d be willing to accept a trade. Politicians get a VAT, but only if they permanently abolish the income tax.

There’s no chance of that happening in Washington, but it may happen in Nebraska, as reported by the North Platte Telegraph.

If Nebraskans can’t agree on reform…, state Sen. Steve Erdman of Bayard has a sweeping answer: …Income and property taxes in Nebraska would be abolished — and the state sales tax replaced by a “consumption tax” to fund state and local governments — if a constitutional amendment spearheaded by Erdman were approved by lawmakers and voters. …It would need “yes” votes from 30 of the 49 senators on final reading to appear on November’s general election ballot. …Nebraska’s state and local governments now collect a combined $9.5 billion annually in taxes, which would require a 10% consumption tax rate to replace, Erdman said. …If income and property taxes go away, Erdman said, all the state and local departments or agencies that enforce, set and collect them wouldn’t be needed, either.

Here’s some additional coverage from KETV.

Imagine not having to pay any property or income taxes in Nebraska, but there’s a catch you’d pay a new consumption tax on just about everything you buy, such as food and medical services, things that are not taxed right now. That is the idea behind a new constitutional resolution introduced by state Sen. Steve Erdman. …He and nine other lawmakers introduced LR300CA on Thursday. The resolution would allow voters to decide whether to replace all those taxes with a consumption tax. It is like a sales tax and would be about 10.6% on everything, including services and food. …He said under this proposal, everyone would get a payment called a prebate of about $1,000, which would offset the cost for low-income families. Erdman said it would also eliminate the need for property tax relief and the state having to offer costly tax incentives to attract businesses. “This is fixing the whole issue, everything. This is eliminating all those taxes and replacing it with a fair tax,” Erdman said. “Nothing is exempt,” Erdman said.

I have no idea if this proposal has any chance of getting approval by the legislature, but Senator Erdman’s proposal for a broad-based neutral tax (i.e., no exemptions) would make Nebraska more competitive.

Which would be a good idea considering that the state is only ranked #28 according to the Tax Foundation and is way down at #44 according to Freedom in the 50 States.

In one fell swoop, Nebraska would join the list of states that have no income tax, which is even better than the states that have flat taxes.

P.S. The switch to a consumption tax would address the revenue side of the fiscal equation. Nebraska should also fix the spending side by copying its neighbors in Colorado and adopting a TABOR-style spending cap.

P.P.S. Unlike advocates of the value-added tax, proponents of a national sales tax support full repeal of the income tax. I don’t think that’s realistic since it’s so difficult to amend the Constitution, but their hearts are in the right place.

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Assessing the Trump Tax Reform after Two Years

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

• Restricting the deduction for state and local taxes.
• A reduction of the corporate tax rate to 21 percent.

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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A Primer on “Full Expensing” of Business Investment

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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Time to Fully Repeal the Tax Deduction for Home Mortgage Interest

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.

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

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 Trump Tax Reform Is Generating Good Results

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.

+++++++++++++++++++++++++++++++++++

Welcome Instapundit readers! Thanks, Glenn

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Understanding the “Tax Base”

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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Debating the IRS Budget

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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How Washington Profits from “Tax Extenders”

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 insurance, Social 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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An Under-Appreciated Benefit of Lower Tax Rates

There are three reasons why the right kind of tax reform can help the economy grow faster.

1. Lower tax rates give people more incentive to earn income.
2. Less double taxation boosts incentives to save and invest.
3. Fewer loopholes improves incentives for economic efficiency.

Let’s focus on the third item. I don’t like special preferences in the tax code because it’s bad for growth when the tax code lures people into misallocating their labor and capital. Ethanol, for instance, shows how irrational decisions are subsidized by the IRS.

Moreover, I’d rather have smart and capable people in the private sector focusing how to create wealth instead of spending their time figuring out how to manipulate the internal revenue code.

That’s why, in my semi-dream world, I’d like to see a flat tax.* Not only would there be a low rate and no double taxation, but there also would be no distortions.

But in the real world, I’m happy to make partial progress.

That’s why I was happy that last year’s tax bill produced a $10,000 cap for the state and local tax deduction and reduced the value of other write-offs by increasing the standard deduction. Yes, I’d like to wipe out the deductions for home mortgage interest, charitable giving, and state and local taxes, but a limit is better than nothing.

And I’m also happy that lower tax rates are an indirect way of reducing the value of loopholes and other preferences.

To understand the indirect benefits of low tax rates, consider this new report from the Washington Post. Unsurprisingly, we’re discovering that a less onerous death tax means less demand for clever tax lawyers.

A single aging rich person would often hire more than a dozen people — accountants, estate administrators, insurance agents, bank attorneys, financial planners, stockbrokers — to make sure they paid as little as possible in taxes when they died. But David W. Klasing, an estate tax attorney in Orange County, Calif., said he’s seen a sharp drop in these kinds of cases. The steady erosion of the federal estate tax, shrunk again by the Republican tax law last fall, has dramatically reduced the number of Americans who have to worry about the estate tax — as well as work for those who get paid to worry about it for them, Klasing said. In 2002, about 100,000 Americans filed estate tax returns to the Internal Revenue Service, according to the IRS. In 2018, only 5,000 taxpayers are expected to file these returns… “You had almost every single tax professional trying to grab as much of that pot as they could,” Klasing said. “Now almost everybody has had to find other work.”

Needless to say, I’m delighted that these people are having to “find other work.”

By the way, I’m not against these people. They were working to protect families from an odious form of double taxation, which was a noble endeavor.

I’m simply stating that I’m glad there’s less need for their services.

Charles “Skip” Fox, president of the American College of Trust and Estate Counsel, said he frequently hears of lawyers shifting their focus away from navigating the estate tax, and adds that there has been a downturn in the number of young attorneys going into the estate tax field. Jennifer Bird-Pollan, who teaches the estate tax to law students at the University of Kentucky, said that nearly a decade ago her classes were packed with dozens of students. Now, only a handful of students every so often may be interested in the subject or pursuing it as a career. “There’s about as much interest in [the class] law and literature,” Pollan said. “The very, very wealthy are still hiring estate tax lawyers, but basically people are no longer paying $1,000 an hour for advice about this stuff. They don’t need it.”

Though I am glad one lawyer is losing business.

Stacey Schlitz, a tax attorney in Nashville, said when she got out of law school about a decade ago roughly 80 percent of her clients were seeking help with their estate taxes. Now, less than 1 percent are, she said, adding that Tennessee’s state inheritance tax was eliminated by 2016. “It is disappointing that this area of my business dried up so that such a small segment of society could get even richer,” Schlitz said in an email.

I hope every rich person in Nashville sees this story and steers clear of Ms. Schlitz, who apparently wants her clients to be victimized by government.

Now let’s shift to the business side of the tax code and consider another example showing why lower tax rates produce more sensible behavior.

Now that the corporate tax rate has been reduced, American companies no longer have as much desire to invest in Ireland.

US investment in Ireland declined by €45bn ($51bn) in 2017, in another sign that sweeping tax reforms introduced by US president Donald Trump have impacted the decisions of American multinational companies. …Economists have been warning that…Trump’s overhaul of the US tax code, which aimed to reduce the use of foreign low-tax jurisdictions by US companies, would dent inward investment in Ireland. …In November 2017, Trump went so far as to single out Ireland, saying it was one of several countries that corporations used to offshore profits. “For too long our tax code has incentivised companies to leave our country in search of lower tax rates. It happens—many, many companies. They’re going to Ireland. They’re going all over,” he said.

Incidentally, I’m a qualified fan of Ireland’s low corporate rate. Indeed, I hope Irish lawmakers lower the rate in response to the change in American law.

And I’d like to see the US rate fall even further since it’s still too high compared to other nations.

Heck, it would be wonderful to see tax competition produce a virtuous cycle of rate reductions all over the world.

But that’s a topic I’ve addressed before.

Today’s lesson is simply that lower tax rates reduce incentives to engage in tax planning. I’ll close with simple thought experiment showing the difference between a punitive tax system and reasonable tax system.

• 60 percent tax rate – If you do nothing, you only get to keep 40 cents of every additional dollar you earn. But if you find some sort of deduction, exemption, or exclusion, you increase your take-home pay by an additional 60 cents. That’s a good deal even if the tax preference loses 30 cents of economic value.
• 20 percent tax rate – If you do nothing, you get to keep 80 cents of every dollar you earn. With that reasonable rate, you may not even care about seeking out deductions, exemptions, and exclusions. And if you do look for a tax preference, you certainly won’t pick one where you lose anything close to 20 cents of economic value.

The bottom line is that lower tax rates are a “two-fer.” They directly help economic growth by increasing incentives to earn income and they indirectly help economic growth by reducing incentives to engage in inefficient tax planning.

*My semi-dream world is a flat tax. My dream world is when the federal government is so small (as America’s Founders envisioned) that there’s no need for any broad-based tax.

P.S. It’s not the focus of today’s column, but since I talked about loopholes, it’s worth pointing out that they should be properly defined. Sadly, that simple task is too challenging for the Joint Committee on Taxation, the Government Accountability Office, and the Congressional Budget Office (or even the Republican party).

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Choosing Reverse-Class-Warfare to Subsidize Bigger Government

Politicians who preach class warfare repeatedly assert that we need higher taxes on “the rich.”

Indeed, that’s been the biggest political issue (and oftentimes biggest economic issue) in every recent tax fight (the Trump tax reform and Obama’s fiscal cliff), as well as the issue that generates the most controversy when discussing tax reform.

So it seems almost inconceivable that the class-warfare crowd would support a change to the tax code that would only benefit the top-10 percent, right?

Yet that’s exactly what’s happening in the fight over the deduction for state and local taxes.

Democrats want to restore an unlimited deduction, thereby enabling people to shield more of their income from tax. But, as the Tax Foundation notes, that change only produces benefits for upper-income taxpayers.

Itemized deductions such as the SALT deduction are mostly utilized by higher-income individuals. As such, any change to the SALT deduction will chiefly impact them. In addition, the value of a deduction increases as a taxpayer’s statutory tax rate increases. A deduction against the top rate of 37 percent is more valuable than a deduction against the 32 percent tax rate. We estimate that eliminating the SALT deduction cap would have no impact on taxpayers in the bottom two income quintiles and a negligible impact on taxpayers in the third and fourth quintiles. …However, taxpayers in the top 5 and 1 percent of income earners would see an increase in after-tax income of 1.6 percent and 3.7 percent respectively.

And if restoring the deduction is “paid for” by raising the corporate tax rate, the net effect is to raise taxes on the bottom-90 percent in order to give a tax to top-10 percent.

Or, to be more precise, to give a tax cut to the top-1 percent.

Some of you may be thinking that the Tax Foundation leans right and therefore can’t be trusted.

So let’s look at some research from the Tax Policy Center, which is a joint project of the left-leaning Urban Institute and left-leaning Brookings Institution.

Only about 9 percent of households would benefit from repeal of the Tax Cuts and Jobs Act’s (TCJA) $10,000 cap on the state and local property tax (SALT) deduction, and more than 96 percent of the tax cut would go to the highest-income 20 percent of households… For all middle-income taxpayers, the average tax cut would be $10. Those in the top 1 percent would pay an average of $31,000, or 2 percent of after-tax income, less.

And here’s the TPC chart showing how almost all the tax relief goes to upper-income taxpayers.

So what’s going on? Why are Democrats fighting for an idea that would give the rich a $31,000 tax cut while only providing $10 of relief for middle-class taxpayers?!?

The simple answer is that they think the loophole is a very valuable way of facilitating higher taxes and bigger government at the state and local level. And they’re right, so I don’t blame them.

But it’s nonetheless very revealing that they are willing to jettison their tax-the-rich rhetoric when it interferes with their make-government-bigger agenda.

P.S. This “SALT” debate strikes me as being similar to the Laffer-Curve debate, which requires folks on the left to choose whether it’s more important to punish rich people or to get more revenue to spend.

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Economic Boom from the Trump Tax Cuts? A Pro-Con Analysis

Earlier this month, I talked about the economy’s positive job numbers. I said the data is unambiguously good, but warned that protectionism and wasteful spending will offset some of the good news from last year’s tax reform.

This is what’s frustrating about the Trump presidency.

Good policies in some areas are being offset by bad policies in other areas, so it’s not easy assigning an overall grade.

And it’s also difficult to predict the effect on economic performance. If you look at the formula for a prosperous economy, there’s no way of predicting whether Trump is a net positive or a net negative. At least in my humble opinion.

As such, I’ll be very curious to see what happens to America’s score in subsequent issues of Economic Freedom of the World.

It would be nice if the United States got back into the Top 10. For what it’s worth, I’m guessing America’s score won’t measurably improve.

That being said, if there was a pro-con debate on Trump’s performance, some people would be quite confident about declaring victory.

Mike Solon, a former budget staffer on Capitol Hill, offers the “pro” assessment in the Wall Street Journal.

Are low taxes key to a booming economy? Their success is harder than ever to deny after Friday’s report that the U.S. economy grew 4.1% in the second quarter, bringing the average quarterly growth rate during the Trump presidency to 2.9%. …In the first five quarters of the Trump presidency, growth has been almost 40% higher than the average rate during the Obama years, and per capita growth in gross domestic product has been 63% faster. …The CBO now projects that additional revenue from this economic surge will offset 88.2% of the estimated 10-year cost of the tax cut. …The CBO’s April revision projected an extra $6.1 trillion in GDP over the next decade—more than $18,000 of growth for every man, woman and child in America. …the Labor Department reports that worker bonuses have hit the highest level ever recorded. The Commerce Department reports that wages and salaries are growing almost 25% faster under President Trump than under Mr. Obama.

Since I have great confidence that lower tax rates are good for growth and that Laffer Curve-type feedback effects are real, I want to applaud what Mike wrote.

And since I’ve also dissed the idea of “secular stagnation,” I also like this part of his column.

Perhaps the most important narrative discredited by the economic revival is the “secular stagnation” excuse. Throughout the Obama years, progressive economists said Americans had become too old, lazy and complacent to achieve the growth that was regular before 2009. But somehow American workers overcame all of these supposed weaknesses when Mr. Trump changed federal policy. The problem was not our people but our government. Stagnation is not fate but a political choice.

Amen to that final sentence. Stagnation is the result of bad policy.

But my problem is that Trump has some bad policies that are offsetting his good tax reform. So I can’t help but think Mike is being too optimistic.

Let’s look at another perspective. It would be an exaggeration to state that Jimmy Pethokoukis of the American Enterprise Institute is in the “con” camp, but he definitely is skeptical.

GOP hot takes will come as fast and furious as the economic growth. “The tax cuts worked!” “Trumponomics rocks!” …Celebrating a stronger economy is not a bad thing, of course. Over the long run, sustainable economic growth is what generates higher living standards and greater social mobility. But drawing sweeping conclusions from a single three-month period is problematic…it doesn’t necessarily tell you a whole lot about where the economy is heading. There were eight quarters of 3 percent growth or faster scattered across the Obama presidency, including four of 4 percent or faster and one of 5.2 percent. But there was never much follow-through, and overall the expansion muddled through at roughly a 2 percent annual pace. …even a very strong report won’t tell us whether the Trump tax cuts, passed in December, are “working.” It’s just too soon. …that process will play out over a numbers of years.

This is a very sensible perspective. I’ve repeatedly warned not to overstate the importance of short-run data. And I also fully agree that there’s often a time lag between the adoption of good policy and the evidence of good results.

But I have the same complaint about the Pethokoukis column as I did about the Solon column. There’s a sin of omission because both focused on the tax reform.

As I noted above, we also need to consider the other policies that have changed in the last 18 months.

I don’t know the answer, but maybe this image will illustrate why we should hesitate before making sweeping assessments.

And also keep in mind that we have no way of knowing whether there’s a Fed-created bubble in the economy. As I said in the interview, what if 2018 is akin to 2006? Back then, most people underestimated the possibility that easy money and Fannie-Freddie subsidies had created an unsustainable housing boom.

But even if we ignore that wild card, I can’t help but wonder whether Trump’s pro-growth polices and Trump’s anti-growth policies are resulting in a wash.

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Debating Trump’s Tax Reform

Guided by the principles of a simple and fair flat tax, I’ve been toiling for decades in the vineyard of tax reform. At the risk of mixing my metaphors, I usually feel like Don Quixote, engaged in a futile quest. Convincing politicians to reduce their power is not an easy task, after all.

But it is possible to make incremental progress. I’ve argued, ad nauseam, about the need to lower the corporate tax rate and the benefits of ending the state and local tax deduction, and we actually took big steps in the right direction last year.

Indeed, while the final legislation was far from perfect, it was certainly better than I expected.

But there’s no such thing as a permanent victory in Washington. The debate has now shifted from “is the tax plan a good idea?” to “is the tax plan working?” And that was the focus of my recent CNBC debate with Austan Goolsbee, the former Chairman of Obama’s Council of Economic Advisers.

Interestingly, Austan and I agreed on several issues.

• We both agreed that the short-run effects (bonuses and stock buybacks) are comparatively minor.
• We both agreed that the lower corporate tax will boost international competitiveness.
• We both agreed that the job market under Trump is doing reasonably well, but is not noticeably better than it was under Obama.
• We both agreed that the higher growth produced by the tax bill will mostly occur because of increased investment.

At the risk of digressing, I should have mentioned that Trump’s corporate rate cut, while a big step in the right direction, should be viewed as a first step. As illustrated by this chart, the overall US corporate rate is still higher than the average for other advanced nations.

Let’s now get back to the interview. Goolsbee and I didn’t agree on everything.

• Austan is fixated on class warfare, which I think is very bad economics because it means high marginal tax rates and/or a heavier tax bias against saving and investment.
• He also frets about deficits, which is rather ironic since he didn’t seem to worry about red ink when Obama was pushing his failed stimulus scheme. In any event, I pointed out that there is no long-run tax cut.

Last but not least, here are some additional points from the interview

• I repeatedly expressed concern that good tax policy won’t be very sustainable unless politicians restrain the excessive growth of government spending, both in the short run and long run.
• I also pointed out that the restriction on the state and local tax deduction will help the national economy if it deters some big states from raising taxes (though that reform certainly isn’t slowing down the big spenders in New Jersey).
• Even small differences in economic growth, if sustained over time, can make a big difference in living standards.
• We should be worried that Trump will sabotage his tax cut with protectionism.

The bottom line is that last year’s tax plan resulted in a less-destructive tax code. That doesn’t guarantee fast growth since we also have to look at other policies, but it will help.

P.S. I indirectly tangled with Goolsbee in about taxes in 2010 and about spending in 2012.

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