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Archive for the ‘Taxation’ Category

Public finance experts sometime differ in how to describe a value-added tax.

  • Is it a hidden form of a national sales tax, imposed at each stage of the production process?
  • Is it a hidden withholding tax on income, imposed at each stage of the production process?

Both answers are actually correct. The VAT is both a tax on consumption and a tax on income because – notwithstanding its other flaws – it has the right “tax base.”

In other words, like the flat tax, a VAT taxes all economic activity, but only one time (i.e., no double taxation of income that is saved and invested). And it usually has a single rate, which is another feature of a flat tax.

That’s why a VAT (in theory!) would be acceptable if it was used to finance the complete abolition of the income tax.

But that’s not a realistic option. Heck, it’s not even an unrealistic option.

Instead, many politicians in the United States want to keep the income tax and also impose a VAT so they can finance a bigger burden of government – which is exactly what’s been happening in Europe.

Unfortunately, they’re getting some support from the American Enterprise Institute. Alan Viard, a resident scholar at AEI, has a new column urging the adoption of a VAT.

Let’s review what he wrote and explain why he’s wrong.

The U.S. faces a large long-term imbalance between projected federal tax revenue and federal spending… To narrow the fiscal imbalance, we should follow the lead of 160 other countries by adopting a value-added tax (VAT), a consumption tax that is economically similar to a retail sales tax. …Adopting a VAT would significantly curb the debt buildup.

I’ve never been impressed with the argument that the U.S. should adopt a policy simply because other nations have done the same thing.

The United States is much richer than other countries in large part because we haven’t replicated their mistakes. So why start now?

But let’s deal with Viard’s assertion that a VAT would “significantly curb the debt buildup.”

I recently showed the opposite happened in Japan. They adopted a VAT (and have repeatedly increased the VAT rate), but debt has increased.

But I think the strongest evidence is from Europe since we have several additional decades of data. Those nations started imposing VATs in the late 1960s and they now all have very high VAT rates.

And what’s happened to debt?

Well, as you can see from the chart, big increases in the tax burden were matched by even bigger increases in government debt.

The moral of the story is that Milton Friedman was right when he warned that, “History shows that over a long period of time government will spend whatever the tax system raises plus as much more as it can get away with.”

So why would Viard support a VAT when the evidence overwhelmingly shows that a big tax increase will worse a nation’s fiscal outlook?

He argues that a VAT would be the least-worst way to finance bigger government.

Although tax increases on the affluent place the burden on those with the most ability to pay, they impede long-run economic growth by penalizing saving and investment and distorting business decisions. The economic costs become larger as tax rates are pushed higher. …The VAT is more growth-friendly than high-income tax increases because it does not penalize saving and investment and poses fewer economic distortions.

He’s right that a VAT doesn’t do as much damage as class-warfare tax, but he’s wildly wrong to assert that it is “growth-friendly.”

Simply stated, a VAT will drive a further wedge between pre-tax income and post-tax consumption. That not only will discourage work. It also will discourage saving and investment.

The only positive thing to say is that a VAT doesn’t discourage those good things as much as some other types of tax increases.

But that’s sort of like saying that it’s better to lose your hand in an accident instead of losing your entire arm. Call me crazy, but I think the best outcome is to avoid the accident in the first place.

In other words, the bottom line is that we shouldn’t have any tax increase. Especially since 100 percent of America’s fiscal problem is the consequence of excessive government spending.

I’ll close by debunking the notion that a VAT is a simple tax.

As you can see from this European map, VATs can impose huge complexity burdens on businesses.

Yes, the map shows that some nations have relatively simple VATs, but American politicians already have shown with the income tax that they can’t resist turning a tax system into a Byzantine nightmare. Of course they would do the same with the VAT, creating special loopholes and penalties to please their donors.

P.S. Here’s my video from 2009, which explains how a VAT works and why it would be a bad idea.

Everything I said back then is even more true today.

P.P.S. The clinching argument is that one of America’s best presidents opposed a VAT and one of America’s worst presidents supported a VAT. That tells you everything you need to know.

P.P.P.S. You can enjoy some amusing – but also painfully accurate – cartoons about the VAT by clicking here, here, and here.

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In Part I of this series, I expressed some optimism that Joe Biden would not aggressively push his class-warfare tax plan, particularly since Republicans almost certainly will wind up controlling the Senate.

But the main goal of that column was to explain that the internal revenue code already is heavily weighted against investors, entrepreneurs, business owners and other upper-income taxpayers.

And to underscore that point, I shared two charts from Brian Riedl’s chartbook to show that the “rich” are now paying a much larger share of the tax burden – notwithstanding the Reagan tax cuts, Bush tax cuts, and Trump tax cuts – than they were 40 years ago.

Not only that, but the United States has a tax system that is more “progressive” than all other developed nations (all of whom also impose heavy tax burdens on upper-income taxpayers, but differ from the United States in that they also pillage lower-income and middle-class residents).

In other words, Biden’s class-warfare tax plan is bad policy.

Today’s column, by contrast, will point out that his tax increases are impractical. Simply stated, they won’t collect much revenue because people change their behavior when incentives to earn and report income are altered.

This is especially true when looking at upper-income taxpayers who – compared to the rest of us – have much greater ability to change the timing, level, and composition of their income.

This helps to explain why rich people paid five times as much tax to the IRS during the 1980s when Reagan slashed the top tax rate from 70 percent to 28 percent.

When writing about this topic, I normally use the Laffer Curve to help people understand why simplistic assumptions about tax policy are wrong (that you can double tax revenue by doubling tax rates, for instance). And I point out that even folks way on the left, such as Paul Krugman, agree with this common-sense view (though it’s also worth noting that some people on the right discredit the concept by making silly assertions that “all tax cuts pay for themselves”).

But instead of showing the curve again, I want to go back to Brian Riedl’s chartbook and review his data on of revenue changes during the eight years of the Obama Administration.

It shows that Obama technically cut taxes by $822 billion (as further explained in the postscript, most of that occurred when some of the Bush tax cuts were made permanent by the “fiscal cliff” deal in 2012) and raised taxes by $1.32 trillion (most of that occurred as a result of the Obamacare legislation).

If we do the math, that means Obama imposed a cumulative net tax increase of about $510 billion during his eight years in office

But, if you look at the red bar on the chart, you’ll see that the government didn’t wind up with more money because of what the number crunchers refer to as “economic and technical reestimates.”

Indeed, those reestimates resulted in more than $3.1 trillion of lost revenue during the Obama years.

I don’t want the politicians and bureaucrats in Washington to have more tax revenue, but I obviously don’t like it when tax revenues shrink simply because the economy is stagnant and people have less taxable income.

Yet that’s precisely what we got during the Obama years.

To be sure, it would be inaccurate to assert that revenues declined solely because of Obama’s tax increase. There were many other bad policies that also contributed to taxable income falling short of projections.

Heck, maybe there was simply some bad luck as well.

But even if we add lots of caveats, the inescapable conclusion is that it’s not a good idea to adopt policies – such as class-warfare tax rates – that discourage people from earning and reporting taxable income.

The bottom line is that we should hope Biden’s proposed tax increases die a quick death.

P.S. The “fiscal cliff” was the term used to describe the scheduled expiration of the 2001 and 2003 Bush tax cuts. According to the way budget data is measured in Washington, extending some of those provisions counted as a tax cut even though the practical impact was to protect people from a tax increase.

P.P.S. Even though Biden absurdly asserted that paying higher taxes is “patriotic,” it’s worth pointing out that he engaged in very aggressive tax avoidance to protect his family’s money.

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During the campaign, Joe Biden proposed a massive tax increase, far beyond what either Barack Obama or Hillary Clinton put forth when they ran for the White House.

Some people speculate that Biden isn’t actually that radical, and that his class-warfare agenda was simply a tactic to fend off Bernie Sanders, so it will be interesting to see how much of his political platform winds up as actual legislative proposals in 2021.

That being said, we can safely assume three things.

  1. Biden will propose higher taxes.
  2. Those tax increases will target upper-income taxpayers such as entrepreneurs, investors, and business owners.
  3. Those tax increases will be a very bad idea.

The main argument that Biden and his supporters will use to justify such a plan is that “rich” taxpayers are not paying their fair share.

More specifically, we’ll be told that upper-income households are not pulling their weight thanks to the cumulative impact of the Reagan tax cuts, the Bush tax cuts, and the Trump tax cuts.

There’s just one problem with this argument. As shown by this multi-decade data from Brian Riedl’s chartbook, it’s wildly, completely, and utterly inaccurate. The richest 20 percent are now shouldering a much greater share of the tax burden.

Every other group, by contrast, is now paying a smaller share of the tax burden.

Some folks on the left assert that the above chart is misleading. They say the chart merely shows that the rich have been getting richer and everyone else is falling behind.

The solution, they argue, is to catch up with the rest of the world by making the tax system more “progressive.”

Their assertions about income trends are wrong, but let’s leave that for another day and focus on so-called progressivity.

Once again, Riedl’s chartbook is the go-to source. As shown in this chart, it turns out that rich people pay a higher share than their counterparts in every other developed nation.

Please notice, by the way, the additional explanation in the lower-left portion of the chart, The numbers displayed do not include the value-added taxes that are imposed by every other nation, which are regressive or proportional depending on the time horizon. This means that the overall American tax code is far more tilted against the rich than shown by this chart.

But the key point to understand, as I’ve noted before, is that difference between Europe and the United States is not the taxation of the rich. The real reason that America has the most progressive tax system is that European nations impose much heavier taxes on lower-income and middle-class taxpayers.

P.S. At the risk of stating the obvious, this is not desirable since class-warfare taxes generally cause the most economic damage on a per-dollar-collected basis.

P.P.S. It’s also worth remembering that higher tax rates on the rich don’t necessarily lead to higher tax revenues.

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Back in 2013, I wrote about Phil Mickelson escaping high-tax California and moving to zero-income tax Florida.

The famed golfer grew up in California, but decided that the 2012 decision to boost the top tax rate to 13.3 percent mattered more than beautiful climate and wonderful scenery.

Needless to say, Mickelson’s not the only tax exile. Florida, Texas, Nevada, and other zero-income tax states receive a steady stream of entrepreneurs, investors, business owners, and others who are tired of California’s predatory politicians.

And celebrities as well. Yahoo! Entertainment reports that a famous rock star is leaving the not-so-Golden State.

Gene Simmons has put his longtime Beverly Hills mansion on the market for $22 million, citing California’s “unacceptable” tax rates as the reason for his move. After 34 years at the home, the KISS rocker and his wife Shannon are heading to Washington state. …In an interview with the Wall Street Journal, Simmons explained, “California and Beverly Hills have been treating folks that create jobs badly and the tax rates are unacceptable. I work hard and pay my taxes and I don’t want to cry the Beverly Hills blues, but enough is enough.”

When I read stories like this, I wonder if my friends on the left will learn any lessons about tax competition, the Laffer Curve, or the economic consequences of bad tax policy.

But I also confess that I’m amused by stories like this.

And so are the folks at America’s top site for satire, the Babylon Bee.

Here are some of their recent articles about California, starting with Governor Newsom’s plan to hinder the exodus of taxpayers.

In a move to prevent Californians from fleeing by the millions, Gavin Newsom announced a ban on gasoline automobiles this week. The law will make it so that Californians can’t drive away and escape the state in a matter of hours… “Now, they’ll have to cross the desert on foot,” Newsom said as he handed down the order. “I’ll show them, trying to flee my progressive utopia! Ha ha ha ha ha!”

The Governor apparently forgot to also ban trucks.

And U-Haul is taking advantage with a new advertising campaign.

To help meet the demand of millions of people desperately trying to escape the dark, ravaged wasteland of California, U-Haul is introducing a new product in its moving van line-up: the War Rig. These weaponized, armored moving vehicles will ensure you and your belongings stay safe during the long and perilous journey out of the state. …said local U-Haul franchise owner Glax Destroyer, who manages 12 locations in Southern California. “We brought in the War Rig to supplement our completely depleted fleet of moving vans. With everyone leaving in droves, we don’t have much left. We’re pretty much salvaging old trucks from the junkyard and then adding armor plating and mounted weapons.”

One problem, though, is that the people escaping from California bring along their bad political preferences.

Which has convinced Texas officials to impose a ban on their ability to vote.

To the relief of Texans across the state, Governor Greg Abbott has signed a law prohibiting escaping Californians from voting after they move to Texas. Experts say this will prevent the happy and prosperous slice of heaven from sliding into the endless despair and crushing poverty of leftist policy. …According to sources, emergency legislation was drafted after it was discovered that 97% of Californians favor destroying every small business on the planet and salting the earth where the businesses once stood. They also favor mandatory gay marriage and banning all country music to avoid hurting the ears of sea turtles. …Californians have marched on the state capital to demand their voting rights back, and have promised they’ll move on to Oklahoma after they finish destroying Texas.

On a serious note, there’s actually some evidence that the folks moving into Texas are more conservative than average.

And with regards to the big-picture issue of California policy, I recommend these columns from 2016 and 2020.

P.S. If you want data comparing Texas and California, click herehereherehere, and here.

P.P.S. My favorite California-themed jokes (not counting the state’s elected officials) can be found herehere, here, and here.

P.P.P.S. Here’s some tongue-in-cheek advice for California from Walter Williams.

P.P.P.P.S. Even Bill Maher is upset about California taxes, though he hasn’t (yet) voted with his feet.

 

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When I opine about class-warfare taxation, I generally focus on the obvious argument that it’s not a good idea to penalize people for creating prosperity.

This argument against punitive tax policy is based on the fact that entrepreneurs, investors, business owners, and other successful people can choose to reduce their levels of work, saving, investment, and risk taking.

And it’s also based on the fact that they can shift their economic activity to tax-favored (but generally unproductive) sectors such as municipal bonds.

Moreover, I don’t want politicians to have more money to finance a bigger burden of government.

But we should also consider how class-warfare taxes also can cause the “geese with the golden eggs” to simply fly away.

The New York Times reports that one of the New York’s richest taxpayers is moving his business to Florida.

…on Wednesday, Mr. Singer, a billionaire who is one of the wealthiest people in the United States, revealed that he was moving his firm’s headquarters from Midtown Manhattan to West Palm Beach, Fla. …The departure by Elliott Management…follows a similar migration in recent years by other aging billionaire investors, including Carl C. Icahn, who left New York City for Florida, home to sunny weather, beaches and generous tax benefits… Mr. Singer’s move could bode ill for the city… New York City’s personal income tax revenue, which is heavily reliant on wealthy New Yorkers, is expected to drop by $2 billion this fiscal year. …For wealthy taxpayers, moving to Florida can provide a significant windfall. Unlike New York State, Florida has no individual income tax, estate tax or capital gains tax.

Singer’s move is just the tip of the iceberg.

A story in the Wall Street Journal earlier this year documented some of the tax-driven migration happening in the United States.

…the federal tax overhaul that Congress passed in late 2017…made it costlier to own a house in many high-price, high-tax areas… its effects are rippling through local economies and housing markets, pushing some people to move from high-tax states where they have long lived. Parts of Florida, for example, are getting an influx of buyers from states such as New York, New Jersey and Illinois. …the 2017 law…curbed how much homeowners can subtract from their federal taxes for paying local property and income taxes, by capping the state and local tax deduction at $10,000. …many residents in New York, New Jersey, Connecticut and California had been deducting well over $10,000 a year. …Mr. Lee estimates the move to Nevada, which has no state income tax, whacked his state tax bill by 90%. …Rick Bechtel, head of U.S. residential lending at TD Bank, lives in the Chicago area and said he recently went to a party where it felt like everyone was planning their moves to Florida. “It’s unbelievable to me the number of conversations that I’m listening to that begin with ‘When are you leaving?’ and ‘Where are you going?’ ” he said. …California has lost residents to Nevada for years, but that accelerated after the tax law passed. Nevada picked up a net of 28,000 people from California in 2018, according to the U.S. Census Bureau. …Mr. Belardi and Ms. LaPorte, who are planning to leave San Francisco, …have been growing tired of state and local politics, as well as the difficulty of running their two small businesses in California. …They estimate the move will save them tens of thousands of dollars annually. “I just hope all the Californians going to Nevada don’t turn Nevada into a California,” Mr. Belardi said.

By the way, there’s even tax-driven migration from some low-tax states to states with even lower taxes.

The dynamic is affecting even states typically thought to have low taxes. Mauricio Navarro and his family left Texas last year for Weston, Fla. Neither state collects its own income tax, but Mr. Navarro was paying more than $25,000 annually in property taxes in the Houston area, he said. …Filling out his 2018 tax returns helped motivate him to move with his wife and two children, said Mr. Navarro, who owns a software-development business.

And there’s tax-driven migration from high-tax nations to low-tax nations.

Here are some excerpts from some scholarly research in the Journal of Economic Perspectives, authored by Henrik Kleven, Camille Landais, Mathilde Muñoz, and Stefanie Stantcheva.

Here’s some of their background data.

Tax rates differ substantially across countries and across locations within countries. An important question is whether people choose locations in response to these tax differentials, thus reducing the ability of local and national governments to redistribute income… In this paper, we review what we know about mobility responses to personal taxation and discuss the policy implications. Our main focus is on the mobility of people, especially high-income people, but we will also discuss the mobility of wealth in response to personal taxes. It is clear that high-income individuals sometimes move across borders to avoid taxes. …The Rolling Stones left England for France in the early 1970s in order to avoid the exceptionally high top marginal tax rates—well above 90 percent—in the UK at the time. Many other British rock stars moved to lower tax jurisdictions, including David Bowie (Switzerland), Ringo Starr (Monte Carlo), Cat Stevens (Brazil), Rod Stewart (United States), and Sting (Ireland). In more recent years, actor Gérard Depardieu moved to Belgium and eventually Russia in response to the 75 percent millionaire tax in France, while a vast number of sports stars in tennis, golf, and motor racing have taken residence in tax havens such as Monte Carlo, Switzerland, and Dubai.

The authors point out that there are challenges, however, when trying to move from interesting anecdotes to statistically supported conclusions.

They overcome that challenge by examining a special tax regime in Denmark.

…the introduction of special tax schemes to foreigners provides such compelling quasi-experimental settings. Consider for instance the Danish tax scheme for foreigners… This scheme was enacted in 1992 and applied to the earnings of foreign workers from June 1991 onwards. Eligibility for the scheme requires annual earnings above a threshold located around the ninety-ninth percentile of the earnings distribution. Initially, the scheme offered a flat income tax rate of 30 percent in lieu of the regular progressive income tax with a top marginal tax rate of 68 percent. …The design of the scheme lends itself to a difference-in-differences approach in which we compare the evolution of the number of foreigners above the eligibility threshold (treatments) and below the eligibility threshold (controls). Such an analysis is presented in Figure 3. It shows the stock of foreigners between 1980–2005 in the treated earnings range and in two untreated earnings ranges, between 80–90 percent of the threshold and between 90–99 percent of the threshold. …The graph provides exceptionally compelling evidence of mobility responses.

Here’s a chart from the study showing a pronounced increase in migration from those (the red line) who could benefit from the lower tax rates.

The study also includes some evidence from the 1986 Tax Reform Act in the United States.

Can elasticities be sizable even for large countries that start with a large base of foreigners? Akcigit, Baslandze, and Stantcheva (2016) shed light on this question. They study the effects of top tax rates on the international mobility of “superstar” inventors—those with the most and best patents. …panel B considers the US Tax Reform Act of 1986 which sharply reduced the top marginal income tax rate. … the US Tax Reform Act of 1986 had a strong effect on the growth of foreign superstar inventors. In fact, the estimated mobility elasticity of top 1 percent superstar inventors for the US economy is extremely large, above 3.

Here’s the chart showing how lower tax rates in the United States helped to attract valuable inventors.

If you want more data, I wrote about the tax-driven mobility of super-entrepreneurs in 2015 and I wrote about the tax-driven mobility of super-inventors in 2016

There are two obvious lessons from all of the data and evidence in today’s column.

First, high tax rates are very costly because high-value taxpayers are far more likely to move. This means there are greater-than-ever penalties for bad policy and greater-than-ever rewards for good policy. Bad news for states like New Jersey and nations such as France. Good news for Florida and Switzerland.

Second, tax competition is a very valuable check on the greed of politicians (a.k.a., the “stationary bandits“). Simply stated, governments no longer have unconstrained ability to tax and spend. Which explains, of course, why international bureaucracies (acting at the behest of politicians) are working very hard to replace the liberalizing force of tax competition with some sort of global tax cartel.

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The good news is that the election season is almost over. The bad news is that we’ll have a president next year who does not embrace classical liberal principles of free markets and social tolerance.

But that doesn’t mean Trump and Biden are equally bad. Depending on what issues you think are most important, they’re not equally bad in what they say. And, because politicians often make insincere promises, they’re not equally bad in what they’ll actually do.

Regarding Trump, we have a track record. We know he’s pro-market on some issues (taxes and red tape) and we know he’s anti-market on other issues (spending and trade).

Regarding Biden, we have his track record in the United States Senate, where he routinely voted to expand the burden of government.

But we also have his presidential platform. And that’s the topic for today’s column. We’re going to review the major economic analyses that have been conducted on his proposals.

We’ll start with a report from Moody’s Analytics, authored by Mark Zandi and Bernard Yaros, which compares the economic impacts of the Trump and Biden agendas.

The economic outlook is strongest under the scenario in which Biden and the Democrats sweep Congress and fully adopt their economic agenda. In this scenario, the economy is expected to create 18.6 million jobs during Biden’s term as president, and the economy returns to full employment, with unemployment of just over 4%, by the second half of 2022. During Biden’s presidency, the average American household’s real after-tax income increases by approximately $4,800, and the homeownership rate and house prices increase modestly. Stock prices also rise, but the gains are limited. …Near-term economic growth is lifted by Biden’s aggressive government spending plans, which are deficit-financed in significant part. …Greater government spending adds directly to GDP and jobs, while the higher tax burden has an indirect impact through business investment and the spending and saving behavior of high-income households. …The economic outlook is weakest under the scenario in which Trump and the Republicans sweep Congress and fully adopt their economic agenda. …Trump has proposed much less expansive support to the economy from tax and spending policies.

Here’s the most relevant set of graphs from the report.

The Moody’s study is an outlier, however. Most other comprehensive analyses are less favorable to Biden.

For instance, a study for the Hoover Institution by Timothy Fitzgerald, Kevin Hassett, Cody Kallen, and Casey Mulligan, finds that Biden’s plan will weaken overall economic performance.

We estimate possible effects of Joe Biden’s tax and regulatory agenda. We find that transportation and electricity will require more inputs to produce the same outputs due to ambitious plans to further cut the nation’s carbon emissions, resulting in one or two percent less total factor productivity nationally. Second, we find that proposed changes to regulation as well as to the ACA increase labor wedges. Third, Biden’s agenda increases average marginal tax rates on capital income. Assuming that the supply of capital is elastic in the long run to its after-tax return and that the substitution effect of wages on labor supply is nontrivial, we conclude that, in the long run, Biden’s full agenda reduces fulltime equivalent employment per person by about 3 percent, the capital stock per person by about 15 percent, real GDP per capita by more than 8 percent, and real consumption per household by about 7 percent.

Wonkier readers may be interested in these numbers, which show that there’s a modest benefit from unwinding some of Trump’s protectionism, but there’s a lot of damage from the the other changes proposed by the former Vice President.

In a report authored by Garrett Watson, Huaqun Li, and Taylor LaJoie, the Tax Foundation estimated the impact of Biden’s proposed policies. Here are some of the highlights.

According to the Tax Foundation General Equilibrium Model, Biden’s tax plan would reduce the economy’s size by 1.47 percent in the long run. The plan would shrink the capital stock by just over 2.5 percent and reduce the overall wage rate by a little over 1 percent, leading to about 518,000 fewer full-time equivalent jobs. …Biden’s tax plan would raise about $3.05 trillion over the next decade on a conventional basis, and $2.65 trillion after accounting for the reduction in the size of the U.S. economy. While taxpayers in the bottom four quintiles would see an increase in after-tax incomes in 2021 primarily due to the temporary CTC expansion, by 2030 the plan would lead to lower after-tax income for all income levels.

Table 2 from the report is worth sharing because it shows what policies have the biggest economic impact.

The bottom line is that it’s not a good idea to raise the corporate tax burden and it’s not a good idea to worsen the payroll tax burden.

Here are some excerpts by a study authored by Professor Laurence Kotlikoff for the Goodman Institute.

The micro analysis is based on The Fiscal Analyzer (TFA), which uses data from the Federal Reserve’s Survey of Consumer Finance to calculate how much representative American households will pay in taxes net of what they will receive in benefits over the rest of their lives. …The key micro issues…are the degree to which the Vice President’s reforms alter relative remaining lifetime net tax burdens and lifetime spending of the rich and poor within specific age cohorts and the impact of the reforms on incentives to work, i.e., remaining lifetime marginal net tax rates. The macro analysis is based on the Global Gaidar Model (GGM)…a dynamic, 90-period OLG, 17-region general equilibrium model. …The analysis includes three sets of findings. The first is the change in lifetime net taxes defined as the change in lifetime net taxes. The second is the percentage change in lifetime spending, defined as the change in the present value of outlays on all goods and services as well as bequests, averaged across all survivor path. The third is the lifetime marginal net tax rate from earning an extra $1,000. TFA’s lifetime marginal net tax rate measure takes full account of so-called double taxation. …The GGM predicts a close to 6 percent reduction in the U.S. capital stock. The GGM predicts close to a 2 percent permanent reduction in annual U.S. GDP.  The GGM predicts a roughly 2 percentage-point reduction in wages of U.S. workers, with a larger reduction in the wages of high-skilled workers.

In a study for the Committee to Unleash Prosperity, Professor Casey Mulligan estimated the following effects.

This study addresses the impact of these tax rate changes on economic behavior – work, investment, output and growth. This study finds that the Biden tax agenda will reduce production, incomes, and employment per capita by increasing taxation of both labor and business capital. Employment will be about 3 million workers less in the long run (five to ten years). This employment effect is primarily due to the agenda’s expansion of health insurance credits, which raises the average marginal tax rates on labor income by 2.4 percentage points. Biden also plans to increase taxes on businesses and their owners by a combined 6 to 10 percentage points. These taxes will reduce long-run wages, GDP per worker, and business capital per worker in the long run. By decreasing both the number of workers per capita and GDP per worker, respectively, these two key elements of Biden’s agenda reinforce to significantly reduce GDP per capita and average household incomes. I estimate that, as a result of Biden’s tax agenda, real GDP per capita would be 4 to 5 percent less, which is about $8,000 per household per year in the long run. The two parts of the tax agenda combine to reduce real per capita business capital by 7 to 12 percent in the long run.

Here’s a table from the study.

I’ll add two points to the above analyses.

First, the reason that the Moody’s study produces wildly different results is that its model is based on Keynesian principles. As such, a bigger burden of government spending is assumed to stimulate growth.

For what it’s worth, I think borrowing and spending can lead to short-run increases in consumption, but I’m very skeptical that Keynesian policies can generate increases in national income (i.e., what we produce rather than what we consume) over the medium-run or long-run.

All of the other studies rely on models that estimate how government policies impact incentives to engage in productive behavior. They don’t all measure the same things (some of the studies look solely at taxes, some look at overall fiscal policy, and some also include a look at regulatory proposals) but the methodologies are similar.

Second, I’ll re-emphasize the point I made at the beginning about how politicians routinely say things during campaigns that are either insincere or impractical.

For instance, Trump promised to restrain domestic discretionary spending by $750 billion and he actually increased it by $700 billion.

Likewise, I don’t expect Biden (assuming he prevails) to deliver on his campaign promises. In this case, that’s good news since he won’t increase taxes and spending by nearly as much as what he’s embraced during the campaign (in my fantasy world, he turns out be like Bill Clinton and actually delivers a net reduction in the burden of government).

P.S. For those on the losing side of the upcoming election, I’ll remind you that Australia is probably the best option if you want to escape the United States. Though you may want to pick Switzerland if you have a lot of money.

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Since Americans are not as sensible as the Swiss, I’m generally not a fan of direct democracy in the United States.

Simply stated, I don’t like untrammeled majoritarianism, which occurs when 51 percent of voters can pillage 49 percent of voters.

But I’ll admit that the level of my angst fluctuates depending on whether voters make wise choices. With that in mind, here are the six ballot initiatives that I’ll be closely watching on election day.

1. Proposed Amendment to the 1970 Illinois Constitution

The most important ballot initiative is the proposal by the hypocritical governor of Illinois to undo the state’s flat tax. I’ve already dedicated an entire column to this issue, so I’ll simply add some additional analysis from a Wall Street Journal editorial.

Illinois voters will decide next month whether to enact a progressive income tax, paving the way for a new top rate of 7.99%. …The Prairie State currently ranks 36th worst in overall tax burden because its flat individual rate of 4.95% offsets very high property and other taxes. …its proposed slate of new individual income tax rates, along with a corporate tax hike tied to the same ballot measure, would drop the state’s rank overall to 47th. That would move Illinois into Dante’s ninth ring of tax hell, ahead of only New Jersey, New York and California. …Iowa and Missouri have…slashed their top rates in recent years rather than jacking them up as Illinois Democrats intend. Kentucky lawmakers in 2018 replaced their progressive income tax with a flat rate of 5%. Heading in the opposite direction of neighboring states could push many of Illinois’s overburdened families and businesses across the border.

2. Arizona Proposition 208

There’s a class-warfare proposal to dramatically increase the top income tax rate in Arizona.

Once again, the editors at the Wall Street Journal have spot-on analysis.

Arizona has long been a refuge for Americans seeking relief from high-tax California and states in the Northeast. But a tax referendum on the ballot Nov. 3 would whack job creators and make people rethink retirement in Scottsdale or a business move to Tucson. …The current top rate of 4.5% would rise to 8%, which would move the state to the 10th highest income-tax rate in the country, from 11th lowest today… Arizona would move closer to California (13.3% top rate) than Nevada (no income tax). …about half of the targets would be small businesses that pay taxes at the individual rate… They employ a huge chunk of Arizona workers, and the added tax costs would trickle down in lower pay and fewer jobs. …One definition of fiscal insanity would be to raise state taxes when the Biden Democrats may soon raise federal tax rates to heights not seen since the 1970s.

3. California Proposition 16

In California, politicians want the state to have to power to engage in racial and sexual discrimination. In pursuit of that goal, they are asking voters to repeal Proposition 209, adopted by voters in 1996.

Gail Heriot, a law professor who also serves on the U.S. Civil Rights Commission, explains why this is a bad idea in a column for Real Clear Politics.

California’s deep-blue legislature has been itching to repeal Proposition 209 for years. …Proposition 209 amended California’s constitution to prohibit the state from engaging in preferential treatment based on race or sex. It was a rebuke to the identity politics obsessions of state and local governments. …By approving Proposition 209 by a wide margin, they aimed to end the race and sex spoils system. …The best reason for retaining Proposition 209 is…that the initiative has been good for Californians — of all races…the number of under-represented minority students in academic jeopardy collapsed. …in the years immediately following Proposition 209, it had three effects on under-represented minorities in the UC system. It increased (1) graduation rates, (2) GPAs, and (3) the number of science or engineering majors.

4. California Proposition 15

Since we just discussed one bad California proposition, we may as well mention another.

There’s also a scheme to (again) raise taxes. The Wall Street Journal opines on this misguided initiative.

Sooner or later California’s public unions had to hit up the hoi polloi to pay for their pensions after soaking what’s left of the state’s millionaire class, and here they come. On Nov. 3, Californians will vote on a “split roll” ballot initiative (Prop. 15) that seeks to enact the biggest tax hike in state history. …Under current law, tax rates on residential and commercial property are capped at 1% of their assessed value—i.e., the purchase price—and can increase by no more than 2% annually. …This is the only balm in California’s oppressive tax climate and acts as a modest restraint on the government spending ratchet. Unions know that attempting to repeal this entirely would spur a homeowner revolt, so they are targeting businesses. …Facebook CEO Mark Zuckerberg is Prop. 15’s second biggest donor. Perhaps he’s trying to atone for his wealth, but as the NAACP and minority business groups explained in a letter to him in August: “Unlike Facebook, restaurants, dry cleaners, nail salons and other small businesses can’t operate right now and many may never open again. The last thing they need is a billionaire pushing higher taxes on them under the false flag of social justice.” …Prop. 15 would raise property taxes by $8.5 billion to $12.5 billion a year by 2025.

5. Colorado Proposition 117

Proponents of fiscal responsibility in Colorado want to strengthen TABOR (or, to be more accurate, stop the erosion of TABOR) by requiring a public vote for non-trivial efforts to increase government revenue.

Here’s a summary from CPR.

Proposition 117..would add a new TABOR-like provision to state law, requiring the state government to get voter permission before it creates major new “enterprises,” which are partially funded by fees. Colorado voters already have authority over tax increases and rarely approve them. The state Supreme Court has held that a fee is different from a tax because it is reasonably connected to a specific purpose. And in the years that TABOR has been in effect, lawmakers have used them as a way to raise money without raising taxes. Critics see fees as an end-run around TABOR’s spending limits.

6. Colorado Proposition 116

Sticking with Colorado, there’s also a proposal to lower the state’s flat tax.

Once again, let’s use CPR as a source.

This initiative would cut the state’s income tax rate from 4.63 percent to 4.55 percent. …This change would reduce the state government’s revenue by an estimated $170 million in the next fiscal year. Supporters argue it would boost businesses and consumer spending, while opponents say it would weaken government services and social supports already severely cut by the downturn. The measure was originally intended to counter a progressive tax measure that failed to make the ballot.

Honorable Mention

There are many other ballot initiatives. Here are some that I care about, even if they were not important enough to be featured.

Proposition 21 for rent control in California. Bad idea.

Proposition 22 to penalize the gig economy in California. Also a bad idea. [Oops, got this backwards. Prop 22 would undo the legislation that penalizes the gig economy.]

Initiatives to legalize marijuana in Arizona, Montana, New Jersey, and South Dakota. The libertarian side of me is very supportive, but the fiscal side of me doesn’t like the fact that one of the motives is a desire to collect more tax revenue.

Ranked-choice voting in Alaska and Massachusetts. This is a system that requires voters rank all candidates and awards victory to whoever has the strongest support across all ballots. It is assumed that the impact will be more centrist candidates and more civil elections. I don’t have strong views, but it’s worth noting that Australia uses this approach and it’s one of my favorite nations.

13 initiatives in San Francisco. Lot of tax increases, as you might expect from that poorly governed city.

P.S. Voting for politicians who make bad decisions is unfortunate. Directly voting for bad propositions isn’t any better.

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Whether we’re examining Economic Freedom of the World, Index of Economic Freedom, World Competitiveness Ranking, the Global Competitiveness Report, or the World Bank’s Doing Business, publications that endeavor to give us apples-to-apples comparisons of economic policy provide useful measuring sticks.

I’m especially interested in comparisons that focus on fiscal policy.

So I was very interested to see that the Tax Foundation just released its annual International Tax Competitiveness Index, which measures the quality of tax policy of nations that are part of the Organization for Economic Cooperation and Development.

Here are highlights from the report, starting with some background.

The structure of a country’s tax code is an important determinant of its economic performance. A well-structured tax code is easy for taxpayers to comply with and can promote economic development… In contrast, poorly structured tax systems can be costly, distort economic decision-making, and harm domestic economies. Many countries have recognized this and have reformed their tax codes. Over the past few decades, marginal tax rates on corporate and individual income have declined significantly… Not all recent changes in tax policy among OECD countries have improved the structure of tax systems; some have made a negative impact. …The International Tax Competitiveness Index (ITCI) seeks to measure the extent to which a country’s tax system adheres to two important aspects of tax policy: competitiveness and neutrality. …To measure whether a country’s tax system is neutral and competitive, the ITCI looks at more than 40 tax policy variables. These variables measure not only the level of tax rates, but also how taxes are structured.

The ITCI is a very useful publication. Indeed, I’d like it to be expanded. When writing about last year’s edition, I mentioned it should cover more nations and also include the aggregate tax burden as one of the variables.

But let’s not make the perfect the enemy of the good. With regards to this year’s version, what nations have the best and worst tax regimes?

Estonia ranks #1 (not a big surprise) and Italy is at the bottom (also not a big surprise).

For the seventh year in a row, Estonia has the best tax code in the OECD. Its top score is driven by four positive features of its tax system. First, it has a 20 percent tax rate on corporate income that is only applied to distributed profits. Second, it has a flat 20 percent tax on individual income that does not apply to personal dividend income. Third, its property tax applies only to the value of land, rather than to the value of real property or capital. Finally, it has a territorial tax system… Italy has the least competitive tax system in the OECD. It has a wealth tax, a financial transaction tax, and an estate tax. Italy also has a high compliance burden associated with its individual tax system. It takes businesses an estimated 169 hours to comply with the individual income tax.

American readers presumably are most interested in the United States, so here’s the data showing that the United States has a mediocre grade, ranking #21 out of 36 nations.

If you dig through the details, the good news is that the United States has a very high score for “consumption taxes,” which largely is because we haven’t copied the mistake of other nations and imposed a value-added tax.

The U.S. also gets credit for “expensing,” though the report notes that policy is scheduled to expire.

The bad news, by contrast, is that America ranks below average for corporate taxes and individual taxes and way below average for property taxes and international tax rules.

The report also notes that America’s “progressive tax” is a weakness that undermines competitiveness.

But let’s look at the glass as being half full rather than half empty. When the Tax Foundation launched this publication back in 2014, the United States was a lowly #32 out of 34 nations. And we were still mired near the bottom in 2016, ranked #31 out of 35 countries.

Thanks to the Trump tax reform, however, the United States has subsequently enjoyed the biggest improvement of any nations. There’s still plenty of policy mistakes that need to be addressed, but at least we’re moving in the right direction.

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Bernie Sanders was considered a hard-core leftist because his platform was based on higher taxes and higher spending.

Elizabeth Warren also was considered a hard-core leftist because she advocated a similar agenda of higher taxes and higher spending.

And Joe Biden, even though he is considered to be a moderate, is currently running on a platform of higher taxes and higher spending.

Want to know who else is climbing on the economically suicidal bandwagon of higher taxes and higher spending? You probably won’t be surprised to learn that the pro-tax International Monetary Fund just published its World Economic Outlook and parts of it read like the Democratic Party’s platform.

Here are some of the ways the IMF wants to expand the burden of government spending.

Investments in health, education, and high-return infrastructure projects that also help move the economy to lower carbon dependence… Moreover, safeguarding critical social spending can ensure that the most vulnerable are protected while also supporting near-term activity, given that the outlays will go to groups with a higher propensity to spend their disposable income… Some fiscal resources…should be redeployed to public investment—including in renewable energy, improving the efficiency of power transmission, and retrofitting buildings to reduce their carbon footprint. …social spending should be expanded to protect the most vulnerable where gaps exist in the safety net. In those cases, authorities could enhance paid family and sick leave, expand eligibility for unemployment insurance, and strengthen health care benefit coverage…social spending measures…strengthening social assistance (for example, conditional cash transfers, food stamps and in-kind nutrition, medical payments for low-income households), expanding social insurance (relaxing eligibility criteria for unemployment insurance…), and investments in retraining and reskilling programs.

And here’s a partial list of the various class-warfare taxes that the IMF is promoting.

Although adopting new revenue measures during the crisis will be difficult, governments may need to consider raising progressive taxes on more affluent individuals and those relatively less affected by the crisis (including increasing tax rates on higher income brackets, high-end property, capital gains, and wealth) as well as changes to corporate taxation that ensure firms pay taxes commensurate with profitability. …Efforts to expand the tax base can include reducing corporate tax breaks, applying tighter caps on personal income tax deductions, instituting value-added taxes.

Oh, by the way, if nations have any rules that protect the interests of taxpayers, the IMF wants “temporary” suspensions.

Where fiscal rules may constrain action, their temporary suspension would be warranted

Needless to say, any time politicians have a chance to expand their power, temporary becomes permanent.

When I discuss IMF malfeasance in my speeches, I’m frequently asked why the bureaucrats propose policies that don’t work – especially when the organization’s supposed purpose is to promote growth and stability.

The answer is “public choice.” Top IMF officials are selected by politicians and are given very generous salaries, and they know that the best way to stay on the gravy train is to support policies that will please those politicians.

And because their lavish salaries are tax free, they have an extra incentive to curry favor with politicians.

P.S. I wish there was a reporter smart enough and brave enough to ask the head of the IMF to identify a single nation – at any point in history – that became rich by expanding the size and cost of government.

P.P.S. There are plenty of good economists who work for the IMF and they often write papers pointing out the economic benefits of lower taxes and smaller government (and spending caps as well!). But the senior people at the bureaucracy (the ones selected by politicians) make all the important decisions.

 

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According to the Fraser Institute’s calculations of overall economic freedom, Delaware apparently has the worst politicians and New Hampshire has the best ones.

According to comprehensive estimates of economic liberty in Freedom in the 50 States, New York’s politicians seem to be the worst and Florida’s are the best.

But what if we focus just on fiscal policy?

Earlier this year, I wrote three columns that illustrated different ways – income taxes, sales taxes, and government spending burden – of measuring the quality of state fiscal policy.

Today, let’s look at a comprehensive assessment of the nation’s governors, courtesy of Chris Edwards. Here’s his core methodology.

…this year’s 15th biennial fiscal report card on the governors…examines state budget actions since 2018. It uses statistical data to grade the governors on their tax and spending records—governors who have restrained taxes and spending receive higher grades, while those who have substantially increased taxes and spending receive lower grades. …Scores ranging from 0 to 100 were calculated for each governor on the basis of seven tax and spending variables. Scores closer to 100 indicate governors who favored smaller-government policies. 

Only four governors got the highest grade (and that’s using a curve!), led by Chris Sununu of New Hampshire.

Those of you who follow politics may be interested in knowing that Kristi Noem (R-SD) and Ron DeSantis (R-FL), both potential presidential candidates in 2024, got “B” grades. So good, but not great.

Now let’s look at the most profligate chief executives.

The worst of the worst is Jay Inslee of Washington. So however bad Biden’s agenda is for the country, let’s be happy that Governor Inslee didn’t win the Democratic presidential nomination.

I’m not surprised by the other “F” governors. Though I am surprised that Gov. Pritzker isn’t in last place, given his efforts to get rid of the the Illinois flat tax.

For what it’s worth, the best-ranked Democrat (a “B” grade) is Steve Sisolak of Nevada. I assume this means he hasn’t tried to ruin the state’s zero-income-tax status. The worst-ranked Republican (a “D” grade) is Bill Lee of Tennessee and his bad score is because of huge increases in the state spending burden.

Last but not least, Chris identifies a systemic problem impacting almost all states. Simply stated, government spending has been growing too rapidly, more than double what would be needed to keep pace with inflation.

General fund spending grew at an annual average rate of 4.1 percent between 2010 and 2020, including increases of 5.5 percent in 2019 and 5.8 percent in 2020.

Here’s the accompanying chart.

In the study, Chris says states should use “rainy day funds” to avoid boom-and-bust budgeting (in other words, set aside some revenue when the economy is growing so it’s not necessary to make big adjustments when there’s a recession).

That’s definitely a prudent approach, and the study points out that some blue-leaning states like California follow that policy, while others (most notably, Illinois) recklessly spent surplus revenue.

My two cents is that a spending cap is the best long-run solution, and Colorado’s TABOR is easily the best fiscal rule among the 50 states.

P.S. Governor Sununu of New Hampshire needs to continue getting good scores to atone for his father’s terrible role, as Chief of Staff for George H.W. Bush, in pushing through the failed 1990 tax increase.

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On election day, most people focus on the big-ticket partisan battles, such as this year’s contest between Trump and Biden.

Let’s not forget, though, that there are sometimes very important referendum battles at the state (or even local) level.

This year, the most important referendum will be in Illinois, where hypocritical Governor J.B. Pritzker wants voters to approve an initiative to replace the state’s flat tax with a discriminatory progressive tax.

I’ve already explained that the flat tax is the only thing saving Illinois from going further and faster in the wrong direction. Let’s add some additional evidence, starting with excerpts from this editorial in the Wall Street Journal.

The last state to adopt a progressive income tax was Connecticut in 1996, and we know how that turned out. Now Democrats in Illinois want to follow Connecticut down the elevator shaft with a referendum replacing the state’s flat 4.95% income tax with progressive rates… Public unions have long wanted to enact a progressive tax to pay for increased spending and pensions, and they think the political moment has finally arrived. Democratic Gov. J.B. Pritzker says a progressive tax will hit only the wealthy… Don’t believe it. There aren’t enough wealthy in the state to pay for his spending promises, so eventually Democrats will come after the middle class. …Illinois has no fiscal room to fail. Since 2015 Illinois’s GDP has grown a mere 1% annually, about half as fast as the U.S. and slower than Ohio (1.4%), Indiana (1.7%), Wisconsin (1.7%) and Michigan (2.1%). About 11% of Illinois residents have left since 2001, the second biggest state exodus after New York. Taxpayer flight has been accelerating as income and property taxes have risen. …A progressive tax would be a gift to Florida and Texas.

The head of the Illinois Chamber of Commerce, Todd Maisch, also worries that other states will benefit if voters make the wrong choice. Here are excerpts from his column in the Chicago Sun-Times.

The rest of the nation’s states are cheering on Illinois’ efforts to enact a progressive income tax. That’s because they know it will be one more self-inflicted blow to our state’s economy, certain to drive dollars, jobs and families into their waiting arms. …The reality is that this proposal is intended to do just one thing: Make it easier to raise taxes on all Illinoisans. …the spenders in Springfield are coming for you too, sooner or later. Proponents of the progressive tax know something they don’t want to tell you. Taxing millionaires will in no way meet their appetite for state spending. There simply isn’t enough money at the higher income levels to satisfy their demands. Tax rates will go up and tax brackets will reach lower and lower incomes. …Other states already are benefiting from the outmigration of Illinoisans and their money. Illinois passing the progressive tax is exactly what they are hoping for.

Amen. We already have lots of evidence showing that taxpayers move from high-tax states to low-tax states. And Illinois already has been bleeding taxable income to other states, so it’s very likely that a progressive tax would dramatically worsen the state’s position.

Illinois voters can and should learn from what’s happened elsewhere.

For instance, Orphe Divounguy of the Illinois Policy Institute shares evidence from California about the adverse impact of class-warfare taxation.

Illinois Gov. J.B. Pritzker finds himself in the same place as then-California Gov. Jerry Brown was in back in 2012 – trying to convince voters that a progressive state income tax hike will fix state finances in crisis. Brown claimed the burden of those tax hikes would only harm those earning $250,000 or more – the top 3% of earners. That’s exactly what Pritzker promises with his “fair tax” proposal. Brown was wrong. …Here are the main findings of the new study… The negative economic effects of the tax hike wiped out nearly half of the expected additional tax revenue. Among top-bracket California taxpayers, outward migration and behavioral responses by stayers together eroded 45% of the additional tax revenues from the tax hike… The “temporary” income tax hike, which has now been extended through 2030, made it about 40% more likely wealthy residents would move out of California, primarily to states without income taxes.

Illinois voters also should learn from the painful experiences of taxpayers in Connecticut and New Jersey.

The Wall Street Journal editorialized this morning about their negative experiences.

Illinois is the nation’s leading fiscal basket case, with runaway pension liabilities and public-union control of Springfield. But it has had one saving grace: a flat-rate income tax that makes it harder for the political class to raise taxes. Now that last barrier to decline is in jeopardy on the November ballot. …the pattern of other blue states is instructive. Democratic governors have often lowballed voters with modest rates when introducing a new tax, only to ratchet up the levels in each administration. …New Jersey first taxed individual income in 1976 amid a national revenue slump, with a top rate of 2.5%. …Democratic Gov. James Florio raised the tax to 7%… A decade later Democrats raised the top rate to 8.97%, and last year Gov. Murphy added the 10.75% rate… Or take Connecticut… For decades its lack of an income tax lured New York workers and businesses, but Gov. Lowell Weicker introduced the tax in 1991…and the original 1.5% rate has since been raised five times to today’s 6.99%.

And here’s the chart that every taxpayer should memorize before they vote next month.

And never forget that ever-increasing tax rates on high earners inevitably are accompanied by ever-increasing tax rates on everyone else – exactly as predicted by the Sixth Theorem of Government.

So if middle-class Illinois voters approve the so-called Fair Tax initiative, they’ll have nobody to blame but themselves when their tax rates also climb.

P.S. If voters in very-blue Illinois reject Pritzker’s class-warfare tax referendum, I wonder if that will discourage Democrats in Washington from embracing Biden’s class warfare agenda next year (assuming he wins the election)?

P.P.S. There’s a debate whether ballot initiatives and other forms of “direct democracy” are a good idea. Professor Garett Jones of George Mason University persuasively argues we’ll get better governance with less democracy. On the other hand, Switzerland is a very successful, very well-governed nation where voters directly decide all sorts of major policy issues.

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Yesterday’s column featured some of Milton Friedman’s wisdom from 50 years ago on how a high level of societal capital (work ethic, spirit of self-reliance, etc) is needed if we want to limit government.

Today, let’s look at what he said back then about that era’s high tax rates.

His core argument is that high marginal tax rates are self-defeating because the affected taxpayers (like Trump and Biden) will change their behavior to protect themselves from being pillaged.

This was in the pre-Reagan era, when the top federal tax rate was 70 percent, and notice that Friedman made a Laffer Curve-type prediction that a flat tax of 19 percent would collect more revenue than the so-called progressive system.

We actually don’t know if that specific prediction would have been accurate, but we do know that Reagan successfully lowered the top tax rate on the rich from 70 percent in 1980 to 28 percent in 1988.

So, by looking at what happened to tax revenues from these taxpayers, we can get a pretty good idea whether Friedman’s prediction was correct.

Well, here’s the IRS data from 1980 and 1988 for taxpayers impacted by the highest tax rate. I’ve circled (in red) the relevant data showing how we got more rich people, more taxable income, and more tax revenue.

The bottom line is that Friedman was right.

Good tax policy (i.e., lower rates on productive behavior) can be a win-win situation. Taxpayers earn more and keep more, while politicians also wind up with more because the economic pie expands.

Something to keep in mind since some politicians in Washington want a return to confiscatory taxes on work, saving, investment, and entrepreneurship.

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Washington is a cesspool of waste, fraud, and abuse.

All taxpayers, to avoid having their income squandered in D.C., should go above and beyond the call of duty to minimize the amount they send to the IRS.

Which is why today’s column is a bipartisan love fest for Donald Trump and Joe Biden – both of whom have been very aggressive in limiting their tax liabilities.

Here are some details from the report in the New York Times about Trump’s leaked tax returns.

Donald J. Trump paid $750 in federal income taxes the year he won the presidency. In his first year in the White House, he paid another $750. He had paid no income taxes at all in 10 of the previous 15 years — largely because he reported losing much more money than he made. …His reports to the I.R.S. portray a businessman who takes in hundreds of millions of dollars a year yet racks up chronic losses that he aggressively employs to avoid paying taxes. …They report that Mr. Trump owns hundreds of millions of dollars in valuable assets, but they do not reveal his true wealth. …Most of Mr. Trump’s core enterprises — from his constellation of golf courses to his conservative-magnet hotel in Washington — report losing millions, if not tens of millions, of dollars year after year. …Business losses can work like a tax-avoidance coupon: A dollar lost on one business reduces a dollar of taxable income from elsewhere. The types and amounts of income that can be used in a given year vary, depending on an owner’s tax status. But some losses can be saved for later use, or even used to request a refund on taxes paid in a prior year.

It’s worth noting that the leaked returns didn’t show any unknown business ties to Russia. Nor do they suggest any criminality.

Instead, Trump appears to have relied on using losses in some years to offset income in other years – a perfectly legitimate practice.

Now let’s look at some of what CNBC reported about Joe Biden’s clever tactic to save lots of money.

…consider borrowing a tax-planning tip from Joe Biden. The former vice president…reported about $10 million in income in 2017 from a pair of S-corporations… The two entities were paid for the couple’s book deals and speaking gigs. …both S-corps generated a lot of income, they paid out modest salaries in comparison. …In 2017, the two companies paid the couple a combined $245,833 in wages. …any amounts the Bidens received as a distribution wasn’t subject to the 15.3% combined Social Security and Medicare tax. …Tim Steffen, CPA and director of advanced planning at Robert W. Baird & Co. in Milwaukee. “…if you don’t report that income to the business as wages, then that portion of the income avoids Social Security and Medicare taxes,” he said.

So how much did this aggressive strategy save  the family?

The article doesn’t do all the math, but it certainly seems like the Biden household avoided having to cough up any payroll taxes on more than $9.75 million.

There’s a “wage base cap” on Social Security taxes (thankfully), so it’s possible that their tax avoidance only saved them about $283,000 (what they would have paid in Medicare taxes – 2.9 percent rather than 15.3 percent).

But that’s still a nice chunk of change – about four times as much as the average household earned that year.

As far as I’m concerned, we should applaud both Trump and Biden. Tax avoidance is legal. Even more important, it’s the right thing to do.

Though my applause for Biden is somewhat muted because he said in 2008 that paying more tax is patriotic. So he’s guilty of tax hypocrisy, which seems to be a common vice for folks on the left (the Clintons, John Kerry, Obama’s first Treasury Secretary, Obama’s second Treasury Secretary, Governor Pritzker of Illinois, etc).

For all his flaws, at least Trump isn’t a hypocrite on this issue (though all his spending may pave the way for future tax increases).

P.S. Here’s a story about the greatest-ever tactic for escaping taxes.

P.P.S. And here’s my favorite adults-only story about tax avoidance.

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New Jersey is a tragic example of state veering in the wrong direction.

Back in the 1960s, it was basically like New Hampshire, with no income tax and no sales tax. State politicians then told voters in the mid-1960s that a sales tax was needed, in part to reduce property taxes. Then state politicians told voters in the mid-1970s that an income tax was needed, again in part to reduce property taxes.

So how did that work out?

Well, the state now has a very high sales tax and a very high income tax. And you won’t be surprised that it still have very high property taxes – arguably the worst in the nation according to the Tax Foundation.

But you have to give credit to politicians from the Garden State.

They are very innovative at coming up with ways to make a bad situation even worse.

In an article for City Journal, Steven Malanga reviews the current status of New Jersey’s misguided fiscal policies.

Relative to the size of its budget, New Jersey’s borrowing is by far the largest. Jersey plans to cover most of the cost of its deficit with debt by tapping a last-resort Federal Reserve lending program. New Jersey is already the nation’s most fiscally unsound state, according to the Institute for Truth in Accounting. It bears some $234 billion in debt, including about $100 billion in unfunded pension liabilities. A recent Pew study estimated that, between 2003 and 2017, the state spent $1 for every 91 cents in revenue it collected. …Before the pandemic, Murphy had proposed a $40.7 billion budget for fiscal 2021, a spending increase of 5.4 percent. …The administration has taken only marginal steps to reduce spending by, for instance, delaying water infrastructure projects. Many other cuts Murphy has announced involve simply shelving plans to spend more money.

The very latest development is that the state’s politicians want to exacerbate New Jersey’s uncompetitive tax system by extending the state’s top tax rate of 10.75 percent to a larger group of taxpayers.

The New York Times reports on a new tax scheme concocted by the Governor and state legislature.

New Jersey officials agreed on Thursday to make the state one of the first to adopt a so-called millionaires tax… Gov. Philip D. Murphy, a Democrat, announced a deal with legislative leaders to increase state taxes on income over $1 million by nearly 2 percentage points, giving New Jersey one of the highest state tax rates on wealthy people in the country. …The new tax in New Jersey…is expected to generate an estimated $390 million this fiscal year… With every call for a new tax comes criticism from Republicans and some business leaders who warn that higher taxes will lead to an exodus of affluent residents.

As is so often the case, the Wall Street Journal‘s editorial does a good job of nailing the issue.

New Jersey Gov. Phil Murphy and State Senate President Steve Sweeney struck a deal on Thursday to raise the state’s top marginal tax rate to 10.75% from 8.97% on income of more than $1 million. Two years ago, Democrats increased the top rate to 10.75% on taxpayers making more than $5 million. …New Jersey’s bleeding budget can’t afford to lose any millionaires. In 2018 New Jersey lost a net $3.2 billion in adjusted gross income to other states, including $2 billion to zero-income tax Florida, according to IRS data. More will surely follow now.

The WSJ is right.

As shown by this map, there’s already been a steady exodus of people from the Garden State. More worrisome is that the people leaving tend to have higher-than-average incomes (and it’s been that way for a while since New Jersey’s been pursuing bad policy for a while).

I’ll add one additional point to this discussion. One of the best features of the 2017 tax reform is that there’s now a limit on deducting state and local taxes when filing with the IRS.

This means that people living in high-tax jurisdiction such as California, New York, and Illinois (and, of course, New Jersey) now bear the full burden of state taxes.

In other words, New Jersey’s politicians are pursuing a very foolish policy at a time when federal tax law now makes bad state policy even more suicidal.

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Every single economic school of thought agrees with the proposition that investment is a key factor in driving wages and growth.

Even foolish concepts such as socialism and Marxism acknowledge this relationship, though they want the government to be in charge of deciding where to invest and how much to invest (an approach that has a miserable track record).

Another widely shared proposition is that higher tax rates will discourage whatever is being taxed. Even politicians understand this notion, for instance, when arguing for higher taxes on tobacco.

To be sure, economists will argue about the magnitude of the response (will a higher tax rate cause a big effect, medium effect, or a small effect?).

But they’ll all agree that a higher tax on something will lead to less of that thing.

Which is why I always argue that we need the lowest-possible tax rates on the activities – work, saving, investment, and entrepreneurship – that create wealth and prosperity.

That’s why it’s so disappointing that Joe Biden, as part of his platform in the presidential race, has embraced class-warfare taxation.

And it’s even more disappointing that he specifically supports policies that will impose a much higher tax burden on capital formation.

How much higher? Kyle Pomerleau of the American Enterprise Institute churned through Biden’s proposals to see what it would mean for tax rates on investment and business activity.

Former Vice President and Democratic presidential candidate Joe Biden has proposed several tax increases that focus on raising taxes on business and capital income. Taxing business and capital income can affect saving and investment decisions by reducing the return to these activities and distorting the allocation across different assets, forms of financing, and business forms. Under current law, the weighted average marginal effective tax rate (METR) on business assets is 19.6 percent… Biden’s tax proposals would raise the METR on business investment in the United States by 7.8 percentage points to 27.5 percent in 2021. The effective tax rate would rise on most assets and new investment in all industries. In addition to increasing the overall tax burden on business investment, Biden’s proposals would increase the bias in favor of debt-financed and noncorporate investment over equity-financed and corporate investment.

Here’s the most illuminating visual from Kyle’s report.

The first row of data shows that the effective tax rate just by almost 8 percentage points.

I also think it’s important to focus on the last two rows. Notice that the tax burden on equity increases by a lot while the tax burden on debt actually drops slightly.

This is very foolish since almost all economists will acknowledge that it’s a bad idea to create more risk for an economy by imposing a preference for debt (indeed, mitigating this bias was one of the best features of the 2017 tax reform).

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It’s not easy to identify the worst international bureaucracy.

As you can see, it’s hard to figure out which bureaucracy is the worst.

I’ve solved this dilemma by allowing a rotation. Today, the OECD is at the top of my list.

That’s because the top tax official at that Paris-based bureaucracy, Pascal Saint-Amans, has a new article about goals for future tax policy.

…policy flexibility and agility may be what is needed to help restore confidence. …Governments should seize the opportunity to build a greener, more inclusive and more resilient economy. Rather than simply returning to business as usual, the goal should be to “build back better” and address some of the structural weaknesses that the crisis has laid bare.

So how do we get a “more resilient economy” with less “structural weakness”?

According to the bureaucrats at the OECD, we achieve that goal with higher taxes. I’m not joking. Here are some additional excerpts.

Today, taxes on polluting fuels are nowhere near the levels needed… Seventy percent of energy-related CO2 emissions from advanced and emerging economies are entirely untaxed.

Here’s a chart from the article showing how nations supposedly are under-taxing energy use.

But it’s not just energy taxes.

The OECD wants a bunch of other tax increases, including a digital tax deal that specifically targets America’s high-tech firms.

It’s also disturbing that the bureaucrats want higher taxes on “personal capital income,” particularly since even economists at the OECD have specifically warned that those types of taxes are particularly harmful to prosperity.

Fair burden sharing will also be central going forward. …consideration should be given to strengthening…social protection in the longer run. …Governments will need to find alternative sources of revenues. The taxation of property and personal capital income will have an important role to play… Rising pressure on public finances as well as increased demands for fair burden sharing should provide new impetus for reaching an agreement on digital taxation.

By the way, “social protection” is OECD-speak for redistribution spending. In other words, “fair burden sharing” means a bigger welfare state financed by ever-higher taxes.

The bureaucrats apparently think we should all be like Greece and Italy.

I want to close by revisiting the topic of environmental taxation. If you peruse the above chart, you’ll see that the OECD wants all nations to impose (at a minimum) a €30-per-ton tax on carbon.

What would that imply for American taxpayers? Well, if we extrapolate from estimates by the Tax Policy Center and Tax Foundation, that would be a tax increase of more than $400-per-year for every man, woman, and child in the United States. That’s $1600 of additional tax for each family of four.

P.S. The OECD has traditionally tailored its analysis to favor Democrats, but even I am surprised that Saint-Amans used the Biden campaign slogan of “build back better” in his column. I’m sure that was no accident. The bureaucrats at the OECD must be quite confident that Biden will win. Or they must feel confident that Republicans will be too stupid to exact any revenge if Trump prevails (probably a safe assumption since Republicans gave the bureaucracy lots of American tax dollars even after a top OECD official compared Trump to Hitler).

P.P.S. To add insult to injury, OECD bureaucrats get tax-free salaries, so they have a special exemption from the bad policies they want for the rest of us.

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New York is in trouble from bad economic policy, especially excessive taxing and spending.

This is one of the reasons why there’s been a steady exodus of taxpayers from the Empire State.

The problem is especially acute for New York City, which has been suffering from Mayor Bill De Blasio’s hard-left governance.

To be sure, not all of the city’s problems are self-inflicted. The 2017 tax reform removed the IRS loophole for state and local tax payments, which means people living in places such as NYC no longer can artificially lower their tax liabilities. And the coronavirus hasn’t helped, either, particularly since Governor Cuomo bungled the state’s response.

The net result of bad policy and bad luck is that New York City has serious economic problems. And this leads, as one might expect, to serious fiscal problems.

What’s surprising, however, is that the normally left-leaning New York Times actually wrote an editorial pointing out that fiscal restraint is the only rational response.

New York is facing…a budget hole of more than $5 billion… Mayor Bill de Blasio has asked the State Legislature to give him the authority to borrow… But borrowing to meet operating expenses is especially hazardous. Cities that do so over and over again are at greater risk of the kind of bankruptcy faced by New York in the late 1970s and Detroit in 2013. …Before Mr. de Blasio adds billions to the city’s debt sheet…he needs to find savings. …The city’s budget grew under Mr. de Blasio, to $92 billion last year from about $73 billion in 2014, his first year in office. Complicating matters, the mayor has hired tens of thousands of employees over his tenure, adding significantly to the city’s pension and retirement obligations. …the mayor will have to be creative, make unpopular decisions and demand serious cost-saving measures… One way to begin is with a far stricter hiring freeze. …The mayor will need to do something he has rarely been able to: ask the labor unions to share in the sacrifice. …There are other cuts to be made.

Wow, this may be the first sensible editorial from the New York Times since it called for abolishing the minimum wage in 1987.*

Mayor De Blasio, needless to say, doesn’t want any form of spending restraint. Depending on the day, he either wants to tax-and-spend or borrow-and-spend.

Both of those approaches are misguided.

Kristin Tate explained in a column for the Hill that the middle class suffers most when class-warfare politicians such as De Blasio impose policies that penalize the private sector.

Finance giant JPMorgan is…slowly relocating many of its operations and jobs to lower tax locations in Ohio, Texas, and Delaware. The Lone Star State currently hosts 25,000 of its employees, and Texas will likely surpass the New York portion in coming years. The resulting move will harm the middle earners of New York far more than that of the wealthy… The exodus is part of a trend sweeping traditionally Democratic states over the last several years. …A whopping 1,800 businesses left California in 2016 alone, while manufacturing firm Honeywell moved its headquarters from New Jersey to greener pastures in North Carolina. …the primary losers in this formula are middle class workers. Between the loss of jobs and revenue, these states and cities press even harder on millions of middle income taxpayers to make up the difference. …Many of the Democrats…who are in charge of the blue state economic models…love to preach that their proposals will make the economy fairer by targeting the most productive members of their states and cities. However, the encompassing butterfly effect spells bad news for people like you and me. Every time you vote for a proposition or a candidate promising a repeat of bad policy, just remember that it will ultimately be the middle class that will pay the largest share.

My contribution to this discussion is to point out that New York City’s fiscal problems are the entirely predictable result of politicians spending too much money over an extended period of time.

In other words, they violated my Golden Rule.

Indeed, the burden of government spending has climbed more than three times faster than inflation during De Blasio’s time in office.

If this story sounds familiar, that’s because excessive spending is the cause of every fiscal crisis (as I’ve noted when writing about Cyprus, Alaska, Ireland, Alberta, Greece, Puerto Rico, California, etc).

My final observation is that New York City’s current $5 billion budget shortfall would be a budget surplus of more than $6 billion if De Blasio and the other politicians had adopted a spending cap back in 2015 and limited budget increases to 2 percent annually.

*The New York Times also endorsed the flat tax in 1982, so there have been rare outbursts of common sense.

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Two weeks ago, I shared some video from a presentation to the New Economic School of Georgia (the country, not the state) as part of my “Primer on the Laffer Curve.”

Here’s that portion of that presentation that outlines the principles of sensible taxation.

Just in case you don’t want to watch me pontificate for nearly 14 minutes, here’s the slide from the presentation that most deserves attention since it captures the key principle of good tax policy.

Simply stated, the more you tax of something, the less you get of that thing.

By the way, I had an opportunity earlier this year to share some similar thoughts about the principles of sound tax policy with the United Nations’ High-Level Panel on Financial Accountability Transparency & Integrity.

Given my past interactions with fiscal people at the U.N., I’m not overflowing with optimism that the following observations with have an impact, but hope springs eternal.

The ideal fiscal environment is one that has a vibrant and productive economy that generates sufficient revenue with modest tax rates that do not needlessly penalize productive behavior. Public finance experts generally agree on the following features

  • Low marginal tax rates. A tax operates by increasing the “price” of whatever is being taxed. This is most obvious in the case of some excise taxes –such as levies on tobacco –where governments explicitly seek to discourage certain behaviors. …but there should be a general consensus in favor of keeping tax rates reasonable on the behaviors –work, saving, investment, risk-taking, and entrepreneurship –that make an economy more prosperous.
  • A “consumption-base.” Because of capital gains taxes, death taxes, wealth taxes, and double taxation of interest and dividends, many nations impose a disproportionately harsh tax burden on income that is saved and invested. This creates a bias against capital formation, which is problematical since every economic theory –including various forms of socialism –share the view that saving and investment are necessary for rising wages and higher living standards.
  • Neutrality. Special preferences in a tax system distort the relative “prices” of how income is earned or how income is spent. Such special tax breaks encourage taxpayers to make economically inefficient choices simply to lower their tax liabilities. Moreover, loopholes, credits, deductions, exemptions, holidays, exclusions, and other preferences reduce tax receipts, thus creating pressure for higher marginal tax rates, which magnifies the adverse economic impact.
  • Territoriality. This is the simple notion that governments should not tax activity outside their borders. If income is earned in Brazil, for instance, the Brazilian government should have the authority over how that income is taxed.The same should be true for all other nations.

By the way, “consumption-base” is simply the jargon used by public-finance economists when referring to a tax system that doesn’t impose double taxation (i.e., extra layers of tax on income that is saved and invested).

Here’s a flowchart I prepared showing the double taxation in the current system compared to what happens with a flat tax.

P.S. At the risk of understatement, it’s impossible to have a good tax system with a bloated public sector, which means it’s not easy to be optimistic about future fiscal policy in the United States.

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Last week, I gave a presentation on the Laffer Curve to a seminar organized by the New Economic School in the nation of Georgia.

A major goal was to help students understand that you can’t figure out how changes in tax rates affect tax revenues without also figuring out how changes in tax rates affect taxable income.

As you might expect, I showed the students a visual depiction of the Laffer Curve, explaining that the government won’t collect any revenue if the tax rate is zero (the left point of the horizontal axis), but also pointing out that the government won’t collect any revenue if tax rates are 100 percent (the right point on the horizontal axis).

The curve between those two points shows how much tax is collected at various tax rates.

The upward-sloping part of the curve shows the “region of increasing revenue” (i.e., where higher tax rates produce more revenue) and the downward-sloping part of the curve shows the “region of declining revenue” (i.e., where higher tax rates produce less revenue).

I noted in my remarks that this is not a controversial concept.

Indeed, I’d wager that every economist in the world will agree.

Just in case you think I’m exaggerating, you can see in this video that even Paul Krugman agrees that there is a Laffer Curve.

Needless to say, this doesn’t mean that we agree on the shape of the Laffer Curve.

Even more important, we presumably don’t agree on the ideal point on the Laffer Curve.

I’m guessing he would want to be at the revenue-maximizing point, whereas I explained in the presentation that it’s much better to at the growth-maximizing point.

To show why this is an important distinction, I specifically cited research from two economists (one from the University of Chicago and one from the Federal Reserve) in hopes of getting students to understand that higher tax rates will destroy a lot of private income for every dollar of additional revenue that politicians will collect.

If you look at the nearby image, you’ll see that’s especially true for taxes on “capital” since households have much more control over the timing, level, and composition of business and investment income.

Maybe I’m just a wild-eyed libertarian, but I don’t think it’s a good idea to destroy lots of private income just so politicians get a bit of extra revenue to spend.

This does not mean, by the way, that the Laffer Curve is a panacea, or some sort of free lunch.

I should have shown the students this one-minute video clip of me pointing out that it’s only in rare circumstances that a tax cut generates enough additional growth (and therefore enough additional taxable income) to be self-financing.

To be sure, self-financing tax cuts do exist.

In the presentation, I shared the IRS data showing that the federal government collected fives times as much money from the rich after President Reagan reduced the top tax rate from 70 percent to 28 percent.

And I also shared the OECD data showing that industrialized nations are collecting more revenue from income taxes today, as a share of economic output, than they were back in 1980 when top tax rates on personal and corporate income were much higher.

And I also could have cited interesting results from Canada, Denmark, HungaryIreland, ItalyPortugal, Russia, France, and the United Kingdom.

I’ll close by recycling my three-part video series from 2008 on the Laffer Curve (assuming you’re not already tired of my voice after the 22-minute presentation at the start of today’s column).

The first video discusses the theory.

The second video looks at the evidence.

And the third video shines a spotlight on the Joint Committee on Taxation’s primitive methodology for producing revenue estimates.

The good news is that the Joint Committee on Taxation has been dragged kicking and screaming in the right direction since 2008, so the present process for estimating the revenue impact of change in tax policy is somewhat more accurate.

P.S. Here’s my response to Matt Yglesias’ supposed debunking of the Laffer Curve.

P.P.S. I used to think my friends on the left could be persuaded since they presumably don’t want tax rates to be so high that revenues decline. But it seems many of them actually are motivated by a desire to punish success rather than a desire to maximize revenue for government.

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Speculating about tax policy in 2021, with Washington potentially being controlling by Joe Biden, Chuck Schumer, and Nancy Pelosi, there are four points to consider.

  1. The bad news is that Joe Biden has endorsed a wide range of punitive tax increases.
  2. The good news is that Joe Biden has not endorsed a wealth tax, which is one of the most damaging ways – on a per-dollar raised basis – for Washington to collect more revenue.
  3. The worse news is that the additional spending desired by Democrats is much greater than Biden’s proposed tax increases, which means there will be significant pressures for additional sources of money.
  4. The worst news is that the class-warfare mentality on the left means the additional tax increases will target successful entrepreneurs, investors, innovators, and business owners – which means a wealth tax is a very real threat.

Let’s consider what would happen if this odious example of double taxation was imposed in the United States.

Two scholars from Rice University, John Diamond and George Zodrow, produced a study for the Center for Freedom and Prosperity on the economic impact of a wealth tax.

They based their analysis on the plan proposed by Senator Elizabeth Warren, which is probably the most realistic option since Biden (assuming he wins the election) presumably won’t choose the more radical plan proposed by Senator Bernie Sanders.

They have a sophisticated model of the U.S. economy. Here’s their simplified description of how a wealth tax would harm incentives for productive behavior.

The most direct effect operates through the reduction in wealth of the affected taxpayers, including the reduction in accumulated wealth over time. Although such a reduction in wealth is, for at least some proponents of the wealth tax, a desirable result, the associated reduction in investment and thus in the capital stock over time will have deleterious effects, reducing labor productivity and thus wage income as well as economic output. …A wealth tax would also affect saving by changing the relative prices of current and future consumption. In the standard life-cycle model of household saving, a wealth tax effectively increases the price of future consumption by lowering the after-tax return to saving, creating a tax bias favoring current consumption and thus reducing saving. … we should note that the apparently low tax rates under the typical wealth tax are misleading if they are compared to income tax rates imposed on capital income, and the capital income tax rates that are analogous to wealth tax rates are often in excess of 100 percent. …For example, with a 1 percent wealth tax and a Treasury bond earning 2 percent, the effective income tax rate associated with the wealth tax is 50 percent; with a 2 percent tax rate, the effective income tax rate increases to 100 percent.

And here are the empirical findings from the report.

We compare the macroeconomic effects of the policy change to the values that would have occurred in the absence of any changes — that is, under a current law long run scenario… The macroeconomic effects of the wealth tax are shown in Table 1. Because the wealth tax reduces the after-tax return to saving and investment and increases the cost of capital to firms, it reduces saving and investment and, over time, reduces the capital stock. Investment declines initially by 13.6 percent…and declines by 4.7 percent in the long run. The total capital stock declines gradually to a level 3.5 percent lower ten years after enactment and 3.7 percent lower in the long run… The smaller capital stock results in decreased labor productivity… The demand for labor falls as the capital stock declines, and the supply of labor falls as households receive larger transfer payments financed by the wealth tax revenues… Hours worked decrease initially by 1.1 percent and decline by 1.5 percent in the long run. …the initial decline in hours worked of 1.1 percent would be equivalent to a decline in employment of approximately 1.8 million jobs initially. The declines in the capital stock and labor supply imply that GDP declines as well, by 2.2 percent 5 years after enactment and by 2.7 percent in the long run.

Here’s the table mentioned in the above excerpt. At the risk of understatement, these are not favorable results.

Other detailed studies on wealth taxation also find very negative results.

The Tax Foundation’s study, authored by Huaqun Li and Karl Smith, also is worth perusing. For purposes of today’s analysis, I’ll simply share one of the tables from the report, which echoes the point about how “low” rates of wealth taxation actually result in very high tax rates on saving and investment.

The American Action Forum also released a study.

Authored by Douglas Holtz-Eakin and Gordon Gray, it’s filled with helpful information. The part that deserves the most attention is this table showing how a wealth tax on the rich results in lost wages for everyone else.

Yes, the rich definitely lose out because their net wealth decreases.

But presumably the rest of us are more concerned about the fact that lower levels of saving and investment reduce labor income for ordinary people.

The bottom line is that wealth taxes are very misguided, assuming the goal is a prosperous and competitive America.

P.S. One obvious effect of wealth taxation, which is mentioned in the study from the Center for Freedom and Prosperity, is that some rich people will become tax expatriates and move to jurisdictions (not just places such as Monaco, Bermuda, or the Cayman Islands, but any of the other 200-plus nations don’t tax wealth) where politicians don’t engage in class warfare.

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There’s a reason that Greece is almost synonymous with bad economic policy. The country has endured some terrible prime ministers, most recently Alexis Tsipras of the far-left Syriza Party.

Andreas Papandreou, however, wins the prize for doing the most damage. He dramatically expanded the burden of government spending in the 1980s (the opposite of what Reagan and Thatcher were doing that decade), thus setting the stage for Greece’s eventual fiscal collapse.

But Greek economic policy isn’t a total disaster.

Policy makers in Athens are trying a bit of supply-side tax policy, at least for a limited group of people.

The U.K.-based Times has a report on Greece’s campaign to lure foreigners with low tax rates.

“The logic is very simple: we want pensioners to relocate here,” Athina Kalyva, the Greek head of tax policy at the finance ministry, said. “We have a beautiful country, a very good climate, so why not?” “We hope that pensioners benefiting from this attractive rate will spend most of their time in Greece,” Ms Kalyva told the Observer. Ultimately, the aim is to expand the country’s tax base, she added. “That would mean investing a bit — renting or buying a home.” …The proposal goes further than other countries, however, with the flat tax rate in Greece to apply to other sources of revenue as well as pensions, according to the draft law. “The 7 per cent flat rate will apply to whatever income a person might have, be that rents or dividends as well as pensions,” said Alex Patelis, chief economic adviser to Kyriakos Mitsotakis, the prime minister. “As a reformist government, we have to try to tick all the boxes to boost the economy and change growth models.”

Here are excerpts from a Reuters report.

Greece will offer financial incentives to encourage wealthy individuals to move their tax residence to the country, part of a package of tax relief measures… Greece’s conservative government is keen to attract investments to boost the recovering economy’s growth prospects. …The so-called “non-dom” programme will offer qualified wealthy investors who opt to shift their tax residence to the country a flat tax of 100,000 euros ($110,710) on global incomes earned outside Greece annually. “The tax incentive will run for a duration of up to 15 years and will include the benefit of no inheritance tax for assets outside Greece,” a senior government official told Reuters. One of the requirements to qualify will be residing in Greece for at least 183 days per year and making an investment of at least 500,000 euros within three years. …Investments of 3 million euros will reduce the flat tax to just 25,000 euros. There will also be a grandfathering clause protecting investors from policy changes by future governments.

By the way, Greece isn’t simply offering a flat-rate tax to wealthy foreigners. It’s offering them a flat-amount tax.

In other words, because they simply pay a predetermined amount, their actual tax rate (at least for non-Greek income) shrinks as their income goes up.

And since tax rates matter, this policy is luring well-to-do foreigners to Greece.

That’s good news. I’m a big fan of cross-border tax migration, both inside countries and between countries. And I’ve specifically applauded “citizenship by investment” programs that offer favorable tax rates to foreigners who bring much-needed investment to countries wanting more growth.

But I want politicians to understand that if low tax rates are good for newcomers, those low rates also would be good for locals.

But here’s the bad news. Fiscal policy in Greece is terrible (ranked #158 for “size of government” out of 162 nations according to the latest edition of Economic Freedom of the World).

What’s especially depressing is that Greece’s score has actually declined ever since the fiscal crisis began about 10 years ago.

In other words, the country got in trouble because of too much government, and politicians responded by actually making fiscal policy worse (aided and abetted by the fiscal pyromaniacs at the IMF).

And the bottom line is that it’s impossible to have overall low tax rates with a bloated public sector – a lesson that applies in other nations, including the United States.

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Because of changing demographics and poorly designed entitlement programs, the burden of government spending in the United States (in the absence of genuine reform) is going to increase dramatically over the next few decades.

That bad outlook will get even worse thanks to all the coronavirus-related spending from Washington.

This is bad news for America since more of the economy’s output will be consumed by government, leaving fewer resources for the private sector. And that problem would exist even if all the spending was magically offset by trillions of dollars of unexpected tax revenue.

Many people, however, think the nation’s future fiscal problem is that politicians will borrow to finance  that new spending. I think that’s a mistaken view, since it focuses on a symptom (red ink) rather than the underlying disease (excessive spending).

But regardless of one’s views on that issue, fiscal policy is on an unsustainable path. And that means there will soon be a fight between twho different ways of addressing the nation’s grim fiscal outlook.

  • Restrain the growth of government spending.
  • Divert more money from taxpayers to the IRS.

Fortunately, we now have some new evidence to help guide policy.

A new study from the Mercatus Center, authored by Veronique de Rugy and Jack Salmon, examines what actually happens when politicians try to control debt with spending restraint or tax increases.

Here’s what the authors wanted to investigate.

Fiscal consolidation can take two forms: (1) adopting a debt-reduction package driven primarily by tax increases or (2) adopting a package mostly consisting of spending restraint. …What policymakers might not know is which of these two forms of consolidation tend to be more effective at reining in debt levels and which are less harmful to economic performance: tax-based (TB) fiscal consolidation or expenditure-based (EB) fiscal consolidation.

Here’s their methodology.

Our analysis focuses on large fiscal consolidations, or consolidations in which the fiscal deficit as a share of GDP improves by at least 1.5 percentage points over two years and does not decrease in either of those two years. …A successful consolidation is defined as one in which the debt-to-GDP ratio declines by at least 5 percentage points three years after the adjustment takes places or by at least 3 percentage points two years after the adjustment. …Episodes in which the consolidation is at least 60 percent revenue increases are labeled TB, and episodes in which the consolidation is at least 60 percent spending decreases are labeled EB.

And here are their results.

…of the 45 EB episodes, more than half were successful, while of the 67 TB episodes, less than 4 in 10 were successful. …The results in table 2 show that while in unsuccessful adjustments most (74 percent) of the changes are on the revenue side, in successful adjustments most (60 percent) of the changes are on the expenditure side. In successful adjustments, for every 1.00 percent of GDP increase in revenues, expenditures are cut by 1.50 percent. By contrast, in unsuccessful adjustments, for every 1.00 percent of GDP increase in revenues, expenditures are cut by less than 0.35 percent. From these findings we conclude that successful fiscal adjustments are those that involve significant spending reductions with only modest increases in taxation. Unsuccessful fiscal adjustments, however, typically involve significant increases in taxation and very modest spending reductions.

Table 2 summarizes the findings.

As you can see, tax increases are the least effective way of dealing with the problem. Which makes sense when you realize that the nation’s fiscal problem is too much spending, not inadequate revenue.

In my not-so-humble opinion, I think the table I prepared back in 2014 is even more compelling.

Based on IMF data, it shows nations that imposed mutli-year spending restraint and how that fiscally prudent policy generated very good results – both in terms of reducing the spending burden and lowering red ink.

When I do debates at conferences with my left-wing friends, I almost always ask them to show me a similar table of countries that achieved good results with tax increases.

Needless to say, none of them have ever even attempted to prepare such a list.

That’s because nations that repeatedly raise taxes – as we’ve seen in Europe – wind up with more spending and more debt.

In other words, politicians pull a bait-and-switch. They claim more revenue is needed to reduce debt, but they use any additional money to buy votes.

Which is why advocates of good fiscal policy should adamantly oppose any and all tax increases.

Let’s close by looking at two more charts from the Mercatus study.

Here’s a look at how Irish politicians have mostly chose to restrain spending.

And here’s a look at how Greek politicians have mostly opted for tax increases.

It goes without saying (but I’ll say it anyhow) that the Greek approach has been very unsuccessful.

P.S. For fiscal wonks, one of the best parts of the Mercatus study is that it cites a lot of academic research on the issue of fiscal consolidation.

Scholars who have conducted research find – over and over again – that spending restraint works.

In a 1995 working paper, Alberto Alesina and Roberto Perotti observe 52 efforts to reduce debt in 20 Organisation for Economic Co-operation and Development (OECD) countries between 1960 and 1992. The authors define a successful fiscal adjustment as one in which the debt-to-GDP ratio declines by at least 5 percentage points three years after the adjustment takes place. In successful adjustments, government spending is reduced by almost 2.2 percent of gross national product (GNP) and taxes are increased by less than 0.5 percent of GNP. For unsuccessful adjustments, government expenditure is reduced by less than 0.5 percent of GNP and taxes are increased by almost 1.3 percent of GNP. These results suggest that successful fiscal adjustments are those that cut spending and include very modest increases in taxation.

International Monetary Fund (IMF) economists John McDermott and Robert Wescott, in a 1996 paper, examine 74 episodes of fiscal adjustment in which countries attempted to address their budget gaps. The authors define a successful fiscal adjustment as a reduction of at least 3 percentage points in the ratio of gross public debt to GDP by the second year after the end of an adjustment. The authors then divide episodes of fiscal consolidation into two categories: those in which the deficit was cut primarily (by at least 60 percent) through revenue increases, and those in which it was reduced primarily (by at least 60 percent) through expenditure cuts. Of the expenditure-based episodes of fiscal consolidation, almost half were successful, while of the tax-based episodes, less than one out of six met the criteria for success.

Jürgen von Hagen and Rolf Strauch observe 65 episodes in 20 OECD countries from 1960 to 1998 and define a successful adjustment as one in which the budget balance stands at no more than 75 percent of the initial balance two years after the adjustment period. …it does find that successful consolidations consist of expenditure cuts averaging more than 1.2 percent of GDP, while expenditure cuts in unsuccessful adjustments are smaller than 0.3 percent of GDP. The opposite pattern is true for revenue-based adjustments: successful consolidations consist of increases in revenue averaging around 1.1 percent, while unsuccessful adjustments consist of revenue increases exceeding 1.9 percent.

American Enterprise Institute economists Andrew Biggs, Kevin Hassett, and Matthew Jensen examine over 100 episodes of fiscal consolidation in a 2010 study. The authors define a successful fiscal adjustment as one in which the debt-to-GDP ratio declines by at least 4.5 percentage points three years after the first year of consolidation. Their study finds that countries that addressed their budget shortfalls through reduced spending burdens were far more likely to reduce their debt than countries whose budget-balancing strategies depended upon higher taxes. …the typical successful adjustment consists of 85 percent spending cuts and just 15 percent tax increases.

In a 1998 Brookings Institution paper, Alberto Alesina and coauthors reexamined the research on the economic effects of fiscal adjustments. Using data drawn from 19 OECD countries, the authors assess whether the composition of fiscal adjustments results in different economic outcomes… Contrary to the Keynesian view that fiscal adjustments are contractionary, the results of this study suggest that consolidation achieved primarily through spending reductions often has expansionary effects.

Another study that observes which features of fiscal adjustments are more or less likely to predict whether the fiscal adjustment is contractionary or expansionary is by Alesina and Silvia Ardagna. Using data from 20 OECD countries during 1960 to 1994, the authors label an adjustment expansionary if the average GDP growth rate in the period of adjustment and in the two years after is greater than the average value (of G7 countries) in all episodes of adjustment. …The authors conclude, “The composition of the adjustment appears as the strongest predictor of the growth effect: all the non-expansionary adjustments were tax-based and all the expansionary ones were expenditure-based.”

French economists Boris Cournède and Frédéric Gonand adopt a dynamic general equilibrium model to compare the macroeconomic impacts of four debt reduction scenarios. Results from the model suggest that TB adjustments are much more costly than spending restraint when policymakers are attempting to achieve fiscal sustainability. Annual consumption per capita would be 15 percent higher in 2050 if consolidation were achieved through spending reductions rather than broad tax increases.

In a review of every major fiscal adjustment in the OECD since 1975, Bank of England economist Ben Broadbent and Goldman Sachs economist Kevin Daly found that “decisive budgetary adjustments that have focused on reducing government expenditure have (i) been successful in correcting fiscal imbalances; (ii) typically boosted growth; and (iii) resulted in significant bond and equity market outperformance. Tax-driven fiscal adjustments, by contrast, typically fail to correct fiscal imbalances and are damaging for growth.”

Economists Christina and David Romer investigated the impact of tax changes on economic activity in the United States from 1945 to 2007. The authors find that an exogenous tax increase of 1 percent of GDP lowers real GDP by almost 3 percent, suggesting that TB adjustments are highly contractionary.

…the IMF released its annual World Economic Outlook in 2010 and included a study on the effects of fiscal consolidation on economic activity. The results of studying episodes of fiscal consolidation for 15 OECD countries over three decades…reveals that EB fiscal adjustments tend to have smaller contractionary effects than TB adjustments. For TB adjustments, the effect of a consolidation of 1 percent of GDP on GDP is −1.3 percent after two years, while for EB adjustments the effect is just −0.3 percent after two years and is not statistically significant. Interestingly, TB adjustments also raise unemployment levels by about 0.6 percentage points, while EB adjustments raise the unemployment rate by only 0.2 percentage points.

…a 2014 IMF study…estimates the short-term effect of fiscal consolidation on economic activity among 17 OECD countries. The authors of the IMF study find that the fall in GDP associated with EB consolidations is 0.82 percentage points smaller than the one associated with TB adjustments in the first year and 2.31 percentage points smaller in the second year after the adjustment.

Focusing on the fiscal consolidations that followed the Great Recession, Alesina and coauthors…find that EB consolidations are far less costly for economic output than TB adjustments. They also find that TB adjustments result in a cumulative contraction of 2 percent of GDP in the following three years, while EB adjustments generate very small contractions with an impact on output not significantly different from zero.

A study by the European Central Bank in 2018…finds that macroeconomic responses are largely caused by differences in the composition of the adjustment plans. The authors find large and negative multipliers for TB adjustment plans and positive, but close to zero, multipliers for EB plans. The composition of adjustment plans is found to be the largest contributor to the differences in economic performance under the two types of consolidation plans.

The bottom line is that nations enjoy success when they obey fiscal policy’s Golden Rule. Sadly, that doesn’t happen very often because politicians focus mostly on buying votes in the short run rather than increasing national prosperity in the long run.

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I participated in a debate yesterday on “tax havens” for the BBC World Service. If you read last month’s two-part series on the topic (here and here), you already know I’m a big defender of low-tax jurisdictions.

But it’s always interesting to interact with people with a different perspective (in this case, former Obama appointee David Carden and U.K. Professor Rita de la Feria).

As you might imagine, critics generally argue that tax havens should be eliminated so politicians have greater leeway to increase tax rates and finance bigger government. And if you listen to the entire interview, that’s an even bigger part of their argument now that there’s lots of coronavirus-related spending.

But for purposes of today’s column, I want to focus on what I said beginning at 49:10 of the interview.

I opined that it’s reasonably to issue debt to finance a temporary emergency and then gradually reduce the debt burden afterwards (similar to what happened during and after World War II, as well as during other points in history).

The most important part of my answer, however, was the discussion about how revenues didn’t decline when tax rates were slashed beginning in 1980.

Let’s first take a look at what happened to top tax rates for 24 industrialized nations from North America, Western Europe, and the Pacific Rim. As you can see, there’s been a big reduction in tax rates since 1980.

In the interview, I mentioned OECD data about taxes on income and profits, which can be found here (specifically data series 1000). So let’s see what happened to revenues during the period of falling tax rates.

Lo and behold, it turns out that revenue went up. Not just nominal revenues. Not just inflation-adjusted revenues. Tax revenues even increased as a share of gross domestic product.

In part, this is the Laffer Curve in action. Lower tax rates meant better incentives to engage in productive behavior. That meant higher levels of taxable income (the variable that should matter most).

For what it’s worth, I suspect that the lower tax rates – by themselves – did not cause tax revenue to rise. After all, there are many policies that determine the overall vitality of an economy.

But there’s no question that there’s a lot of “revenue feedback” when tax rates are changed.

The bottom line is that the folks advocating higher tax rates shouldn’t expect a windfall of tax revenue if they succeed in imposing class-warfare tax policy.

P.S. For the folks on the left who are motivated by spite rather than greed, it doesn’t matter if higher tax rates generate more money.

P.P.S. Interestingly, both the IMF and OECD have admitted, at least by inference, that lower corporate tax rates don’t result in lower tax revenues.

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New York is ranked dead last for fiscal policy according to Freedom in the 50 States.

But it’s not the worst state, at least according to the Tax Foundation, which calculates that the Empire State is ranked #49 in the latest edition of the State Business Tax Climate Index.

Some politicians from New York must be upset that New Jersey edged them out for last place (and the Garden State does have some wretched tax laws).

So in a perverse form of competition, New York lawmakers are pushing a plan to tax unrealized capital gains, which would be a form of economic suicide for the Empire State and definitely cement its status as the place with the worst tax policy.

Here are some excerpts from a CNBC report.

The tax, part of a new “Make Billionaires Pay” campaign by progressive lawmakers and activists, would impose a new form of capital gains tax on New Yorkers with $1 billion or more in assets. …“It’s time to stop protecting billionaires, and it’s time to start working for working families,” Rep. Alexandria Ocasio-Cortez, D-N.Y., said… Currently, taxpayers pay capital gains tax on assets only when they sell. The new policy would tax any gain in value for an asset during the calendar year, regardless of whether it’s sold. Capital gains are taxed in New York at the same rate as ordinary income, so the rate would be 8.8%.

Given her track record, I’m not surprised that Ocasio-Cortez has embraced this punitive idea.

That being said, the proposal is so radical that even New York’s governor understands that it would be suicidal.

Gov. Andrew Cuomo said raising taxes on billionaires and other rich New Yorkers will only cause them to move to lower-tax states. …“If they want a tax increase, don’t make New York alone do a tax increase — then they just have the people move… Because if you take people who are highly mobile, and you tax them, well then they’ll just move next door where the tax treatment is simpler.”

Actually, they won’t move next door. After all, politicians from New Jersey and Connecticut also abuse and mistreat taxpayers.

Instead, they’ll be more likely to escape to Florida and other states with no income taxes.

In a column for the New York Post, E.J. McMahon points out that residents already have been fleeing.

…there were clear signs of erosion at the high end of New York’s state tax base even before the pandemic. Between 2010 and 2017, according to the Internal Revenue Service, the number of tax filers with incomes above $1 million rose 75 percent ­nationwide, but just 49 percent in New York. …Migration data from the IRS point to a broader leakage. From 2011-12 through 2017-18, roughly 205,220 New Yorkers moved to Florida. …their average incomes nearly doubled to $120,023 in 2017-18, from $63,951 at the start of the period. Focusing on wealthy Manhattan, the incomes of Florida-bound New Yorkers rose at the same rate from a higher starting point— to $244,936 for 3,144 out-migrants in 2017-18, from $124,113 for 3,712 out-migrants in 2011-12.

What should worry New York politicians is that higher-income residents are disproportionately represented among the escapees.

And the author also makes the all-important observation that these numbers doubtlessly will grow, not only because of additional bad policies from state lawmakers, but also because the federal tax code no longer includes a big preference for people living in high-tax states.

These figures are from the ­period ending just before the new federal tax law temporarily virtually eliminated state and local tax deductions for high earners, raising New York’s effective tax rates higher than ever. …soak-the-rich tax sloganeering is hardly a welcome-home signal for high earners now on the fence about their futures in New York.

The bottom line is that it’s a very bad idea for a country to tax unrealized capital gains.

And it’s a downright suicidal idea for a state to choose that perverse form of double taxation. After all, it’s very easy for rich people to move to Florida and other states with better tax laws.

And since the richest residents of New York pay such a large share of the tax burden (Investor’s Business Daily points out that the top 1 percent pay 46 percent of state income taxes), even a small increase in out-migration because of the new tax could result in receipts falling rather than rising.

Another example of “Revenge of the Laffer Curve.”

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Yesterday, in Part I of our series about greedy state politicians, we looked at top income tax rates.

The worst state, not surprisingly, was California with a top tax rate of 13.3 percent.

This onerous tax rate, combined with low-quality government and absurd levels of red tape, helps to explain why so many people have fled the Golden State.

(And because California’s problems are self-inflicted, that’s the biggest reason why the state should not get a bailout from Uncle Sam.)

Today, we’re going to look at another major source of tax revenue for state politicians.

Here are some excerpts from the Tax Foundation’s report on sales tax rates.

While graduated income tax rates and brackets are complex and confusing to many taxpayers, sales taxes are easier to understand; consumers can see their tax burden printed directly on their receipts. In addition to state-level sales taxes, consumers also face local sales taxes in 38 states. These rates can be substantial, so a state with a moderate statewide sales tax rate could actually have a very high combined state and local rate compared to other states. This report provides a population-weighted average of local sales taxes… Five states do not have statewide sales taxes: Alaska, Delaware, Montana, New Hampshire, and Oregon. Of these, Alaska allows localities to charge local sales taxes. The five states with the highest average combined state and local sales tax rates are Tennessee (9.55 percent), Arkansas (9.53 percent), Louisiana (9.52 percent), Washington (9.23 percent), and Alabama (9.22 percent). The five states with the lowest average combined rates are Alaska (1.76 percent), Hawaii (4.44 percent), Wyoming (5.34 percent), Wisconsin (5.43 percent), and Maine (5.50 percent). California has the highest state-level sales tax rate, at 7.25 percent.

Here’s the map that accompanied the report.

It’s good to be gray. By contrast the states with the darkest colors have the most onerous rates.

As noted in the excerpt above, Tennessee, Arkansas, Louisiana, and Washington have the greediest politicians, at least measured by sales tax rates.

But this is the point where it makes sense to merge today’s map with yesterday’s map. Because Tennessee and Washington don’t impose income taxes, while Louisiana and Arkansas both make that mistake.

And if you combine the tax rates from both maps, you’ll find that Tennessee and Washington are relatively low-tax states while Louisiana and Arkansas are relatively high-tax states.

So one of the lessons to be learned is that it’s never a good idea to give politicians multiple sources of revenue (something to remember every time greedy officials in D.C. broach the idea of a value-added tax).

But let’s keep our focus on the main topic, which is identifying the state with the greediest politicians?

If we continue with the methodology of combining the numbers from both maps, California easily ranks as the worst state, with a combined rate of 21.98 percent.

Indeed, it has a huge lead compared to the next-worst states (New York, New Jersey, and Minnesota), all of which have combined rates of between 17-18 percent.

What’s the best state?

Depends on the approach. If you count only wages and salaries, then New Hampshire wins with a combined rate of 0.0 percent. But if you include New Hampshire’s unfortunate policy of imposing income tax on interest and dividends, then Alaska wins with a combined rate of 1.76 percent.

Wyoming, South Dakota, and Florida also deserve applause. Those states are ranked #3, #4, and #5 because they have no income taxes and also manage to keep sales taxes at semi-reasonable levels.

P.S. Alaska and Wyoming both collect large amounts of energy taxes, so their good scores don’t necessarily reflect a commitment to low overall tax burdens.

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When considering which state has the greediest politicians, the flippant (but understandable) answer is to say “all of them.”

A more serious way of dealing with that question, though, is to look at overall rankings of economic policy.

According to the Fraser Institute, we can assume that Delaware apparently has the worst politicians and New Hampshire has the best ones.

According to comprehensive calculations in Freedom in the 50 States, New York’s politicians seem to be the worst and Florida’s are the best.

But what if we just want to know the state where politicians squeeze the most money from taxpayers? In other words, which state has the worst tax system?

The Tax Foundation gives us part of the answer in their review of state income tax burdens.

Individual income taxes are a major source of state government revenue, accounting for 37 percent of state tax collections. …Forty-one tax wage and salary income… Of those states taxing wages, nine have single-rate tax structures… Conversely, 32 states levy graduated-rate income taxes… Top marginal rates range from North Dakota’s 2.9 percent to California’s 13.3 percent.

Here’s the accompanying map.

It’s very good to live in a gray state (no income tax!) and you definitely don’t want to live in a red or maroon state.

Unsurprisingly, California is the worst of the worst, with a top tax rate of 13.3 percent. No wonder productive people have been escaping the not-so-Golden State.

Hawaii and New Jersey are the next worst states, followed by Oregon and Minnesota. Though it’s definitely worth noting that there’s a local income tax in New York City, which would put the residents of that unfortunate community (if NYC was a state) in second place after California.

P.S. The disadvantage of living in a high-tax jurisdiction is especially significant now that there’s no longer a loophole in the federal tax code that subsidizes state profligacy.

P.P.S. The maroon and red states are obviously among the worst places to be an entrepreneur, investor, or business owner, though people with lots of unrealized capital gains fortunately don’t have to worry (yet!) about punitive tax laws.

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The good news is that Joe Biden has not embraced many of Bernie Sanders’ worst tax ideas, such as imposing a wealth tax or hiking the top income tax rate to 52 percent..

The bad news is that he nonetheless is supporting a wide range of punitive tax increases.

  • Increasing the top income tax rate to 39.6 percent.
  • Imposing a 12.4 percent payroll tax on wages above $400,000.
  • Increasing the double taxation of dividends and capital gains from 23.8 percent to 43.4 percent.
  • Hiking the corporate tax rate to 28 percent.
  • Increasing taxes on American companies competing in foreign markets.

The worst news is that Nancy Pelosi, et al, may wind up enacting all these tax increases and then also add some of Crazy Bernie‘s proposals.

This won’t be good for the U.S. economy and national competitiveness.

Simply stated, some people will choose to reduce their levels of work, saving, and investment when the tax penalties on productive behavior increase. These changes give economists the information needed to calculate the “elasticity of taxable income”.

And this, in the jargon of economists, is a measure of “deadweight loss.”

But now there’s a new study published by the Federal Reserve which suggests that these losses are greater than traditionally believed.

Authored by Brendan Epstein, Ryan Nunn, Musa Orak and Elena Patel, the study looks at how best to measure the economic damage associated with higher tax rates. Here’s some of the background analysis.

The personal income tax is one of the most important instruments for raising government revenue. As a consequence, this tax is the focus of a large body of public finance research that seeks a theoretical and empirical understanding of the associated deadweight loss (DWL). …Feldstein (1999) demonstrated that, under very general conditions, the elasticity of taxable income (ETI) is a sufficient statistic for evaluating DWL. …It is well understood that, apart from rarely employed lump-sum taxes and…Pigouvian taxes, revenue-raising tax systems impose efficiency costs by distorting economic outcomes relative to those that would be obtained in the absence of taxation… ETI can potentially serve as a perfect proxy for DWL…this result is consistent with the ETI reflecting all taxpayer responses to changes in marginal tax rates, including behavioral changes (e.g., reductions in hours worked) and tax avoidance (e.g., shifting consumption toward tax-preferred goods). …a large empirical literature has provided estimates of the individual ETI, identified based on variation in tax rates and bunching at kinks in the marginal tax schedule.

And here are the new contributions from the authors.

… researchers have fairly recently come to recognize an important limitation of the finding that the ETI is a sufficient statistic for deadweight loss… we embed labor search frictions into the canonical macroeconomic model…and we show that within this framework, a host of additional information beyond the ETI is needed to infer DWL …once these empirically observable factors are controlled for, DWL can be calculated easily and in a straightforward fashion as the sum of the ETI and additional terms involving these factors. … We find that…once search frictions are introduced, …DWL can be between 7 and 38 percent higher than the ETI under a reasonable calibration.

To give you an idea of what this means, here are some of their estimates of the economic damage associated with a 1 percent increase in tax rates.

As you peruse these estimates, keep in mind that Biden wants to increase the top income tax rate by 2.6 percentage points and the payroll tax by 12.4 percentage points (and don’t forget he wants to nearly double tax rates on dividends, capital gains, and other forms of saving and investment).

Those are all bad choices with traditional estimates of deadweight loss, and they are even worse choices with the new estimates from the Fed’s study.

So what’s the bottom line?

The political impact will be that “the rich” pay more. The economic impact will be less capital formation and entrepreneurship, and those are the changes that hurt the vast majority of us who aren’t rich.

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Yesterday’s column focused on the theoretical argument for tax havens.

At the risk of oversimplifying, I explained that the pressure of tax competition was necessary to prevent “stationary bandits” from saddling nations with “goldfish government.”

And I specifically explained why the left’s theory of “capital export neutrality” was only persuasive if people just paid attention to one side of the equation.

Today, let’s look at some real-world evidence to better understand the beneficial role of these international financial centers.

We’ll start with a column in the Hill by Jorge González-Gallarza.

Using as a natural experiment the terminal phase-out in 2006 of corporate tax exemptions to affiliates of U.S. companies setting shop in Puerto Rico, the research finds that scrapping the island’s status as a tax haven led U.S. companies to cut back investments and job creation in the mainland substantially. The provision in question was Section 936 of the Internal Revenue Code and it exempted Puerto Rico-based affiliates of U.S. companies from paying any corporate income tax altogether. …In 1996, President Clinton signed the Small Business Job Creation Act, spelling §936’s full phaseout by 2006. …ditching §936 appears to have raised U.S. companies’ average effective tax rate on domestic corporate income by 10 percentage points. Notably yet unsurprisingly, they responded by cutting global investment by a whopping 23 percent while balancing away from domestic projects, in Puerto Rico and the mainland alike — domestic investment fell by 38 percent, with Foreign Direct Investments’ (FDIs) share of the total growing 17.5 percent. …Employing 11 million workers in the continental US before repeal, firms taking advantage of §936 laid off a million of them, amounting to a 9.1 percent decline in payrolls.

In other words, higher taxes on business resulted in less investment and fewer jobs. Gee, what a surprise.

Hopefully, the 2017 reduction in the corporate tax rate is now offsetting some of that damage.

In an article for the Tax Foundation, Elke Asen shares some academic research on how tax havens help mitigate the destructive policies of high-tax governments.

Tax havens, or “offshore financial centers,” can be defined as small, well-governed tax jurisdictions that do not have substantial domestic economic activity and impose low or zero tax rates on foreign investors. By doing so, they attract a considerable amount of capital inflow, particularly from high-tax countries. …academic research reveals that high-tax jurisdictions may also have something to gain from tax havens. …A 2004 paper by economists Mihir Desai, C. Fritz Foley, and James Hines…found that tax havens indirectly stimulate the growth of businesses in non-haven countries located in the same region. …These findings suggest that although high-tax countries can lose tax revenue due to profit shifting, tax havens can indirectly facilitate economic growth in high-tax countries by reducing the cost of financing investment in those countries.

By the way, I cited the Desai-Foley-Hines paper in my video on “The Economic Case for Tax Havens” because it makes the key point that governments hurt their own economies when they go after low-tax jurisdictions.

Here are some excerpts from an article by Abrar Aowsaf in the Bangladesh-based Dhaka Tribune. It’s especially worth citing since it notes that tax havens are a refuge for oppressed people around the world.

A tax haven is basically a jurisdiction with low taxes, high legal security, and a high degree of protection of savers’ privacy. …The Cayman Islands, Switzerland, Singapore, Hong Kong, Cyprus, Jersey, and Bermuda — all of these jurisdictions that we recognize as tax havens are characterized by their high legal safety. Savers know that the government will not decide to take their money on a whim. …Operating in tax havens is not illegal in itself. …Singer Shakira, for example, uses tax havens to minimize her tax bills within the bounds of the law. …Another very important detail is that tax havens are a refuge for millions of citizens who have had the misfortune of being born in authoritarian and unstable countries. In many countries, the most basic human rights are not guaranteed. There also exist states where authoritarian governments arbitrarily decide who to repress or prosecute. Many investors do not seek protection just for the lower taxes, but they are also escaping political, ideological, and religious persecution. …In reality, tax havens are not to be blamed…nor do they force us to pay more taxes or harm our economies. Ireland, for example, was poorer than Spain in 1980. Today, thanks to its low taxes, it is the second richest country in the Eurozone. In order to improve general welfare, what we need are more companies, not more incompetent politicians and haphazard public spending. The problems faced by countries with economic difficulties do not come from tax havens, but from their politicians and ineffective policies.

Amen. More people need to be making “The Moral Case for Tax Havens.”

Andy Morriss, the Dean of Texas A&M’s School of Innovation, explains the vital role of these low-tax jurisdictions in bring more investment and prosperity to poor nations.

The seemingly endless debate over the role of IFCs in corporate and personal tax avoidance ignores these jurisdictions’ crucial role in providing the rule of law for international transactions. …The world’s poorest countries desperately need their economies to grow if their populations are to have better lives. For example, Africa has about 17 per cent of the world’s population but only 3 per cent of global GDP. The root causes of African nations’ underdevelopment are complex, but one critical element is that there is too little investment in their economies. …most developing countries lack the legal and regulatory infrastructure necessary to support a domestic capital market. …When multiple investors pool their investments, they need a mechanism to address the governance of their pooled investment. …By providing legal systems which offer a powerful combination of modern, efficient, well-designed laws and regulations, regulatory agencies staffed with experienced, well-credentialed experts, and court systems capable of quick, fair, and thoughtful decisions, IFCs offer alternative locations for transactions and entities. …In short, the price of investing in a developing economy is reduced.  And when the price of something falls, the amount demanded increases. That’s good for investors, it’s good for developing countries, and it’s good for the world’s poorest. …Improving the lives of the poorest around the world is going to require massive private investment in productive activities. This need cannot be met by government provided aid… Only economic growth can solve this problem. And growth requires investment… Fortunately, IFCs are helping to meet this need.

Click here if you want more information on how tax havens help the developing world.

Writing for the Bahamas-based Tribune and citing former Finance Minister James Smith, Neil Hartnell warns that the OECD’s agenda of “neo-colonialism” will cripple his nation’s economy.

The Bahamas “may devastate the economy” if it surrenders too easily to demands from high-tax European nations for a corporate income tax, a former finance minister warned yesterday. …OECD and European Union (EU) initiatives…calling for all nations to impose some form of “minimum level of” taxation on the activities of multinational entities. …Mr Smith…blasted the OECD’s European members for seemingly seeking to “recast our economy in their own image”, adding that this nation’s economic model had worked well for 50 years without income and other direct forms of taxation. …Describing the OECD and EU pressures as a form of “neo-colonialism”, Mr Smith said The Bahamas shared few economic characteristics with their members. He pointed out that this nation was suffering from high unemployment and “low wages for the majority” of Bahamians. “Conceptually the take from an income tax may devastate the economy,” he told Tribune Business.

The former Finance Minister is correct in that the OECD is trying to export its high-tax policies.

For what it’s worth, I’ve reversed the argument and pointed out that OECD nations should be copying zero-income tax jurisdictions such as the Bahamas.

So what’s the argument against tax havens?

As illustrated by this article from the International Monetary Fund, authored by Jannick Damgaard, Thomas Elkjaer, and Niels Johannesen, all the complaints revolve around the fact that some people don’t like it when governments can’t grab as much money.

Although Swiss Leaks, the Panama Papers, and recent disclosures from the offshore industry have revealed some of the intricate ways multinational firms and wealthy individuals use tax havens to escape paying their fair share, the offshore financial world remains highly opaque. …These questions are particularly important today in countries where policy initiatives aiming to curb the harmful use of tax havens abound. …a new study…finds that a stunning $12 trillion…consists of financial investment passing through empty corporate shells… These investments in empty corporate shells almost always pass through well-known tax havens. The eight major pass-through economies—the Netherlands, Luxembourg, Hong Kong SAR, the British Virgin Islands, Bermuda, the Cayman Islands, Ireland, and Singapore—host more than 85 percent of the world’s investment in special purpose entities, which are often set up for tax reasons. …private individuals also use tax havens on a grand scale… Globally, individuals hold about $7 trillion—corresponding to roughly 10 percent of world GDP—in tax havens. …the stock of offshore wealth ranges…to about 50 percent in some oil-producing countries, such as Russia and Saudi Arabia, and in countries that have suffered instances of major financial instability, such as Argentina and Greece.

I find it interesting that even the pro-tax IMF felt obliged to acknowledge that people living in nations with bad governments are especially likely to make use of tax havens.

Though I’m not sure I fully trust the data in this chart from the article.

Because of problems such as corruption, expropriation, crime, and political persecution, I’m sure that usage of tax havens by people in nations such as China, India, Iran, Mexico, and South Africa is much greater than what we see in the chart.

Though perhaps the numbers are distorted because the authors didn’t include the United States (sadly, the policies that make the U.S. a tax haven are only available for foreigners).

P.S. American taxpayers legally can use Puerto Rico as a tax haven.

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As part of my presentation earlier this month to IES Europe, I discussed topics such as comparative economics and federalism.

I also had a chance to explain why tax havens are good for global prosperity.

Many of the points I made will be familiar to regular readers.

1. Because politicians have been worried that the “geese with the golden eggs” can escape – thanks to tax havens and tax competition – governments around the world reluctantly have lowered tax rates and reduced discriminatory taxes on saving and investment.

2. The Paris-based Organization for Economic Cooperation and Development (heavily subsidized by American taxpayers) is a bureaucracy that is controlled by high-tax governments and it seeks to undermine tax competition and tax havens by creating a global tax cartel – sort of an “OPEC for politicians.”

3. When tax competition is weakened, politicians respond by increasing tax rates.

4. There is an economic theory that is used to justify tax harmonization. It’s called “capital export neutrality” and I shared a slide in the presentation to show why CEN doesn’t make sense. Here’s a new version of the slide, which I’ve augmented to help people understand why tax havens and tax competition are good for prosperity.

The bottom line is that we should fight to protect tax havens and tax competition. The alternative is “stationary bandits” and “Goldfish Government.”

P.S. My work on this issue has been…umm…interesting, resulting in everything from a front-page attack by the Washington Post to the possibility of getting tossed in a Mexican jail.

P.S.S. This column has four videos on the issue of tax competition, and this column has five videos on the issue of tax havens.

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Assuming the goal is more prosperity, lawmakers who work on tax issues should be guided by 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) that penalizes saving and investment.
  3. No complicating preferences and loopholes that encourage inefficient economic choices.

Today, with these three principles as our guide, we’re going to discuss a major problem in how dividends are taxed in the United States.

Simply stated, there’s an unfair and counterproductive double tax. All you really need to know is that if a corporation earns a profit, the corporate income tax takes a chunk of the money. But that money then gets taxed again as dividend income when distributed to shareholders (the people who own the company).

So why is this a bad thing?

From an economic perspective, the extra layer of tax means that the actual tax burden on corporate income is not 21 percent (the corporate tax rate) or 23.8 percent (how dividends are taxed on the 1040 form), but a combination of the two rates. And when you include the average additional tax imposed at the state level, the real tax rate on dividends in the United States can be as high as 47.47 percent according to the OECD.

You don’t need to be a wild-eyed supply-sider to think that incentives to build businesses and create jobs are adversely affected when the government grabs nearly half of the additional income generated by corporate investment.

Keep in mind, by the way, that workers ultimately bear most of this tax since lower levels of investment translate to lower wages.

So what’s the solution?

If we want a properly designed system for taxing businesses, we know the answer. Just get rid of the extra layer of tax.

A 2015 report from the Tax Foundation explains how various types of “corporate integration” can achieve this goal.

The United States’ tax code treats corporations and their shareholders as separate taxable entities. The result is two layers of taxation on corporate income: one at the corporate level and a second at the shareholder level. This creates a high tax burden on corporate income, increasing the cost of capital. The double taxation of corporate income reduces investment and distorts business decisions. … Many developed countries have integrated their tax systems in order to mitigate or completely eliminate the double taxation of corporate income. …There are several ways to integrate the corporate tax code. Corporate income can be fully taxed at the entity level (a corporate income tax) and then tax exempt when passed to shareholders as dividend income, or corporations could be given a deduction for dividends passed to their shareholders, who pay tax on the dividend income. Alternatively, shareholders and corporations both pay tax on their income, but shareholders can be given a credit to offset taxes the corporation already paid on their behalf.

For what it’s worth, I think it would be best to get rid of the double tax by eliminating the layer of tax that is imposed on individuals.

In other words, modify the above image in this way.

Though the economic benefit would be the same if the corporate income tax was abolished and the income was taxed one time at the individual level.

I’ll close today’s column with a bit of good news.

A few years ago, the United States had a much higher burden of double taxation because the corporate tax rate was so high. Indeed, the combined tax rate on dividends was the fourth-highest in the developed world.

Today, thanks to the 2017 tax reform, the combined tax rate is “only” the tenth-highest in the developed world.

P.S. The Estonian tax system for businesses is a good role model.

P.P.S. Under Joe Biden’s tax plan, the U.S. would have the world’s-highest combined tax rate on dividends.

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