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Posts Tagged ‘Double Taxation’

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

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

Here are a couple of observations on our discussion.

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

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

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

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

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Welcome Instapundit readers! Thanks, Glenn

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

My goal was to explain the problem of double taxation.

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

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

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

Here’s how I illustrated the current system.

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

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

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

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

Yes, that’

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

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

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

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

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

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

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

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

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

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

Time for one final point.

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

That’s certainly true.

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

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

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

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

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

 

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President Kennedy’s tax rate reductions were a big success. Sadly, very few modern Democrats share JFK’s zeal for pro-growth tax policy.

And there’s another arrow in the class-warfare quiver.

The Wall Street Journal reports on a misguided new idea from Ron Wyden, the ranking Democrat on the Senate Finance Committee.

The top Democrat on the Senate’s tax-writing committee proposed taxing unrealized gains in investment assets every year at the same rates as other income…an idea that would transform how the U.S. taxes the wealthiest people. …Under Mr. Wyden’s concept, capital gains would be taxed annually based on how much assets have gained in value. Now, by contrast, gains are taxed only when assets are sold and at a top rate of 23.8% instead of 37% for ordinary income.

There are two big reasons why this is a terrible idea.

First, the right policy is to abolish any tax on capital gains. Drop the rate to zero.

Simply stated, there shouldn’t be an added layer of tax on people who earn money, pay tax on that money, and then buy assets with some of the remaining after-tax income.

Especially since the income generated by that additional investment already would be hit by the corporate income tax and the extra layer of tax on dividends.

This system is also very bad for workers because of the long-standing relationship between investment and employee compensation.

Second, levying such a tax would be a logistical nightmare. Here’s another brief excerpt from the article.

Mr. Wyden’s concept would present logistical challenges. He would need to figure out how to value complex assets, handle declines in value, deal with people without enough cash to pay the tax and address illiquid investments such as closely held businesses and real estate.

So why would Sen. Wyden propose such a clunky class-warfare scheme?

Because it would generate (at least on paper) a lot of money that could be used to buy votes.

This mark-to-market tax concept…could raise substantial money. A similar proposal…would generate an estimated $125 billion in 2025 alone… Democrats, who are campaigning on wide-ranging and costly ideas for more spending on health care, infrastructure and education, can point to plans by Mr. Wyden and others to explain how they would pay for policy proposals.

Of course, no amount of tax increases would generate the revenue to finance the so-called Green New Deal.

In reality, a major reason for Wyden’s plan is that the left is motivated by class warfare rather than revenue collection.

Democrats have frequently found unfairness in the different ways that the U.S. tax system approaches wage and investment income. They have focused their response, in part, on the “Buffett Rule”, inspired by Warren Buffett’s claim that he pays a lower tax rate than his secretary.

I added this final excerpt simply so I can point out that Buffett’s claim is utter nonsense.

And so is the “Buffett rule” that some folks on the left have proposed.

I’ll close by noting that the United States has one of the world’s least friendly tax codes for investment.

The lower corporate rate in the Trump tax plan was a step in the right direction.

But even with that positive reform, the overall tax burden on capital gains is very high compared to America’s major trading partners.

And now Senator Wyden wants to make a bad situation worse.

For further information, here’s my video explaining why there shouldn’t be any tax on capital gains.

P.S. Uncle Sam also forces investors to pay capital gains tax when assets rise in value because of inflation.

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I despise the death tax. It should be abolished.

My main objection is that it is immoral. If a person earns money, pays tax on the money, and then responsibly saves and invests the money (which generally requires paying another layer of tax), it is reprehensible that politicians want to tax the money yet again simply because the person dies.

But I’m also an economist, so I don’t like the tax because it is the most pernicious form of double taxation. The levy not only drains capital from the private sector, it also discourages the building and creating of wealth in the first place, while also lining the pockets of accountants and tax lawyers.

None of that is good for those of us who will never have enough money to get hit by the tax.

The only silver lining to this dark cloud is that we get very interesting stories of what people are willing to do to escape this unfair and destructive levy.

Jeanne Calment’s apparent longevity turned her into a global celebrity before she died at the age of 122 years and 164 days in 1997. However, that age is being challenged… Yuri Deigin, a genealogist, claims that Mrs Calment actually died in 1934 and that her daughter, Yvonne, usurped her identity… The genealogist said that Mrs Calment, born in 1875, and Fernand, her husband, were the joint owners of a department store in Arles, in Provence. If Mrs Calment’s death had been registered, Mr Calment would have had to pay inheritance tax of up to 38 per cent on his wife’s half of the business. …Mr Deigin said that Mr Calment avoided the bill by telling officials that it was his daughter who had died. The daughter then passed herself off as her mother for the rest of her life.

Not everyone accepts Mr. Deigin’s analysis and it’s possible that will be genetic testing of Mrs. Calment’s remains.

For what it’s worth, I’m guessing the story is accurate. We already have lots of evidence that people will take extraordinary steps to protect family funds from this additional layer of tax.

Sadly, I don’t have to worry about the death tax. But if I did, I would do everything in my power to make sure my kids got my money rather than the despicable people in Washington.

So I admire Mrs. Calment. Yes, she broke the law, but that doesn’t bother me when the law is unjust.

P.S. I’ll defend just about anybody who benefits from dodging the death tax, even if they are hypocrites or buffoons.

P.P.S. Sadly, the U.S. death tax is more punitive than the French death tax.

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I’ve advocated for some of the President’s policies, but I’ve never defended Donald Trump when he’s personally attacked.

That’s partly because I’m a policy wonk rather than political pundit, but also because many of the attacks seem justified. Indeed, his boorish behavior is one of the reasons I thought he would lose the presidential race.

Today, though, I’m going to defend Trump. Albeit only because of my disdain for the death tax.

To be more specific, the New York Times published a major hit job last week that asserted the Trump family played all sorts of games – and perhaps even broke the law – to minimize gift taxes when Trump’s father was alive and to minimize death taxes when he passed away.

The president…received at least $413 million in today’s dollars from his father’s real estate empire, much of it through tax dodges in the 1990s. President Trump participated in dubious tax schemes during the 1990s, including instances of outright fraud, that greatly increased the fortune he received from his parents… Much of this money came to Mr. Trump because he helped his parents dodge taxes. He and his siblings set up a sham corporation to disguise millions of dollars in gifts from their parents, records and interviews show. Records indicate that Mr. Trump helped his father take improper tax deductions worth millions more. He also helped formulate a strategy to undervalue his parents’ real estate holdings by hundreds of millions of dollars on tax returns, sharply reducing the tax bill when those properties were transferred to him and his siblings.

That meant less money went to Washington (hopefully helping to starve the beast).

The president’s parents, Fred and Mary Trump, transferred well over $1 billion in wealth to their children, which could have produced a tax bill of at least $550 million under the 55 percent tax rate then imposed on gifts and inheritances. The Trumps paid a total of $52.2 million, or about 5 percent, tax records show.

The article implies the Trump family broke the law, though both the IRS and state government accepted the tax return.

The line between legal tax avoidance and illegal tax evasion is often murky, and it is constantly being stretched by inventive tax lawyers. There is no shortage of clever tax avoidance tricks that have been blessed by either the courts or the I.R.S. itself. The richest Americans almost never pay anything close to full freight. But tax experts briefed on The Times’s findings said the Trumps appeared to have done more than exploit legal loopholes. They said the conduct described here represented a pattern of deception and obfuscation, particularly about the value of Fred Trump’s real estate, that repeatedly prevented the I.R.S. from taxing large transfers of wealth to his children.

There’s not much ambiguity in my reaction to this report. I think the death tax is both immoral and economically misguided. It’s a terrible example of double taxation and it drains job-creating capital from the private economy.

The correct rate for the death tax is zero, so I’m glad the Trump family did everything possible to minimize the amount of money grabbed by Washington.

I’m embarrassed that death taxes are worse in the United States than they are in Venezuela.

Sadly, not everyone shares my perspective. Some folks are even using this NYT story as an excuse to make the death tax more onerous.

Here are some excerpts from a story in the Hill.

Democrats are calling for changes to the estate tax following a bombshell news report detailing how the Trump family navigated the tax code to protect the family’s financial assets. …”We need to look at the estate tax and certainly the issue that is raised by this investigation about the undervaluation of assets and gifts and the use of the various devices,” Rep. Lloyd Doggett (Texas), the top Democrat on the House Ways and Means Subcommittee on Tax Policy, who called for hearings on the matter. Sen. Bob Menendez (D-N.J.) said it was time to reexamine the loopholes. …Democrats say their interest in closing the loopholes are not new.

The last sentence in that excerpt is true. Obama wanted to make the death tax worse. So did Hillary.

And I’m disgusted that there are people in the business of financial planning who support the death tax since it creates business for them.

This awful levy should be repealed. Yesterday, if possible.

P.S. I assume everyone will admit that death taxes impact incentives to build wealth, but how many people realize that death taxes change incentives on when people die?

P.P.S. Smart rich people opted to die in 2010 (admittedly an extreme form of tax avoidance). They also avoid certain states.

P.P.P.S. I’ll defend just about anybody who tries to escape the vicious and destructive death tax, including straight men who marry each other and gay men who arrange fake adoptions.

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When I write about the economics of fiscal policy and need to give people an easy-to-understand explanation on how government spending affects growth, I share my four-part video series.

But. other than a much-too-short primer on growth and taxation from 2016, I don’t have something similar for tax policy. So I have to direct people to various columns about marginal tax rates, double taxation, tax favoritism, tax reform, corporate taxation, and tax competition.

Today’s column isn’t going to be a comprehensive analysis of taxes and growth, but it is going to augment the 2016 primer by taking a close look at how some taxes are more destructive than others.

And what makes today’s column noteworthy is that I’ll be citing the work of left-leaning international bureaucracies.

Let’s look at a study from the OECD.

…taxes…affect the decisions of households to save, supply labour and invest in human capital, the decisions of firms to produce, create jobs, invest and innovate, as well as the choice of savings channels and assets by investors. What matters for these decisions is not only the level of taxes but also the way in which different tax instruments are designed and combined to generate revenues…investigating how tax structures could best be designed to promote economic growth is a key issue for tax policy making. … this study looks at consequences of taxes for both GDP per capita levels and their transitional growth rates.

For all intents and purposes, the economists at the OECD wanted to learn more about how taxes distort the quantity and quality of labor and capital, as illustrated by this flowchart from the report.

Here are the main findings (some of which I cited, in an incidental fashion, back in 2014).

The reviewed evidence and the empirical work suggests a “tax and growth ranking” with recurrent taxes on immovable property being the least distortive tax instrument in terms of reducing long-run GDP per capita, followed by consumption taxes (and other property taxes), personal income taxes and corporate income taxes. …relying less on corporate income relative to personal income taxes could increase efficiency. …Focusing on personal income taxation, there is also evidence that flattening the tax schedule could be beneficial for GDP per capita, notably by favouring entrepreneurship. …Estimates in this study point to adverse effects of highly progressive income tax schedules on GDP per capita through both lower labour utilisation and lower productivity… a reduction in the top marginal tax rate is found to raise productivity in industries with potentially high rates of enterprise creation. …Corporate income taxes appear to have a particularly negative impact on GDP per capita.”

Here’s how the study presented the findings. I might quibble with some of the conclusions, but it’s worth noting all the minuses in the columns for marginal tax, progressivity, top rates, dividends, capital gains, and corporate tax.

This is all based on data from relatively prosperous countries.

A new study from the International Monetary Fund, which looks at low-income nations rather than high-income nations, reaches the same conclusion.

The average tax to GDP ratio in low-income countries is 15% compared to that of 30% in advanced economies. Meanwhile, these countries are also those that are in most need of fiscal space for sustainable and inclusive growth. In the past two decades, low-income countries have made substantial efforts in strengthening revenue mobilization. …what is the most desirable tax instrument for fiscal consolidation that balances the efficiency and equity concerns. In this paper, we study quantitatively the macroeconomic and distributional impacts of different tax instruments for low-income countries.

It’s galling that the IMF report implies that there’s a “need for fiscal space” and refers to higher tax burdens as “strengthening revenue mobilization.”

But I assume some of that rhetoric was added at the direction of the political types.

The economists who crunched the numbers produced results that confirm some of the essential principles of supply-side economics.

…we conduct steady state comparison across revenue mobilization schemes where an additional tax revenues equal to 2% GDP in the benchmark economy are raised by VAT, PIT, and CIT respectively. Our quantitative results show that across the three taxes, VAT leads to the least output and consumption losses of respectively 1.8% and 4% due to its non-distorting feature… Overall, we find that among the three taxes, VAT incurs the lowest efficiency costs in terms of aggregate output and consumption, but it could be very regressive… CIT, on the other hand, though causes larger efficiency costs, but has considerable better inequality implications. PIT, however, deteriorates both the economic efficiency and equity, thus is the most detrimental instrument.

Here’s the most important chart from the study. It shows that all taxes undermine prosperity, but that personal income taxes (grey bar) and corporate income tax (white bar) do the most damage.

I’ll close with two observations.

First, these two studies are further confirmation of my observation that many – perhaps most – economists at international bureaucracies generate sensible analysis. They must be very frustrated that their advice is so frequently ignored by the political appointees who push for statist policies.

Second, some well-meaning people look at this type of research and conclude that it would be okay if politicians in America imposed a value-added tax. They overlook that a VAT is bad for growth and are naive if they think a VAT somehow will lead to lower income tax burdens.

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I wrote last month about a new book from the Fraser Institute about demographics and entrepreneurship.

My contribution was a chapter about the impact of taxation, especially the capital gains tax.

At a panel in Washington, I had a chance to discuss my findings.

If you don’t want to watch an 11-minute video, my presentation can be boiled down to four main points.

1. Demographics is destiny – Other authors actually had the responsibility of explaining in the book about the importance of demographic change. But it never hurts to remind people that this is a profound and baked-in-the-cake ticking time bomb.

So I shared this chart with the audience and emphasized that a modest-sized welfare state may have been feasible in the past, but will be far more burdensome in the future for the simple reason that the ratio of taxpayers to tax-consumers is dramatically changing.

And it goes without saying that big-sized welfare states are doomed to collapse. Think Greece and extend it to Italy, France, Japan, and other developed nations (including, I fear, the United States).

2. Entrepreneurship drives growth – Capital and labor are the two factors of production, but entrepreneurs are akin to the chefs who figure out news ways of mixing those ingredients.

For all intents and purposes, entrepreneurs produce the creative destruction that is a prerequisite for growth.

3. The tax code discourages entrepreneurship – The bulk of my presentation was dedicated to explaining that double taxation is both pervasive and harmful.

I shared my flowchart showing how the American tax code is biased against income that is saved and invest, which discourages entrepreneurial activity.

And then showed the capital gains tax burden in developed countries.

The U.S. is probably even worse than shown in the above chart since our capital gains tax is imposed on inflationary gains.

4. The United States need to be more competitive – Last but not least, I pointed out that America’s class-warfare tax policies are the fiscal equivalent of an “own goal” (soccer reference for World Cup fans).

And this chart from my chapter shows how the United States, as of mid-2016, had the highest combined tax rate on capital gains when including the effect of the capital gains tax.

That’s the bad news. The good news is that the Trump tax cuts did produce a lower corporate rate. So in the version below, I’ve added my back-of-the-envelope calculation of where the U.S. now ranks.

But the bottom line is still uncompetitive when looking at the tax burden on investment.

And never forget that this ultimately backfires against workers since it translates into lower pay.

P.S. The Wall Street Journal produced an excellent description of why capital gains taxation is very destructive.

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