Posts Tagged ‘Supply-side economics’

Earlier this year, I pointed out that Trump and Republicans could learn a valuable lesson from Maine Governor Paul LePage on how to win a government shutdown.

Today, let’s look at a lesson from North Carolina on how to design and implement pro-growth tax policy.

In today’s Wall Street Journal, Senator Thom Tillis from the Tarheel State explains what happened when he helped enact a flat tax as Speaker of the State House.

In 2013, when I was speaker of the state House, North Carolina passed a serious tax-reform package. It was based on three simple principles: simplify the tax code, lower rates, and broaden the base. We replaced the progressive rate schedule for the personal income tax with a flat rate of 5.499%. That was a tax-rate cut for everyone, since the lowest bracket previously was 6%. We also increased the standard deduction for all tax filers and repealed the death tax. We lowered the 6.9% corporate income tax to 6% in 2014 and 5% in 2015. …North Carolina’s corporate tax fell to 3% in 2017 and is on track for 2.5% in 2019. We paid for this tax relief by expanding the tax base, closing loopholes, paring down spending, reducing the cost of entitlement programs, and eliminating “refundable” earned-income tax credits for people who pay no taxes.

Wow, good tax policy enabled by spending restraint. Exactly what I’ve been recommending for Washington.

Have these reforms generated good results?  The Senator says yes.

More than 350,000 jobs have been created, and the unemployment rate has been cut nearly in half. The state’s economy has jumped from one of the slowest growing in the country to one of the fastest growing.

What about tax revenue? Has the state government been starved of revenue?


…a well-mobilized opposition on the left stoked fears that tax reform would cause shrinking state revenues and require massive budget cuts. This argument has been proved wrong. State revenue has increased each year since tax reform was enacted, and budget surpluses of more than $400 million are the new norm. North Carolina lawmakers have wisely used these surpluses to cut tax rates even further for families and businesses.

Senator Tillis didn’t have specific details on tax collections in his column. I got suspicious that he might be hiding some unflattering numbers, so I went to the Census Bureau’s database on state government finances. But it turns out the Senator is guilty of underselling his state’s reform. Tax revenue has actually grown faster in the Tarheel State, compared the average of all other states (many of which have imposed big tax hikes).

Another example of the Laffer Curve in action.

And here’s a chart from North Carolina’s Office of State Budget and Management. As you can see, revenues are rising rather than falling.

By the way, I’m guessing that the small drop in 2014 and the big increase in 2015 were caused by taxpayers delaying income to take advantage of the new, friendlier tax system. We saw the same thing in the early 1980s when some taxpayer deferred income because of the multi-year phase-in of the Reagan tax cuts.

But I’m digressing. Let’s get back to North Carolina.

Here’s what the Tax Foundation wrote earlier this year.

After the most dramatic improvement in the Index’s history—from 41st to 11th in one year—North Carolina has continued to improve its tax structure, and now imposes the lowest-rate corporate income tax in the country at 4 percent, down from 5 percent the previous year. This rate cut improves the state from 6th to 4th on the corporate income tax component, the second-best ranking (after Utah) for any state that imposes a major corporate tax. (Six states forego corporate income taxes, but four of them impose economically distortive gross receipts taxes in their stead.) An individual income tax reduction, from 5.75 to 5.499 percent, is scheduled for 2017. At 11th overall, North Carolina trails only Indiana and Utah among states which do not forego any of the major tax types.

And in a column for Forbes, Patrick Gleason was even more effusive.

…the Republican-controlled North Carolina legislature enacted a new budget today that cuts the state’s personal and corporate income tax rates. Under this new budget, the state’s flat personal income tax rate will drop from 5.499 to 5.25% in January of 2019, and the corporate tax rate will fall from 3% to 2.5%, which represents a 16% reduction in one of the most harmful forms of taxation. …This new budget, which received bipartisan support from a three-fifths super-majority of state lawmakers, builds upon the Tar Heel State’s impressive record of pro-growth, rate-reducing tax reform. …It’s remarkable how much progress North Carolina has made in improving its business tax climate in recent years, going from having one of the worst businesses tax climates in the country (ranked 44th), to one of the best today (now 11th best according to the non-partisan Tax Foundation).

Most importantly, state lawmakers put the brakes on spending, thus making the tax reforms more political and economically durable and successful.

Since they began cutting taxes in 2013, North Carolina legislators have kept annual increases in state spending below the rate of population growth and inflation. As a result, at the same time North Carolina taxpayers have been allowed to keep billions more of their hard-earned income, the state has experienced repeated budget surpluses. As they did in 2015, North Carolina legislators are once again returning surplus dollars back to taxpayers with the personal and corporate income tax rate cuts included in the state’s new budget.

Last but not least, I can’t resist sharing this 2016 editorial from the Charlotte Observer. If nothing else, the headline is an amusing reminder that journalists have a hard time understanding that higher tax rates don’t necessarily mean more revenue and that lower tax rates don’t automatically lead to less revenue.

A curious trend you might have noticed of late: North Carolina’s leaders keep cutting taxes, yet the state keeps taking in more money. We saw it happen last year, when the state found itself with a $400 million surplus, despite big cuts in personal and corporate tax rates. …Now comes word that in the first six months of the 2016 budget year (July to December), the state has taken in $588 million more than it did in the same period the previous year. …the overall surge in tax receipts certainly shouldn’t go unnoticed, especially since most of the increased collections for the 2016 cycle so far come from higher individual income tax receipts. They’re up $489 million, 10 percent above the same period of the prior year.

Though the opinion writers in Charlotte shouldn’t feel too bad. Their counterparts at the Washington Post and Wall Street Journal have made the same mistake. As did a Connecticut TV station.

P.S. My leftist friends doubtlessly will cite Kansas as a counter-example to North Carolina. According the narrative, tax cuts failed and were repealed by a Republican legislature. I did a thorough analysis of what happened in the Sunflower State earlier this year. I pointed out that tax cuts are hard to sustain without some degree of spending restraint, but also noted that the net effect of Brownback’s tenure is a permanent reduction in the tax burden. If that’s a win for the left, I hope for similar losses in Washington. It’s also worth comparing income growth in Kansas, California, and Texas if you want to figure out what tax policies are good for ordinary people.

Read Full Post »

Why were the Reagan tax cuts so successful? Why did the economy rebound so dramatically from the malaise of the 1970s?

The easy answer is that we got better tax policy, especially lower marginal tax rates on personal and business income. Those lower rates reduced the “price” of engaging in productive behavior, which led to more work, saving, investment, and entrepreneurship.

That’s right, but there’s a story behind the story. Reagan’s tax policy (especially the Economic Recovery Tax Act of 1981) was good because the President and his team ignored the class-warfare crowd. They didn’t care whether all income groups got the same degree of tax relief. They didn’t care about static distribution tables. They didn’t care about complaints that “the rich” benefited.

They simply wanted to reduce the onerous barriers that the tax system imposed on the economy. They understood – and this is critically important – that faster growth was the best way to help everyone in America, including the less fortunate.

Kimberley Strassel of the Wall Street Journal thinks that Donald Trump may be taking the same approach. Her column today basically argues that the President is making a supply-side case for growth. She starts by taking a shot at self-styled “reform conservatives.”

In May 2014, a broad collection of thinkers and politicians gathered in Washington to celebrate a new conservative “manifesto.” The document called for replacing stodgy old Reaganite economics with warmer, fuzzier handouts to the middle class.

She’s happy Trump isn’t following their advice (and I largely agree).

Donald Trump must have missed the memo. …Mr. Trump wants to make Reagan-style tax reform great again.

The class-warfare crowd is not happy about Trump’s pro-growth message, Kimberley writes.

The left saw this clearly, which explains its furious and frustrated reaction to the speech. …Democratic strategist Robert Shrum railed in a Politico piece that the “plutocrat” Mr. Trump was pitching a tax cut for “corporations and the top 1 percent” yet was getting away with a “perverted populism.” …Mr. Trump is selling pro-growth policies—something his party has forgotten how to do. …The left has defined the tax debate for decades in terms of pure class warfare. Republicans have so often been cast as stooges for the rich that the GOP is scared to make the full-throated case for a freer and fairer tax system. …Mr. Trump isn’t playing this game—and that’s why the left is unhappy. The president wants to reduce business tax rates significantly… He wants to simplify the tax code in a way that will eliminate many cherished carve-outs. …his address was largely a hymn to supply-side economics, stunning Democrats who believed they’d forever dispelled such voodoo. …Mr. Trump busted up the left’s class-warfare model. He didn’t make tax reform about blue-collar workers fighting corporate America. Instead it was a question of “our workers” and “our companies” and “our country” competing against China. He noted that America’s high tax rates force companies to move overseas. He directly and correctly tied corporate rate cuts to prosperity for workers, noting that tax reform would “keep jobs in America, create jobs in America,” and lead to higher wages.

Amen. That’s the point I made last week about investment being the key to prosperity for ordinary people.

Ms. Strassel concludes by putting pressure on Congress to do its job and get a bill to the President’s desk.

His opening salvo has given Republicans the cover to push ahead, as well as valuable pointers on selling growth economics. If they can’t get the job done—with the power they now have in Washington—they’d best admit the Democrats’ class-warfare “populism” has won.

I largely agree with Kimberley’s analysis. Trump’s message of jobs, growth, and competitiveness is spot on. His proposal for a 15 percent corporate rate would be very good for the economy. And I also agree with her that it’s up to congressional Republicans to move the ball over the goal line.

But I also think she’s giving Trump too much credit. As I point out in this interview, the Administration isn’t really playing a major role in the negotiations. The folks on Capitol Hill are doing the real work while the President is waiting around for a bill to sign.

Moreover, I’ve been repeatedly warning that there are some very difficult issues that Congress needs to decide.

Since big companies will benefit from a lower corporate rate, will there be similar tax relief for small businesses that file using “Schedule C” of the individual income tax? That’s a good idea, but there are big revenue implications.

Since Republicans (and this definitely includes Trump) are weak on spending, will they achieve deficit neutrality (necessary for permanent reform) by eliminating loopholes? That’s a good idea, but interest groups will resist.

Unfortunately, the White House isn’t offering much help on these issues. The President simply wants big tax cuts and is leaving these tough decisions to everyone else.

P.S. I should have been more specific in the interview. I said we would have a flat tax in my “fantasy world” but that I would settle for partial reform in my “ideal world.” I was grading on a curve, so I want to redeem myself. Here’s how things really rank.

P.P.S. I’m very hopeful that lawmakers will get rid of the deduction for state and local taxes. Not only would that provide some revenue that can be used for pro-growth changes, but it also would get rid of a very unfair distortion that enables higher taxes in states such as Illinois, California, New York, New Jersey, and Connecticut.

P.P.P.S. I have no objection to family-oriented tax relief and other policies that target middle-class taxpayers. Such provisions are politically useful since they expand the coalition of supporters. But I want policy makers to understand that economic growth is the best way of helping everyone – including the poor. That’s why supply-side provisions should be the primary focus of any tax package.

P.P.P.P.S. The class-warfare crowd doesn’t like lower tax rates on upper-income taxpayers. They argue that rich people won’t pay enough and that the government will be starved of revenue. Yet they have no answer when I show them this IRS data. Or this data from the United Kingdom. Or this data from France.

P.P.P.P.P.S. Notwithstanding the title of today’s column, I don’t think Trump is a principled supply-sider like Reagan. But it might be accurate to say he’s a practical supply sider like President John F. Kennedy.

Read Full Post »

To be blunt, Republicans are heading in the wrong direction on fiscal policy. They have full control of the executive and legislative branches, but instead of using their power to promote Reaganomics, it looks like we’re getting a reincarnation of the big-government Bush years.

As Yogi Berra might have said, “it’s deja vu all over again.”

Let’s look at the evidence. According to the Hill, the Keynesian virus has infected GOP thinking on tax cuts.

Republicans are debating whether parts of their tax-reform package should be retroactive in order to boost the economy by quickly putting more money in people’s wallets.

That is nonsense. Just as giving people a check and calling it “stimulus” didn’t help the economy under Obama, giving people a check and calling it a tax cut won’t help the economy under Trump.

Tax cuts boost growth when they reduce the marginal tax rate on productive behavior such as work, saving, investment, or entrepreneurship. When that happens, people have an incentive to generate more income. And that leads to more national income, a.k.a., economic growth.

Borrowing money from the economy’s left pocket and then stuffing checks (oops, I mean retroactive tax cuts) in the economy’s right pocket, by contrast, simply reallocates national income.

Indeed, this is one of the reasons why the economy didn’t get much benefit from the 2001 Bush tax cut, especially when compared to the growth-oriented 2003 tax cut. Unfortunately, Republicans haven’t learned that lesson.

Republicans have taken steps in the past to ensure that taxpayers directly felt the benefits of tax cuts. As part of the 2001 tax cuts enacted by President George W. Bush, taxpayers received rebate checks.

The article does include some analysis from people who understand that retroactive tax cuts aren’t economically beneficial.

…there are also drawbacks to making tax changes retroactive. …such changes would add to the cost of the bill, but would not be an effective way to encourage new spending and investments. “It has all of the costs of the tax cuts but none of the economic benefits,” said Committee for a Responsible Federal Budget President Maya MacGuineas, who added that “you don’t make investments in the rear-view mirror.”

I’m not always on the same side as Maya, but she’s right on this issue. You can’t encourage people to generate more income in the past. If you want more growth, you have to reduce marginal tax rates on future activity.

By the way, I’m not arguing that there is no political benefit to retroactive tax cuts. If Republicans simply stated that they were going to send rebate checks to curry favor with voters, I’d roll my eyes and shrug my shoulders.

But when they make Keynesian arguments to justify such a policy, I can’t help but get upset about the economic illiteracy.

Speaking of bad economic policy, GOPers also are pursuing bad spending policy.

Politico has a report on a potential budget deal where everyone wins…except taxpayers.

The White House is pushing a deal on Capitol Hill to head off a government shutdown that would lift strict spending caps long opposed by Democrats in exchange for money for President Donald Trump’s border wall with Mexico, multiple sources said.

So much for Trump’s promise to get tough on the budget, even if it meant a shutdown.

Instead, the back-room negotiations are leading to more spending for all interest groups.

Marc Short, the White House’s director of legislative affairs, …also lobbied for a big budget increase for the Pentagon, another priority for Trump. …The White House is offering Democrats more funding for their own pet projects.

The only good news is that Democrats are so upset about the symbolism of the fence that they may not go for the deal.

Democrats show no sign of yielding on the issue. They have already blocked the project once.

Unfortunately, I expect this is just posturing. When the dust settles, I expect the desire for more spending (from both parties) will produce a deal that is bad news. At least for those of us who don’t want America to become Greece (any faster than already scheduled).

Republican and Democratic congressional aides have predicted for months that both sides will come together on a spending agreement to raise spending caps for the Pentagon as well as for nondefense domestic programs.

So let’s check our scorecard. On the tax side of the equation, we’ll hopefully still get some good policy, such as a lower corporate tax rate, but it probably will be accompanied by some gimmicky Keynesian policy.

On the spending side of the equation, it appears my fears about Trump may have been correct and he’s going to be a typical big-government Republican.

It’s possible, of course, that I’m being needlessly pessimistic and we’ll get the kinds of policies I fantasized about in early 2016. But I wouldn’t bet money on a positive outcome.

Read Full Post »

Supply-side economics is simply the common-sense notion that people respond to incentives, though some folks think this elementary observation is “voodoo economics” or “trickle-down economics.”

If you want a wonkish definition of supply-side economics, it is the application of micro-economic principles. In other words, what does “price  theory” tell us about how people will respond when a tax goes up or down.

All of which can be illustrated using supply and demand curves, for those who prefer something visual.

None of this is controversial. Indeed, left-wing economists presumably will agree with everything I just wrote.

There is disagreement, however, about magnitude of supply-side responses. Do people respond a lot or a little when tax policy changes (using economic jargon, what are the “elasticities” of behavioral response)?

And even if there was a consensus on those magnitudes, that still wouldn’t imply agreement on the proper policy since people have different views on whether the goal should be more growth or more redistribution (what economist Arthur Okun referred to as the equality-efficiency tradeoff).

For what it’s worth, this is why there is a lot of fighting about the Laffer Curve. Every left-wing economist agrees with the underlying principle of the Laffer Curve (in other words, because people can change their behavior, nobody actually thinks there is a linear relationship between tax rates and tax revenue).

But economists don’t agree on the shape of the curve. Is the revenue-maximizing rate for the personal income tax 25 percent or 75 percent? And even if people somehow agreed on the shape of the curve, that doesn’t lead to agreement on the ideal tax rate because some statists want very high rates even if the result is less revenue. And people like me only care about the growth-maximizing tax rate.

I’m giving this background for the simple reason that the policy world is lagging the economics profession. And I’m not just referring to the Joint Economic Committee’s resistance to “dynamic scoring.” My bigger complaint is that a lot of politicians still act as if there is zero insight from supply-side economics and the Laffer Curve.

In hopes of rectifying this situation, I’ve been sharing examples of supply-side-motivated tax changes that have been adopted by leftists. In other words, tax changes that were adopted specifically to alter behavior.

Here’s the list of “successful” leftist tax hikes that have crossed my desk.

Now we have another example to add to my collection, this time from a tax on plastic bags in Chicago.

Just as predicted, there is revenue feedback because people change their behavior in response to changes in tax policy.

Chicago’s effort to keep plastic and paper bags out of area landfills by imposing a 7 cents-per-bag tax is succeeding beyond officials’ wildest dreams. The bad news is that the success of the fee in dissuading shoppers from taking single-use bags means the city’s coffers are taking a steep hit. Chicago officials balanced the city’s 2017 spending plan based on an assumption that the city would earn $9.2 million this year from the tax.

But receipts will fall far short of that goal.

The city has earned just $2.4 million in the five months the tax has been in effect, said Molly Poppe, a spokeswoman for the city’s Finance Department. If bag use continues at the current pace, that means the city would net just $7.7 million from the tax for the year. …the number of plastic and paper bags Chicagoans used to haul home their groceries dropped 42 percent in the first month after the tax was imposed.

Incidentally, the Mayor claims that the tax is a success because the real goal was discouraging plastic bags rather than raising revenue.

That’s certainly a very legitimate position, but note that his policy is based on supply-side economics: The more you tax of something, the less you get of it.

My frustration is that the politicians who say we need higher taxes to discourage bad things (smoking, sugar, plastic bags, etc) oftentimes are the same ones who say that higher taxes won’t discourage good things (work, saving, investment, entrepreneurship, etc).

Needless to say, this doesn’t make sense. They are either clueless or hypocritical. But maybe if I accumulate enough example of “successful” supply-side tax hikes, they’ll finally realize it’s not a good idea to punish productive behavior.

P.S. Check out the IRS data from the 1980s on what happened to tax revenue from the rich when Reagan dropped the top tax rate from 70 percent to 28 percent. I’ve used this information in plenty of debates and I’ve never run across a statist who has a good response.

P.P.S. Here’s my video with more evidence in favor of the Laffer Curve.

P.P.P.S. I also think this polling data from certified public accountants is very persuasive. I don’t know about you, but I suspect CPAs have a much better real-world understanding of the impact of tax policy than the bureaucrats at the Joint Committee on Taxation.

Read Full Post »

Whenever I debate my left-wing friends on tax policy, they routinely assert that taxes don’t matter.

It’s unclear, though, whether they really believe their own rhetoric.

After all, if taxes don’t affect economic behavior, then why are folks on the left so terrified of tax havens? Why are they so opposed to tax competition?

And why are they so anxious to defend loopholes such as the deduction for state and local taxes.

Perhaps most revealing, why do leftists sometimes cut taxes when they hold power? A story in the Wall Street Journal notes that there’s been a little-noticed wave of state tax cuts. Specifically reductions and/or eliminations of state death taxes. And many of these supply-side reforms are happening in left-wing states!

In the past three years, nine states have eliminated or lowered their estate taxes, mostly by raising exemptions. And more reductions are coming. Minnesota lawmakers recently raised the state’s estate-tax exemption to $2.1 million retroactive to January, and the exemption will rise to $2.4 million next year. Maryland will raise its $3 million exemption to $4 million next year. New Jersey’s exemption, which used to rank last at $675,000 a person, rose to $2 million a person this year. Next year, New Jersey is scheduled to eliminate its estate tax altogether, joining about a half-dozen others that have ended their estate taxes over the past decade.

This is good news for affected taxpayers, but it’s also good news for the economy.

Death taxes are not only a punitive tax on capital, but they also discourage investors, entrepreneurs, and other high-income people from earning income once they have accumulated a certain level of savings.

But let’s focus on politics rather than economics. Why are governors and state legislators finally doing something sensible? Why are they lowering tax burdens on “rich” taxpayers instead of playing their usual game of class warfare?

I’d like to claim that they’re reading Cato Institute research, or perhaps studies from other market-oriented organizations and scholars.

But it appears that tax competition deserves most of the credit.

This tax-cutting trend has been fueled by competition between the states for affluent and wealthy taxpayers. Such residents owe income taxes every year, but some are willing to move out of state to avoid death duties that come only once. Since the federal estate-and-gift tax exemption jumped to $5 million in 2011, adjusted for inflation, state death duties have stood out.

I don’t fully agree with the above excerpt because there’s plenty of evidence that income taxes cause migration from high-tax states to zero-income-tax states.

But I agree that a state death tax can have a very large impact, particularly once a successful person has retired and has more flexibility.

Courtesy of the Tax Foundation, here are the states that still impose this destructive levy.

Though this map may soon have one less yellow state. As reported by the WSJ, politicians in the Bay State may be waking up.

In Massachusetts, some lawmakers are worried about losing residents to other states because of its estate tax, which brought in $400 million last year. They hope to raise the exemption to half the federal level and perhaps exclude the value of a residence as well. These measures stand a good chance of passage even as lawmakers are considering raising income taxes on millionaires, says Kenneth Brier, an estate lawyer with Brier & Ganz LLP in Needham, Mass., who tracks the issue for the Massachusetts Bar Association. State officials “are worried about a silent leak of people down to Florida, or even New Hampshire,” he adds.

I’m not sure the leak has been silent. There’s lots of data on the migration of productive people to lower-tax states.

But what matters is that tax competition is forcing the state legislature (which is overwhelmingly Democrat) to do the right thing, even though their normal instincts would be to squeeze upper-income taxpayers for more money.

As I’ve repeatedly written, tax competition also has a liberalizing impact on national tax policy.

Following the Reagan tax cuts and Thatcher tax cuts, politicians all over the world felt pressure to lower their tax rates on personal income. The same thing has happened with corporate tax rates, though Ireland deserves most of the credit for getting that process started.

I’ll close by recycling my video on tax competition. It focuses primarily on fiscal rivalry between nations, but the lessons equally apply to states.

P.S. For what it’s worth, South Dakota arguably is the state with the best tax policy. It’s more difficult to identify the state with the worst policy, though New Jersey, Illinois, New York, California, and Connecticut can all make a strong claim to be at the bottom.

P.P.S. Notwithstanding my snarky title, I don’t particularly care whether there are tax cuts for rich people. But I care a lot about not having tax policies that penalize the behaviors (work, saving, investment, and entrepreneurship) that produce income, jobs, and opportunity for poor and middle-income people. And if that means reforms that allow upper-income people to keep more of their money, I’m okay with that since I’m not an envious person.

Read Full Post »

What’s the right way to define good tax policy? There are several possible answers to that question, including the all-important observation that the goal should be to only collect the amount of revenue needed to finance the legitimate functions of government, and not one penny above that amount.

But what if we want a more targeted definition? A simple principle to shape our understanding of tax policy?

I’m partial to what I wrote last year.

the essential insight of supply-side economics…when you tax something, you get less of it.

I’m not claiming this is my idea, by the way. It’s been around for a long time.

Indeed, it’s rumored that Reagan shared a version of this wisdom.

I don’t know if the Gipper actually said those exact words, but his grasp of tax policy was very impressive. And the changes he made led to very good results, even if folks on the left still refuse to believe the IRS data showing that Reagan’s lower tax rates on the rich generated more revenue.

In any event, our friends on the nanny-state left actually understand this principle when it suits their purposes. They propose sugar taxes, soda taxes, carbon taxes, housing taxes, tanning taxes, tobacco taxes, and even “adult entertainment” taxes with the explicit goal of using the tax code to reduce the consumption of things they don’t like.

I don’t like the idea of government trying to dictate people do with their own money, but these so-called sin taxes generally are successful because supply-siders are right about taxes impacting incentives.

But that doesn’t mean it’s always popular when statist governments impose such policies. At least not in Belarus, according to a story from RFERL.

Protests over a new tax aimed at reducing social welfare spread beyond the Belarusian capital, as thousands took to the streets in Homel and other towns. Along with similar protests two days earlier in Minsk, the February 19 demonstrations were some of the largest in the country in years. In Homel, near the border with Russia, at least 1,000 people marched and chanted slogans against the measure, known as the “Law Against Social Parasites.”

But what are “social parasites” and what does the law do?

…the law…requires people who were employed fewer than 183 days in a calendar year to pay a tax of about $200. …The measure is aimed at combating what President Alyaksandr Lukashenka has called “social parasitism.”

For what it’s worth, the Washington Post reports that the government had to back down.

The protesters won. On Thursday, Lukashenko announced that he won’t enforce the measure this year, though he’s not scrapping it. “We will not collect this money for 2016 from those who were meant to pay it,” he told the state news agency Belta. Those who have already paid will get a rebate if they get a job this year. The law, signed into effect in 2015, is reminiscent of Soviet-era crackdowns against the jobless, who undermined the state’s portrayal of a “workers’ paradise.”

That’s good news.

If people can somehow survive without working (assuming they’re not mooching off taxpayers, which is something that should be discouraged), more power to them. It’s not the life I would want, but it’s not the role of government to tax them if they don’t work. Or if they simply choose to work 182 days per year.

Mr. Lukashenko should concentrate instead on taking the heavy foot of government off the neck of his people. According to the most-recent Index of Economic Freedom, Belarus is only ranked #104, with especially weak scores for “rule of law” and “open markets.”

If he turns his country into a Slavic version of Hong Kong, based on free markets and small government, people will be clamoring to work. But I’m not holding my breath expecting that to happen.

P.S. While government shouldn’t tax people for not working, it’s also a bad idea to subsidize them for not working. Indeed, there’s even a version of the Laffer Curve for poverty and redistribution.

P.P.S. Given the low freedom ranking for Belarus, I suspect the real parasites in that country (just like in the U.S.) are the various interest groups that are feeding from the government trough.

P.P.P.S. On an amusing note, here’s the satirical British video on killing the poor instead of taxing them.

Read Full Post »

I shared yesterday an example of how a big tax increase on expensive homes led to fewer sales. Indeed, the drop was so pronounced that the government didn’t just collect less money than projected, which is a very common consequence when fiscal burdens increase, but it actually collected less money than before the tax hike was enacted.

That’s the Laffer Curve on steroids.

The purpose of that column was to share with my leftist friends an example of a tax increase that achieved something they desired (i.e., putting a damper on sales of expensive houses) in hopes of getting them to understand that higher taxes on other types of economic activity also will have similar effects.

And some of those “other types of economic activity” will be things that they presumably like, such as job creation, entrepreneurship, and upward mobility.

I now have another example to share. The New York Times is reporting that a Mexican tax on soda is causing a big drop in soda consumption.

In the first year of a big soda tax in Mexico, sales of sugary drinks fell. In the second year, they fell again, according to new research. The finding represents the best evidence to date of how sizable taxes on sugary drinks, increasingly favored by large American cities, may influence consumer behavior.

This is an amazing admission. Those first three sentences of the article are an acknowledgement of the central premise of supply-side economics: The more you tax of something, the less you get of it.

In other words, taxes do alter behavior. In the wonky world of economics, this is simply the common-sense observation that demand curves are downward-sloping. When the price of something goes up (in this case, because of taxes), the quantity that is demanded falls and there is less output.

And here’s another remarkable admission in the story. The effect of taxes on behavior can be so significant that revenues are impacted.

The results…matter for policy makers who hope to use the money raised by such taxes to fund other projects. …some public officials may be dismayed… Philadelphia passed a large soda tax last year and earmarked most of its proceeds to pay for a major expansion to prekindergarten. City budget officials had assumed that the tax would provide a stable source of revenue for education. If results there mirror those of Mexico, city councilors may eventually have to find the education money elsewhere.

Wow, not just an admission of supply-side economics, but also an acknowledgement of the Laffer Curve.

Now if we can get the New York Times to admit that these principle also apply to taxes on work, saving, investment, and entrepreneurship, that will be a remarkable achievement.

P.S. Leftists are capable of amazing hypocrisy, so I won’t be holding my breath awaiting the consistent application of the NYT‘s newfound knowledge.

P.P.S. Just because some folks on the left are correct about the economic impact of soda taxes, that doesn’t mean they are right on policy. As a libertarian, I don’t think it’s the government’s job to dictate (or even influence) what we eat and drink.

Read Full Post »

In my never-ending strategy to educate policy makers about the Laffer Curve, I generally rely on both microeconomic theory (i.e., people respond to incentives) and real-world examples.

And my favorite real-world example is what happened in the 1980s when Reagan cut the top tax rate from 70 percent to 28 percent. Critics said Reagan’s reforms would deprive the Treasury of revenue and result in rich people paying a lot less tax. So I share IRS data on annual tax revenues from those making more than $200,000 per year to show that there was actually a big increase in revenue from upper-income taxpayers.

It has slowly dawned on me, though, that this may not be the best example to share if I’m trying to convince skeptical statists. After all, they presumably don’t like Reagan and they may viscerally reject my underlying point about the Laffer Curve since I’m linking it to the success of Reaganomics.

So I have a new strategy for getting my leftist friends to accept the Laffer Curve. I’m instead going to link the Laffer Curve to “successful” examples of left-wing policy. To be more specific, statists like to use the power of government to control our behavior, often by imposing mandates and regulations. But sometimes they impose taxes on things they don’t like.

And if I can use those example to teach them the basic lesson of supply-side economics (if you tax something, you get less of it), hopefully they’ll apply that lesson when contemplating higher taxes on thing they presumably do like (such as jobs, growth, competitiveness, etc).

Here’s a list of “successful” leftist tax hikes that have come to my attention.

Now I’m going to augment this list with an example from the United Kingdom.

By way of background, there’s been a heated housing market in England, with strong demand leading to higher prices. The pro-market response is to allow more home-building, but the anti-developer crowd doesn’t like that approach, so instead a big tax on high-value homes was imposed.

And as the Daily Mail reports, this statist approach has been so “successful” that the tax hike has resulted in lower tax revenues.

George Osborne’s controversial tax raid on Britain’s most expensive homes has triggered a dramatic slump in stamp duty revenues. Sales of properties worth more than £1.5million fell by almost 40 per cent last year, according to analysis of Land Registry figures… This has caused the total amount of stamp duty collected by the Treasury to fall by around £440million, from £1.079billion to a possible £635.7million. The figures cover the period between April and November last year compared to the same period in 2015.

Our leftist friends, who sometimes openly admit that they want higher taxes on the rich even if the government doesn’t actually collect any extra revenue, should be especially happy because the tax has made life more difficult for people with more wealth and higher incomes.

Those buying a £1.5 million house faced an extra £18,750 in stamp duty. …Tory MP Jacob Rees-Mogg…described Mr Osborne’s ‘punitive’ stamp duty hikes as the ‘politics of envy’, adding that they have also failed because they have raised less money for the Treasury.

By the way, the fact that the rich paid less tax last year isn’t really the point. Instead, the lesson to be learned is that a tax increase caused there to be less economic activity.

So I won’t care if the tax on expensive homes brings in more money next year, but I will look to see if fewer homes are being sold compared to when this tax didn’t exist.

And if my leftist friends say they don’t care if fewer expensive homes are being sold, I’ll accept they have achieved some sort of victory. But I’ll ask them to be intellectually consistent and admit that they are implementing a version of supply-side economics and that they are embracing the notion that tax rates change behavior.

Once that happens, it’s hopefully just a matter of time before they recognize that it’s not a good idea to impose high tax rates on things that are unambiguously good for an economy, such as work, saving, investment, and entrepreneurship.

Yes, hope springs eternal.

P.S. In addition to theory and real-world examples, my other favorite way of convincing people about the Laffer Curve is to share the poll showing that only 15 percent of certified public accountants agree with the leftist view that taxes have no impact have taxable income. I figure that CPAs are a very credible source since they actually do tax returns and have an inside view of how behavior changes in response to tax policy.

Read Full Post »

For more than 30 years, I’ve been trying to educate my leftist friends about supply-side economics and the Laffer Curve.

Why is it so hard for them to recognize, I endlessly wonder, that when you tax something, you get less of it? And why don’t they realize that when you tax something at high rates, the effect is even larger?

And if the tax is high and the affected economic activity is sufficiently discouraged, why won’t they admit that this will have an impact on tax revenue?

Don’t they understand the basic economics of supply and demand?

But I’m not giving up, which means I’m either a fool or an optimist.

In this Skype interview with the Blaze’s Dana Loesch, I pontificate about the economy and tax policy.

I made my standard points about the benefits a lower corporate rate and “expensing,” while also warning about the dangers of the the “border adjustable tax” being pushed by some House Republicans.

But for today, I want to focus on the part of the interview where I suggested that a lower corporate tax rate might generate more revenue in the long run.

That wasn’t a throwaway line or an empty assertion. America’s 35 percent corporate tax rate (39 percent if you include the average of state corporate taxes) is destructively high compared to business tax systems in other nations.

Last decade, the experts at the American Enterprise Institute calculated that the revenue-maximizing corporate tax rate is about 25 percent.

More recently, the number crunchers at the Tax Foundation estimated the long-run revenue-maximizing rate is even lower, at about 15 percent.

You can (and should) read their studies, but all you really need to understand is that companies will have a greater incentive to both earn and report more income when the rate is reasonable.

But since the U.S. rate is very high (and we also have very punitive rules), companies are discouraged from investing and producing in America. Firms also have an incentive to seek out deductions, credits, exemptions, and other preferences when rates are high. And multinational companies understandably will seek to minimize the amount of income they report in the United States.

In other words, a big reduction in the corporate rate would be unambiguously positive for the American economy. And because there will be more investment and job creation, there also will be more taxable income. In other words, a bigger “tax base.”

Though I confess that I’m not overly fixated on whether that leads to more revenue. Remember, the goal of tax policy should be to finance the legitimate functions of government in the least-destructive manner possible, not to maximize revenue for politicians.

P.S. Economists at the Australian Treasury calculated the effect of a lower corporate rate and found both substantial revenue feedback and significant benefits for workers. The same thing would happen in the United States.

Read Full Post »

Yesterday was “Australia Day,” which I gather for Aussies is sort of like the 4th of July for Americans.

To belatedly celebrate for our friends Down Under, I suppose we could sing Waltzing Matilda.

But since I’m a policy wonk with a special fondness for the nation, let’s instead acknowledge Australia Day by citing some very interesting research

Economists at the Australian Treasury crunched the numbers and estimated the economic effects of a lower corporate tax rate. They had several levers in their model for how this change could be financed, including increases in other taxes.

Corporate income taxes are one of the most destructive ways for a government to generate revenue, so it’s not surprising that the study concluded that a lower rate would be desirable under just about any circumstance.

But what caught my attention was the section that looked at the economic impact of a lower corporate tax rate that is offset by a reduction in the burden of government spending. The consequences are very positive.

This subsection reports the findings from the model simulation of a company income tax rate cut from 30 to 25 per cent, leaving all other tax rates unchanged and assuming any shortfall in revenue across all jurisdictions is financed by a cut in government spending. …Under this scenario, GNI is expected to rise by 0.7 per cent in the long run (see Chart 9). …the improvement in real GNI is largely due to the gain in labour income. Underlying the gain in COE is an estimated rise in before-tax real wages of around 1.1 per cent and a rise in employment of 0.1 per cent.

For readers unfamiliar with economic jargon, GNI is gross national income and COE is compensation of employees.

And here’s the chart that was referenced. Note that workers (labour income) actually get more benefit from the lower corporate rate than investors (capital income).

So the bottom line is that a lower corporate tax rate leads to more economic output, with workers enjoying higher incomes.

And higher output and increased income also means more taxable income. And this larger “tax base” means that there is a Laffer Curve impact on tax revenues.

No, the lower corporate tax rate isn’t self financing. That only happens in rare circumstances.

But the study notes that about half of the revenue lost because of the lower corporate rate is recovered thanks to additional economic activity.

…After second-round effects, it is estimated that government spending must be cut by 51 cents for every dollar of direct net company tax cut. It is also estimated that 13 cents of every dollar cut is recovered through higher personal income tax receipts in the long run, while 14 cents is recovered thorough higher company income tax receipts. In the long run, the total revenue dividend from the company tax cut is estimated to be around 49 cents per dollar lost through the company tax cut

Here’s the relevant chart showing these results.

And the study specifically notes that the economic benefits of a lower corporate rate are largest when it is accompanied by less government spending.

A decrease in the company income tax rate financed by lower government spending implies a significantly higher overall welfare gain when compared with the previous scenarios of around 0.7 percentage points… As anticipated in the theoretical discussion, when viewed from the standpoint of the notional owners of the factors of production, the welfare gain is largely due to a significant improvement in labour income due to higher after-tax real wages.

By the way, the paper does speculate whether the benefits (of a lower corporate rate financed in part by less government spending) are overstated because they don’t capture benefits that might theoretically be generated by government spending. That’s a possibility, to be sure.

But it’s far more likely that the benefits are understated because government spending generates negative macroeconomic and microeconomic effects.

In the conclusion, the report sensibly points out that higher productivity is the way to increase higher living standards. And if that’s the goal, a lower corporate tax rate is a very good recipe.

Australia’s terms of trade, labour force participation and population growth are expected to be flat or declining in the foreseeable future which implies any improvement in Australia’s living standards must be driven by a higher level of labour productivity. This paper shows that a company income tax cut can do that, even after allowing for increases in other taxes or cutting government spending to recover lost revenue, by lowering the before tax cost of capital. This encourages investment, which in turn increases the capital stock and labour productivity.

This is spot on. A punitive corporate income tax is a very destructive way of generating revenue for government.

Which is why I hope American policy makers pay attention to this research. We already have the highest corporate tax rate in the developed world (arguably the entire world depending on how some severance taxes in poor nations are counted), and we magnify the damage with onerous rules that further undermine competitiveness.

P.S. By world standards, Australia has a lot of economic freedom. But that’s in part a sad indictment on the global paucity of market-oriented nations. There are some very good policies Down Under, but the fiscal burden of government is far too large. The current government is taking some small steps in the right direction (lower corporate rate, decentralization), but much more is needed.

P.P.S. In the interest of being a good neighbor, the Australian government should immediately put an end to its crazy effort to force Vanuatu to adopt an income tax.

Read Full Post »

I don’t like tax increases, but I like having additional evidence that higher tax rates change behavior. So when my leftist friends “win” by imposing tax hikes, I try to make lemonade out of lemons by pointing out “supply-side” effects.

I’m hoping that if leftists see how tax hikes are “successful” in discouraging things that they think are bad (such as consumers buying sugary soda or foreigners buying property), then maybe they’ll realize it’s not such a good idea to tax – and therefore discourage – things that everyone presumably agrees are desirable (such as work, saving, investment, and entrepreneurship).

Though I sometimes worry that they actually do understand that taxes impact pro-growth behavior and simply don’t care.

But one thing that clearly is true is that they get very worried if tax increases threaten their political viability.

This is why Becket Adams, in a column for the Washington Examiner, is rather amused that Mayor Kenney of Philadelphia has been caught with his hand in the tax cookie jar.

Philadelphia Mayor Jim Kenney fought hard to pass a new tax on soda and other sugary drinks. He won, and the 1.5-cents-per-ounce tax is now in place, affecting both merchants and consumers, because that’s how taxes work. Businesses pay the levies, and they offset the cost by charging higher prices. That is as basic as it gets. The only person who doesn’t seem to understand this is Kenney, who is now accusing business owners of extortion. “They’re gouging their own customers,” the mayor said.

Yes, consumers are being extorted and gouged, but the Mayor isn’t actually upset about that.

He’s irked because people are learning that it’s his fault.

Philadelphians are obviously outraged by the skyrocketing cost of things as simple as a soda, which has prompted some businesses to post signs explaining why the drinks are now do damned expensive. Kenney said that this effort by businesses to explain the rising cost is “wrong” and “misleading.” The mayor apparently thought the city council could impose a major new tax on businesses, and that customers somehow wouldn’t be affected.

In other words, it’s probably safe to say that Mayor Kenney has no regrets about the soda tax. He’s just not pleased that he can’t blame merchants for the price increase.

The International Monetary Fund, by contrast, may actually have learned a real lesson that higher taxes aren’t always a good idea. That bureaucracy is infamous for blindly supporting tax increases, but if we can believe this story from the Wall Street Journal, even those bureaucrats don’t think additional tax hikes in Greece would be a good idea.

IMF officials have said Greece’s economy is already overtaxed. New taxes that came into affect on Jan. 1 are squeezing household incomes further. Economists say even-higher income taxes—in the form of lower tax-free income allowances—could add to a mountain of unpaid taxes. Greeks currently owe the state €94 billion ($99 billion), equivalent to 54% of gross domestic product, and rising, in taxes that they can’t pay.

Here are some stories to illustrate the onerous tax system in Greece, starting with a retired couple that will probably lose their house because of a new property tax.

…the 87-year-old former economist and his 81-year-old wife are unable to repay the property tax imposed on their 70-year old house, a family inheritance. The annual tax is around ‎€33,000, but Mr. Kokkalis’s pension—already cut by half—is €28,000 a year. The couple borrowed money when the tax was imposed, initially as a temporary austerity measure in 2011. But they are already behind on nearly €200,000 of tax payments and can’t borrow more. Mr. Kokkalis says the state is calculating tax based on outdated property prices that have since collapsed, and that if he tried to sell the house now, nobody would be interested. “They impose taxes on an imaginary value,” Mr. Kokkalis says. “This is confiscation.”

I’ve already written about this punitive property tax. The good news is that property taxes generally are transparent, so people know how much they’re paying.

The bad news is that the tax in Greece is far too onerous.

And I’ve also noted that small businesses are being wiped out in Greece as well. The WSJ has a new example.

Tax increases under previous rounds of austerity have put a middle-class lifestyle beyond reach for many. “Our only goal now is survival,” says arts teacher Mimi Bonanou. Until recent years she also made a living as a practicing artist, selling her works in Greece and abroad. But increasingly heavy taxes that self-employed Greeks must pay at the start of each year, based on the state’s often-ambitious forecast of their incomes, have forced her to rely on teaching alone.

All things considered, Greece is a painful example that a country can’t tax its way to prosperity (though some politicians never learned that lesson).

Moreover, it’s nice to have further evidence that even the IMF recognizes that Greece is on the wrong side of the Laffer Curve.

And if a left-leaning bureaucracy is now willing to admit that excessive taxation can lead to less revenue, maybe eventually the Republicans on Capitol Hill will install people at the Joint Committee on Taxation who also understand this elementary insight.

Read Full Post »

There’s a lot of speculation in Washington about what a Trump Administration will do on government spending. Based on his rhetoric it’s hard to know whether he’ll be a big-spending populist or a hard-nosed businessman.

But what if that fight is pointless?

Back in October, Will Wilkinson of the Niskanen Center wrote a very interesting – albeit depressing – article about the potential futility of trying to reduce the size of government. He starts with the observation that government tends to get bigger as nations get richer.

“Wagner’s Law” says that as an economy’s per capita output grows larger over time, government spending consumes a larger share of that output. …Wagner’s Law names a real, observed, robust empirical pattern. …It’s mainly the positive relationship between rising demand for welfare services/transfers and rising GDP per capita that drives Wagner’s Law.

I’ve also written about Wagner’s Law, mostly to debunk the silly leftist interpretation that bigger government causes more wealth (in other words, they get the causality backwards), but also to point out that other policies matter and that some big-government nations have wisely mitigated the harmful economic impact of excessive spending and taxation by having very pro-market policies in areas such as trade and regulation.

In any event, Will includes a chart showing that there certainly has been a lot more redistribution spending in the United States over the past 70 years, so it certainly is true that the political process has produced results consistent with Wagner’s Law. As America has become richer, voters and politicians have figured out how to redistribute ever-larger amounts of money.

By the way, this data is completely consistent with my recent column that pointed out how defense spending plays only a minor role in America’s fiscal challenge.

But let’s get back to Will’s article. He asserts that Wagner’s Law is bad news for advocates of smaller government.

…free-marketeers tend to insist that the key to achieving higher rates of economic growth is slashing the size of government. After all, it’s true that the private sector is better than government at putting resources to their most productive use and that some public spending crowds out private investment. If you’re really committed to the idea of stronger economic growth through government contraction, you’re pretty much committed to the idea that the pattern behind Wagner’s Law is a sort of fluke—a contingent correlation without any real cause-and-effect basis—and that there’s got to be some workaround or fix.

I don’t particularly agree with his characterization. You can believe (as I surely do) that smaller government would lead to faster growth without having to disbelieve, deny, or debunk Wagner’s Law.

  • First, it’s quite possible to have decent growth along with expanding government so long as other policy levers are moving in the right direction. Which is exactly what one Spanish scholar found when examining data for developed nations during the post-World War II period.
  • Second, it’s overly simplistic to characterize this debate as government or growth. The real issue is the rate of growth. After all, even France has a bit of growth in an average year. The real issue is whether there could be more growth with a lower level of taxes and spending. In other words, would the rest of the developed world grow faster with Hong Kong-sized government?

All that being said, Will certainly is right in his article when he points out that libertarians and other advocates of smaller government haven’t done a good job of constraining government spending.

He then examines some of the ideas have been proposed by folks on the right who want to constrain spending. Beginning with the starve-the-beast hypothesis.

The idea that it is possible to “starve the beast”—to reduce the size of government by starving the government of tax revenue—springs from this hope. But the actual effect of cutting taxes below the amount necessary to sustain current levels of government spending only underscores the unforgiving lawlikeness of Wagner’s Law. As our namesake Bill Niskanen showed, tax cuts that lead to budget shortfalls don’t lead to corresponding cuts in government spending. On the contrary, financing government spending through debt rather than taxes makes voters feel that government spending is cheaper than it really is, which makes them want even more of it.

Here’s my first substantive disagreement with Will. I’m definitely not in the all-we-have-to-do-is-cut-taxes camp, but I certainly like lower tax rates and I definitely believe that higher taxes would worsen our long-run fiscal outlook.

And I’ve looked closely at the starve-the-beast academic research. Niskanen’s study has some methodological problems and the Romer & Romer study that most people cite when arguing against the starve-the-beast hypothesis actually shows that cutting taxes is somewhat effective so long as tax cuts are durable.

Will then looks at whether it would be effective to end withholding.

…withholding made tax collection cheaper and more reliable. …paying taxes automatically and with a minimum of pain makes it less likely that you’ll be livid about them when you vote. The complaint…is the libertarian/conservative argument against a VAT or national sales tax in a nutshell. It’s the same line of reasoning that leads some libertarians and conservatives to flirt with the idea that we ought to pass a law that requires us to write a single, hugely infuriating check to the IRS each year.  The idea is that if voters are really ticked off about taxes, they’ll want lower tax rates. So taxes need to be as salient and painful—i.e., as inefficient and distortionary—as possible.

Will is skeptical of this approach, though I would point out that the one major developed economy that doesn’t have withholding is Hong Kong. And that’s a place that has successfully constrained government spending.

To be sure, the spending restraint could exist for other reasons (such as the spending cap in Article 107 of the jurisdiction’s Basic Law), but the hypothesis that people will want less government if taxes are painful is quite reasonable.

And, by the way, requiring lump-sum payments rather than withholding wouldn’t change the degree to which taxes are distortionary.

Will then turns his attention to the ‘supply-side” argument about lower tax rates.

Supply-siders generally present two scenarios, and neither helps reduce the size of government. One: If the tax cuts pushed by ticked-off taxpayers create supply-side stimulus and increase rather than decrease revenue, there’s no downward pressure on spending. …But it doesn’t make government smaller. Two: If tax cuts aren’t self-funding and simply leave a hole in the budget, the beast (as Niskanen showed) does not therefore get starved. Instead, spending feels cheap, the beast grows even more, and the tax bill gets shifted to the future.

Since I’ve already addressed the starve-the-beast issue, I’ll simply note that self-financing tax cuts (which do exist, though only in rare cases) are only possible if there’s a big uptick in growth and/or compliance. And to the extent that the revenue feedback is due to growth, that will mean that the burden of government spending will fall relative to the size of the private sector even if actual outlays stay the same.

Maybe I’m insufficiently libertarian, but I’ll take that outcome every day of the week. Heck, I’m willing to let government get bigger so long as the private sector gets to grow at a faster pace.

Now we get to Will’s main point. He suggests that maybe libertarians shouldn’t be so fixated on the size of government.

…well-funded and well-organized attempts “to convince voters to reduce their demand for the services financed by federal spending” so far have all failed. It’s time to consider the possibility that there’s no convincing them. …If we look at the world, what we see is that when people get richer, they want more welfare state. Maybe there’s nothing much we can do about that. …When people get richer, they want more welfare state. You can want Americans to get continuously wealthier and also want the government to consume a smaller share of national economic output, but there’s very little reason to think you can have both of those things. That is what the world is telling us.

To the extent that Will is simply making a prediction about the likelihood of continued government expansion, I assume (and fear) he’s right.

But to the degree he’s arguing that we should meekly acquiesce to that outcome, then I’ll strongly disagree. I may lose the fight against big government, but I intend to go down swinging.

Interestingly, Will and I may not actually disagree. This passage points out that it’s a good idea to fight against ineffective programs and to support entitlement reform.

…accepting that it’s probably not possible to shrink government would have a transformative effect on right-leaning politics. We would focus on figuring out the best ways to match receipts to outlays… You start to accept that spending cuts are ultimately more about optimizing the composition and effectiveness of spending than about the overall level of spending or its rate of growth. This doesn’t mean not fighting like hell to slash nonsense programs, or not prioritizing reforms to make entitlement programs fiscally sustainable, or not trying to balance budgets from the spending side, or not trying to minimize the rate of spending growth. This just means that you do it all knowing that the rate of spending growth isn’t going to go negative unless you hit a recession, a debt crisis, or end a major war.

And, most important, this passage also highlights the desirability of a policy to “minimize the rate of spending growth.”

Gee, I think I know someone who relentlessly argues in favor of that approach. Indeed, this guy is so fixated on that policy that he even created a “Rule” to give the concept more attention.

I can’t remember his name right now, but I’m sure he’s a swell guy.

More seriously (and to echo the point I made above), it would be a libertarian victory to have government grow slower than the productive sector of the economy. To be sure, obeying my rule (which actually does happen every so often) doesn’t mean we’ll soon reach the libertarian Nirvana of the “night watchman” state set forth in the Constitution.

But the real fiscal fight in America is whether government is becoming a bigger burden, relative to the private economy, or whether its growth is being constrained so that it’s becoming a smaller burden.

Will closes with a very sensible point about not overlooking the other policy areas where government is hindering prosperity (though that doesn’t require us to give up on the very practical quest to limit the growth of government).

Giving up on the quixotic quest to…falsify Wagner’s Law would also lead us to…focus our energy on removing regulatory barriers to economic participation, innovation, and growth.

And his concluding passage is correct, but too pessimistic.

This is just a conjecture. But when…the United States—where the freedom-as-small-government philosophy is most powerfully promoted and most widely accepted—has lost ground in economic freedom year after year for nearly two decades, it’s a conjecture worth taking very seriously.

Yes, he’s right that overall economic freedom has declined during the Bush-Obama years.

But what about the fact that overall economic freedom increased during the ReaganClinton years? And what about the fact that we achieved a five-year nominal spending freeze even with Obama in the White House?

In other words, there’s no need to throw in the towel. I may not be overflowing with optimism about whether we ultimately succeed in sufficiently constraining the growth of government, but I feel very confident that it’s a worthwhile fight.

P.S. While I disagree with a few of Will’s points, I think his article is very worthwhile. Moreover, a consensus on restraining the growth of government would be an excellent outcome to the debate he has triggered.

But I can’t resist being a bit more critical about something Noah Smith wrote about Will’s article. In his Bloomberg column discussing the hypothesis that libertarians should focus less on (or perhaps even give up on) the battle against government spending, he has a passage that is designed to lure readers into thinking that small government is associated with economic deprivation.

…a stark fact — the richer a country is, the more its government tends to spend. …Today, the top spenders include countries such as France, Denmark and Finland, while the small-government ranks include Sudan, Nigeria and Bangladesh.


It’s true that the burden of government spending is much higher in France, Denmark, and Finland than in Sudan, Nigeria, and Bangladesh, but let’s take a look at the overall data from Economic Freedom of the World.

France (#57), Denmark (#21), and Finland (#20) are all much more market-oriented than Sudan (unrated, but would have an awful score), Nigeria (#113), and Bangladesh (#121). Smith’s argument is akin to me saying that government-built roads cause economic misery because that’s how they do it in the hellhole of North Korea.

More important, he either ignores or is unaware of the research showing that nations such as France, Denmark, and Finland became rich when government spending was very small. Sigh, again.

Read Full Post »

There are several features of President-Elect Trump’s tax plan that are worthy of praise, including death tax repeal, expensing, and lower marginal tax rates on households.

But the policy that probably deserves the most attention is Trump’s embrace of a 15 percent tax rate for business.

What makes this policy so attractive – and vitally important – is that the rest of the world has been in a race to reduce corporate tax burdens.

Ironically, the U.S. helped start the race by cutting the corporate tax rate as part of the 1986 Tax Reform Act. But ever since then, policy in America has stagnated while other developed nations are engaged in a virtuous contest to become more competitive.

And that race continues every day.

Most impressively, as reported by the Financial Times, Hungary will cut its corporate tax rate from 19 percent to 9 percent.

Hungary’s government is to cut its corporate tax rate to the lowest level in the EU in a sign of increasingly competitive tax practices among countries seeking to lure foreign direct investment. Prime Minister Viktor Orban said a new 9 per cent corporate tax rate would be introduced in 2017, significantly lower than Ireland’s 12.5 per cent. …The government said the new single band would apply to all businesses. “Corporation tax will be lowered to single digits next year: a rate of 9 per cent will apply equally to small and medium-sized enterprises and large corporations,” a statement said. …Gabor Bekes, senior research fellow at Hungary’s Institute of Economics…said the measure would likely provoke complaints of unfair tax competition from western capitals.

Needless to say, complaints from Paris, Rome, and Berlin would be a sign that Hungary is doing the right thing.

Croatia also is moving policy in the right direction, albeit in a less aggressive fashion.

Corporate income tax will…be cut from 20 to 18 per cent for large companies and from 20 to 12 per cent for small and mid-level companies whose income is no higher than 400,000 euros annually.

Though the Croatian government also plans to lower tax rates on households.

Before the reform, people with salaries between 300 and 1,750 euros a month were taxed at 25 per cent, while now everyone earning up to 2,325 euros a month will be taxed at a 24 per cent rate. People earning more than 2,325 euros a month will have a 36 per cent tax rate, replacing a 40 per cent tax rate for anyone earning over 1,750 euros a month.

But let’s keep the focus on business taxation.

Our friends on the left don’t like Trump’s plan for a corporate tax cut, but here are there things they should know.

  1. A lower corporate tax rate won’t necessarily reduce corporate tax revenue, particularly over time as there’s more investment and job creation.
  2. A lower corporate tax rate will dramatically – if not completely – eliminate any incentive for American companies to engage in inversions.
  3. A lower corporate tax rate will boost workers wages by increasing the nation’s capital stock and thus improving productivity.

If you want more information, here’s my primer on corporate taxation. You can also watch this video.

Or, to make matters simple, we can just copy Estonia, which has the world’s best system according to the Tax Foundation.

Read Full Post »

Back in August, I acknowledged that lifestyle leftists in California won a real victory. They imposed a tax on sugary soft drinks in Berkeley and achieved a reduction in consumption.

But I pointed out that their success actually was an affirmation of supply-side economics, which is simply the common-sense principle that taxes impact behavior. Simply stated, the more you tax of something, the less you get of it.

Which is why I’m constantly trying to get my leftist friends to be intellectually consistent. Even though I don’t think it’s the role of government to dictate our private behavior, I tell them that they are right about higher taxes on tobacco leading to less smoking (also more smuggling, but that’s a separate issue).

Yet these people simultaneously claim that higher tax rates on income (especially on the evil rich!) won’t lead to less work, saving, investment, and entrepreneurship.

Maybe the disconnect is that leftists think tobacco and sugar are special cases.

So let’s look at another example of a “successful” tax increase.

Oct 4 Home sales in the Vancouver region’s heated housing market fell for the second consecutive month after the province introduced a tax on foreign home ownership, the Real Estate Board of Greater Vancouver said on Tuesday. In a statement, the board said September’s sales were at 2,253 homes, down 32.6 percent on a year-to-year basis and down 9.5 percent from August, the first full month after British Columbia announced a 15 percent tax on foreign buyers.

Hmmm…., a tax gets imposed on X (in this case, housing) and the result in less X. What a shocking outcome!

One week ago, I would have suggested that Hillary Clinton look at this story before moving forward with her plan for more class-warfare tax hikes.

Given the surprising election outcome, I’ll suggest that Donald Trump look at this story before moving forward with his plan to boost the capital gains tax on “carried interest.” And he definitely should use this example to bolster support for the main features of his tax plan, particularly the lower corporate rate and death tax repeal.

P.S. Even Barack Obama has endorsed the core principle of supply-side economics.

Read Full Post »

Back in 2010, I shared a cartoon video making a very important point that there’s a big downside when class-warfare politicians abuse and mistreat highly productive taxpayers.

Simply stated, the geese with the golden eggs may fly away. And this isn’t just theory. As revealed by IRS data, taxpayer will move across borders to escape punitive taxation.

It’s harder to move across national borders, of course, but it happens. Record numbers of Americans have given up their passports, including some very high-profile rich people.

Some folks on the left like to argue that taxes don’t actually lead to behavioral changes. Whenever there’s evidence of migration from high-tax jurisdictions to low-tax jurisdictions, they argue other factors are responsible. The rich won’t move just because tax rates are high, they contend.

Oh, really?

Here are some excerpts from a new Research Brief from the Cato Institute. Authored by economists from Harvard, the University of Chicago, and Italy’s Einaudi Institute, the article summarizes some scholarly research on how top-level inventors respond to differences in tax rates. Here’s what they did.

According to World Intellectual Property Organization data, inventors are highly mobile geographically with a migration rate of around 8 percent. But what determines their patterns of migration, and, in particular, how does tax policy affect migration? …Our research studies the effects of top income tax rates on the international migration of inventors, who are key drivers of technological progress. …We use a unique international data set on all inventors from the U.S. and European patent offices to track the international location of inventors since the 1970s. …We combine these inventor data with international top effective marginal tax rates data. Particularly interesting are “superstar” inventors, those with the most abundant and most valuable innovations. …We define superstar inventors as those in the top 1 percent of the quality distribution, and similarly construct the top 1–5 percent, the top 5–10 percent, and subsequent quality brackets. The evidence presented suggests that the top 1 percent superstar inventors are well into the top tax bracket.

And here’s what they ascertained about the behavioral response of the superstar inventors.

We start by documenting a negative correlation between the top tax rate and the share of top quality foreign inventors who locate in a country, as well as the share of top quality domestic inventors who remain in their home country. …We find that the superstar top 1 percent inventors are significantly affected by top tax rates when choosing where to locate. …the elasticity of the number of foreign top 1 percent superstar inventors to the net-of-tax rate is much larger, with corresponding values of 0.63, 0.85, and 1.04. The far greater elasticity for foreign relative to domestic inventors makes sense since, when a given country adjusts its top tax rate, it potentially affects inventor migration from all other countries.

And they point out a very obvious lesson.

…if the economic contribution of these key agents is important, their migratory responses to tax policy might represent a cost to tax progressivity. … An additional relevant consideration is that inventors may have strong spillover effects on their geographically close peers, making it even more important to attract and retain them domestically

And don’t forget the research I shared last year showing that superstar entrepreneurs are more likely to be found in lower-tax jurisdictions.

P.S. Seems to me, given that upper-income taxpayers shoulder most of the nation’s fiscal burden, that our leftist friends should be applauding the rich rather than demonizing them.

P.P.S. Let’s close with some more election-related humor.

Saw this very clever item on Twitter today.

And connoisseurs of media bias will have to double check to confirm this is satire rather than reality.

Regular readers know I’m skeptical about whether Trump will seek to control big government, but one thing I can safely say is that we’ll have an opportunity to enjoy some amusing political humor for the next four years.

Read Full Post »

I know exactly how Ronald Reagan must have felt back in 1980 when he famously said “There you go again” to Jimmy Carter during their debate.

That’s because I endlessly have to deal with critics who try to undercut the Laffer Curve by claiming that it’s based on the notion that all tax cuts “pay for themselves.”

Now it’s time for me to say “There you go again.”

Reuters regurgitated this misleading trope about the Laffer Curve last year, issuing a report about how the head of the Congressional Budget Office supposedly disappointed “devotees” of “Reaganomics” by saying that tax cuts are not self-financing.

The…Republican-appointed director of the Congressional Budget Office delivered some bad news…to the party’s “Reaganomics” devotees: Tax cuts don’t pay for themselves through turbocharged economic growth. Keith Hall, who served as an economic adviser to former President George W. Bush, made the pronouncement… “No, the evidence is that tax cuts do not pay for themselves,” Hall said in response to a reporter’s question. “And our models that we’re doing, our macroeconomic effects, show that.” His comment is at odds with lingering economic theory from the 1980s.

Well, I’m a “devotee of Reaganomics.” So was I disappointed?

Nope. I largely agree with the CBO Director on this topic.

But I think he should have included two caveats.

First, while there are some politicians (both now and also back in the 1980s) who blindly act as if all tax cuts are self-financing, Reaganomics was not based on that notion.

Instead, proponents of the Reagan tax cuts simply argued reforms would lead to more growth – and therefore more taxable income. And, on that basis, it was a slam-dunk victory.

Interestingly, the report from Reuters quasi-admits that Reaganomics wasn’t based on self-financing tax cuts, noting instead that the core belief was that revenue generated by additional growth would result in “less need” (as opposed to “no need”) to find offsetting budget cuts.

Stronger economic growth generated by tax cuts would boost revenues so much that there is less need to find offsetting savings.

The second caveat is that not all tax cuts (or tax increases) are created equal. Some changes in tax policy have big effects on incentives to work, save, and invest. Others don’t have much impact on economic activity because the tax system’s penalty on productive behavior isn’t altered.

In a few cases, it actually is possible for a tax cut to be self-financing. But in the vast majority of cases, the real issue is the degree to which there is some amount of revenue feedback. In other words, the discussion should focus on the extent to which the foregone revenue from lower tax rates is offset by revenue gains from increased taxable income.

Let’s now look at a real-world example from Sweden to see how politicians are blind to this common-sense insight. The left-wing coalition government in that country indirectly increased marginal tax rates (by phasing out a credit) for some high-income taxpayers this year. The experts at Timbro have examined the potential revenue impact. They start with a description of what happened to policy.

To finance their reforms, …the marginal tax rate for some 400,000 people working in Sweden – e g doctors, engineers, accountants/auditors and others in high income brackets – will be increased by three percentage points to 60 per cent. …it is also necessary to take into consideration payroll tax… Under current rules, the effective marginal tax rate is 75 per cent for high earners. After the phase-out it rises to 77 per cent.

Amazingly, the Swedish government assumes that taxpayers won’t change their behavior in reaction to this high marginal tax rate.

Decades of economics research show that if you raise income tax, people will reduce their working time, put in less effort on the job and engage in more tax planning. When the government calculated the expected increase in revenue of SEK 2.7 billion from the earned income tax credit’s phase out, it failed to take changes in behaviour into consideration because revenue and expenses in the budget are calculated statically.

The folks at Timbro explain what likely will happen as upper-income taxpayers respond to the higher marginal tax rate.

The amount of revenue generated from a tax hike depends on how people change their behaviour as a result. … High elasticity means that salary earners are sensitive to changes in taxation, and that they are very likely to alter their behaviour with certain types of reforms. Examples of this are increasing or decreasing hours worked, switching jobs, or starting a company to enable more tax-planning options. …Elasticity of 0.3 is often used in international literature (e g Hendren, 2014) as a reasonable estimate of the mainstream for this area of research. Piketty & Saez (2012) state that most estimates of elasticity are within the range of 0.1 and 0.4. They conclude that 0.25 is “a realistic mid-range estimate” of elasticity.

So what happens when you apply these measures of taxpayer responsiveness to the Swedish tax hike?

With zero elasticity, i e a static assessment, the revenue increase from phase-out of the earned income tax is assessed at SEK 2.6 billion. That is in line with the government’s estimate of SEK 2.7 billion. … all revenue disappears already at a low, 0.1, level of elasticity.

And when you look at the more mainstream measures of taxpayer responsiveness, the net effect of the government’s tax hike is that the Swedish Treasury will have less revenue.

In other words, this is one of those rare examples of taxable income changing by enough to swamp the impact of the change in the marginal tax rate.

And since we’re dealing with turbo-charged examples of the Laffer Curve, let’s look at what my colleague Alan Reynolds shared about the “huge across-the-board increase in marginal tax rates…Herbert Hoover pushed for” in the early 1930s.

Total federal revenues fell dramatically to less than $2 billion in 1932 and 1933 – after all tax rates had been at least doubled and the top rate raised from 25% to 63%.  That was a sharp decline from revenues of $3.1 billion in 1931 and more than $4 billion in 1930, when the top tax was just 25%. …Revenues fell even as a share of falling GDP –  from 4.1% in 1930 and 3.7% in 1931 to 2.8% in 1932 (the first year of the Hoover tax increase) and 3.4% in 1933. That illusory 1932-33 “increase” was entirely due to less GDP, not more revenue.

Roosevelt’s additional tax increases in the mid-1930s didn’t work much better.

The 15 highest tax rates were increased again in 1936, dividends were made fully taxable at those higher rates, and both corporate and capital gains tax rates were also increased…  Yet all of those massive “tax increases”…failed to bring as much revenue in 1936 as was collected with much lower tax rates in 1930.

The point of these examples is not that governments wound up with less money. What matters is that politicians destroyed private-sector output as a consequence of more punitive tax policy.

And that’s why the tax increases that generate more tax revenue are almost as misguided as the ones that lose revenue.

Consider Hillary Clinton’s tax-hike plan. The Tax Foundation crunched the numbers and concluded it would generate more revenue for the federal government. But I argued that shouldn’t matter.

she’s willing to lower our incomes by 0.80 percent to increase the government’s take by 0.46 percent. A good deal for her and her cronies, but bad for America.

At the risk of repeating myself, we shouldn’t try to be at the revenue-maximizing point of the Laffer Curve.

Read Full Post »

My buddy from grad school, Steve Horwitz, has a column for CapX that looks at the argument over “trickle-down economics.” As he points out (and as captured by the semi-clever nearby image), this is mostly a term used by leftists to imply that supporters of economic liberty want tax cuts for the “rich” based on a theory that some of those tax cuts eventually will trickle down to the less fortunate.

People who argue for tax cuts, less government spending, and more freedom for people to produce and trade what they think is valuable are often accused of supporting something called “trickle-down economics.” It’s hard to pin down exactly what that term means, but it seems to be something like the following: “those free market folks believe that if you give tax cuts or subsidies to rich people, the wealth they acquire will (somehow) ‘trickle down’ to the poor.”

But Steve points out that no economist actually uses this argument.

The problem with this term is that, as far as I know, no economist has ever used that term to describe their own views. …There’s no economic argument that claims that policies that themselves only benefit the wealthy directly will somehow “trickle down” to the poor.

So why, then, do leftists characterize tax cuts as “trickle-down economics” when no actual advocate uses that term or that argument?

There are a couple of possible answers, one of which is malicious and one of which is mistaken.

  • First, they’ve latched on to a politically effective way of characterizing tax cuts, so it’s understandable that they want to continue with that approach.
  • Second, their argument for Keynesian economics actually is a version of trickle-down economics since the people who get money from so-called stimulus programs spend the money, which means it gradually trickles to other people (that part is true, but Keynesians fail to understand that government can’t inject money into the economy in this fashion without first taking money out of the economy by borrowing from private capital markets). And since they believe the economy is driven by people spending money (rather than people earning money) and having it trickle to other people, maybe they assume that advocates of tax cuts believe the same thing.

In reality, of course, proponents of lower tax rates are motivated by a desire to improve incentives for people to earn additional income with more work, more saving, and more investment. That’s the basic insight of supply-side economics. It has nothing to do with how they spend (or don’t spend) their income.

With that out of the way, I want to address the part of Steve’s column where he suggested that policies which benefit one group are never helpful to other groups.

I don’t think that’s worded very well. If we lower the capital gains tax on people making more than $10 million annually, that is a policy that obviously benefits only the rich, at least when looking at direct or first-order effects.

But the impact of less double taxation should boost economic performance, even if only by a modest amount, and that will benefit everyone in society.

By the way, this works both ways. If we do something that is particularly beneficial for the poor, such as cutting back on occupational licensing requirements, that presumably doesn’t generate any direct benefit for rich people. But they will gain (as will middle-class people) as the economy becomes more productive and efficient.

Steve understands this. He closes his column by making a very similar argument about the economy-wide benefits of more economic liberty.

…allowing everyone to pursue all the opportunities they can in the marketplace, with the minimal level of taxation and regulation, will create generalized prosperity. The value of cutting taxes is not just cutting them for higher income groups, but for everyone. Letting everyone keep more of the value they create through exchange means that everyone has more incentive to create such value in the first place, whether it’s through the ownership of capital or finding new uses for one’s labor.

Now that we’ve dispensed with the silly left-wing caricature of trickle-down economics, let’s discuss how there actually is a sensible way to think about the issue.

Way back in 1996, I gave a speech in Sweden about the impact of fiscal policy on economic growth (later reprinted as a Heritage Foundation publication).

As part of my comments, I spoke about the damaging impact of the tax code’s bias against saving and investment and explained that this lowered wages because of the link between the capital stock (machinery, technology, etc) and employee compensation.

I also quoted John Shoven, a professor at Stanford University who wrote a paper back in 1990 about this topic for the American Council for Capital Formation. And here we actually have an example of an economist using “trickle-down economics” in the proper sense.

The mechanism of raising real wages by stimulating investment is sometimes derisively referred to as “trickle-down” economics. But regardless of the label used, no one doubts that the primary mechanism for raising the return to work is providing each worker with better and more numerous tools. One can wonder about the length of time it takes for such a policy of increasing saving and investments to have a pronounced effect on wages, but I know of no one who doubts the correctness of the underlying mechanism. In fact, most economists would state the only way to increase real wages in the long run is through extra investments per worker.

Amen. Capital and labor are complementary goods, which means that more of one helps make the other more valuable.

Read Full Post »

Our statist friends like high taxes for many reasons. They want to finance bigger government, and they also seem to resent successful people, so high tax rates are a win-win policy from their perspective.

They also like high tax rates to micromanage people’s behavior. They urge higher taxes on tobacco because they don’t like smoking. They want higher taxes on sugary products because they don’t like overweight people. They impose higher taxes on “adult entertainment” because…umm…let’s simply say they don’t like capitalist acts between consenting adults. And they impose higher taxes on tanning beds because…well, I’m not sure. Maybe they don’t like artificial sun.

Give their compulsion to control other people’s behavior, these leftists are very happy about what’s happened in Berkeley, California. According to a study published in the American Journal of Public Health, a new tax on sugary beverages has led to a significant reduction in consumption.

Here are some excerpts from a release issued by the press shop at the University of California Berkeley.

…a new UC Berkeley study shows a 21 percent drop in the drinking of soda and other sugary beverages in Berkeley’s low-income neighborhoods after the city levied a penny-per-ounce tax on sugar-sweetened beverages. …The “Berkeley vs. Big Soda” campaign, also known as Measure D, won in 2014 by a landslide 76 percent, and was implemented in March 2015. …The excise tax is paid by distributors of sugary beverages and is reflected in shelf prices, as a previous UC Berkeley study showed, which can influence consumers’ decisions. …Berkeley’s 21 percent decrease in sugary beverage consumption compares favorably to that of Mexico, which saw a 17 percent decline among low-income households after the first year of its one-peso-per-liter soda tax that its congress passed in 2013.

I’m a wee bit suspicious that we’re only getting data on consumption by poor people.

Why aren’t we seeing data on overall soda purchases?

And isn’t it a bit odd that leftists are happy that poor people are bearing a heavy burden?

I’m also amused by the following passage. The politicians want to discourage people from consuming sugary beverages. But if they are too successful, then they won’t collect all the money they want to finance bigger government.

In Berkeley, the tax is intended to support municipal health and nutrition programs. To that end, the city has created a panel of experts in child nutrition, health care and education to make recommendations to the City Council about funding programs that improve children’s health across Berkeley.

In other words, one of the lessons of the Berkeley sugar tax and the 21-percent drop in consumption is that the Laffer Curve applies to so-called sin taxes just like it applies to income taxes.

But the biggest lesson to learn from this episode is that it confirms the essential insight of supply-side economics. Simply stated, when you tax something, you get less of it.

Which is something that statists seem to understand when they urge higher “sin taxes,” but they deny when the debate shifts to taxes on work, saving, entrepreneurship, and investment.

I’m not joking. I debate leftists all the time and they will unabashedly argue that it’s okay to have higher tax rates on labor income and more double taxation on capital income because taxpayers supposedly don’t care about taxes.

Oh, and the same statists who say that high tax burdens don’t matter because people don’t change their behavior get all upset about “tax havens” and “tax competition” because…well, because people will change their behavior by shifting their economic activity where tax rates are lower.

It must be nice not to be burdened by a need for intellectual consistency.

Speaking of which, Mark Perry used the Berkeley soda tax as an excuse to add to his great collection of Venn Diagrams.

P.S. On the issue of sin taxes, a brothel in Austria came up with an amusing form of tax avoidance. The folks in Nevada, by contrast, believe in sin loopholes. And the Germans have displayed Teutonic ingenuity and efficiency.

Read Full Post »

Among Republicans and conservatives, Ronald Reagan is widely revered as a great President.

From their perspective, he was the candidate who actually made America great again.

Fans of the Gipper tell us the economy rebounded, inflation was tamed, incomes rose, unemployment fell, and the Evil Empire was defeated. What’s not to love?

That’s an impressive list of accomplishments, but is it accurate? Did Reagan and his policies produce good results, or has history created a misleading perspective (just as people for many decades credited Franklin Roosevelt for ending the Great Depression when we now know that FDR’s policies actually lengthened and deepened the downturn)?

Some libertarians are skeptics, arguing that Reagan’s rhetoric about reining in big government was much better than his actual record.

So let’s look at what actually happened in the 1980s.

The place to start, if we want neutral and unbiased data, is Economic Freedom of the World. Annual data for the 1980s isn’t available, but the every-five-year data allows us to see that economic liberty did increase between 1980 and 1990.

By the way, a couple of caveats would be helpful at this point. Reagan entered office in January 1981 and left office in January 1989, so there’s not a perfect overlap between the EFW data and the Reagan years. Also, the EFW data measures changes in a nation’s economic liberty and it silent on whether a president (or the legislative branch) deserves credit or blame.

Now let’s look at the specific components to see the potential impact of Reaganomics on important variables such as fiscal policy, rule of law and property rights, trade policy, regulatory policy, and monetary policy.

I’ve created a table from the data on page 188 of the latest Economic Freedom of the World. As you can see, there was a substantial improvement in fiscal policy, a modest improvement in monetary policy, no change in regulation, no change in rule of law and property rights, and a small drop in trade.

And if you then dig into the EFW excel file and look at the specific variables that are used to create these five scores, you’ll get more details.

On fiscal policy, for instance, there was a modest improvement in the “government consumption” score but a huge jump in the “top marginal tax rate” score. All of which makes sense because the burden of government spending (measured as a share of GDP) fell slightly during the Reagan years while the top tax rate dropped dramatically from 70 percent t0 28 percent.

Monetary policy improved for the obvious reason that the big drop in inflation meant a big increase in the “inflation” score. And the trade score dipped mostly because of an erosion in score for “tariffs.”

Now for my subjective assessment. I think Reagan was even better than shown by the EFW data. Here are three reasons.

  1. The overall burden of government spending only fell by a small amount, but that number masks the fact that domestic spending was reduced significantly as a share of GDP during the Reagan years. That decrease was somewhat offset by a buildup of defense spending, but you can argue that the subsequent collapse of the Soviet Union meant this was a rare instance of government outlays actually generating a positive rate of return.
  2. Reagan’s approach to monetary policy rarely gets the credit it deserves. By supporting a tough anti-inflation policy, he made it possible for the Federal Reserve to restore price stability. It’s very rare for a politician to allow some short-run pain (especially political pain) to achieve long-run gain for the country. And, to be fair, some of the credit goes to Jimmy Carter (though he also deserves blame for letting the inflation genie out of the bottle in the first place).
  3. On trade policy, Reagan’s legacy is much better than indicated by the EFW scores. During his tenure, the NAFTA and GATT/WTO trade liberalization negotiations began and gained considerable steam. Yes, the implementation occurred later (with both the first President Bush and President Clinton deserving credit for following through), but we never would have reached that stage without Reagan’s vision of expanded trade and rejection of the protectionist philosophy.

Last but not least, let’s look at what Reagan’s policies meant for ordinary people. Did more economic liberty lead to better lives?

The answer is yes. The poisonous hidden tax of inflation largely disappeared. The unemployment rate fell. Labor force participation increased (in marked contrast with Obama). And there was a big increase in income for average Americans (again, in sharp contrast with Obama).

No wonder, when presented with a hypothetical matchup, the American people said they would elect Reagan over Obama in a landslide.

P.S. Critics of Reaganomics, including some on the right, inevitably raise the issue of deficits and debt and assert that Reagan failed. I think red ink is the wrong measure, but even for those who fixate on that variable, it’s worth noting that deficits were relatively small by the time Reagan left office and the Congressional Budget Office predicted they would continue falling if his policies were maintained. Moreover, the 1980-1982 double-dip recession was the reason red ink expanded so much during the early Reagan years, and that was primarily the inevitable consequence of the reckless monetary policy of the 1970s.

P.P.S. For Reagan humor, click here, here, and here.

P.P.P.S. If you want to be inspired, click here and here to see two short clips of Reagan in action. And at the bottom of this post, there’s a great video of Reagan embracing libertarianism.

Read Full Post »

About one year ago, Scott Hodge authored a report explaining the mechanics and utility of the Tax Foundation’s Taxes and Growth Dynamic Model. He made a very persuasive argument about the need to modernize and improve the Joint Committee on Taxation’s antiquated revenue-estimating process by estimating the degree to which changes in tax policy impact economic performance. The use of “dynamic scoring,” Scott explained, would produce more accurate data than “static scoring,” which is based on rather bizarre and untenable assumption that the economy’s output is unaffected by taxation.

Conventional scoring treats this process as an exercise in arithmetic, whereas dynamic scoring makes the process an exercise in economics.

Since I’m a proponent of the Laffer Curve, I obviously applaud the Tax Foundation’s superb work on this issue.

And for those who doubt the value of dynamic scoring, I challenge them to come up with an alternative explanation for why rich people paid five times as much tax after Reagan lowered the top tax rate from 70 percent to 28 percent in the 1980s.

But the Laffer Curve isn’t the focus of today’s column. Instead, I want to address the argument that supply-side tax policy (i.e., lower marginal tax rates, less tax bias against saving and investment) is no longer important or desirable.

Writing for Slate, Reihan Salam argues that Donald Trump’s success is a sign that the traditional tax-cutting agenda no longer is relevant.

Why can’t his GOP opponents convince Republican voters that they would do a far better job than Trump of defending middle-class economic interests? …Trump has demonstrated its weakness and the failure of its stale policy agenda to resonate with voters. …The GOP can no longer survive as the party of tax cuts for the rich. …If Republicans are to win the trust of working- and middle-class voters who’ve grown deeply skeptical of their economic nostrums, they will have to do something dramatic: It’s time for the GOP to abandon its near-obsessive devotion to tax cuts that disproportionately benefit upper-income households. …The GOP elite has also yet to grasp that most voters simply don’t care as much about taxes as they did in the Reagan era. …the share of voters who consider their federal tax burden their top priority is a mere 1 percent. To break out of their tax trap, Republicans…should continue to back tax cuts for the middle class, and in particular for middle-class parents. But until the country sees large and sustained budget surpluses, there should be no tax cuts for households earning $250,000 or more.

I’m not an expert on politics, so I won’t pretend to have any insight on whether tax policy motivates voters. But from an economic perspective, assuming the goal is a faster-growing economy that creates broadly shared prosperity, it would be very unfortunate if Republicans abandoned supply-side tax policy.

In the Tax Foundation study, Scott succinctly summarized the issue.

The primary goal of comprehensive tax reform is economic growth. …It is critically important that lawmakers make the right choices that lift everyone’s standards of living.

And here’s what I recently wrote, specifically addressing the assertion that proponents of good policy simply want to help the “rich.”

…It’s not that we lose any sleep about the average tax rate of successful people. We just don’t want to discourage highly productive investors, entrepreneurs, and small business owners from doing things that result in more growth and prosperity for the rest of us.

But what are those “right choices” that “result in more growth and prosperity for the rest of us”?

The Tax Foundation points us in the right direction. Let’s look at some charts (updated versions of the ones in Scott’s report), starting with this estimate of how various tax cuts affect overall economic output.

As you can see, expanded child credits don’t have any positive impact on growth for the simple reason that they don’t alter incentives to work, save, or invest (they may be desirable for other reasons, however). Lower marginal tax rates lead to some added growth, particularly if the top rate is reduced since upper-income taxpayers have far greater control of the timing, level, and composition of their income. But the biggest growth effects come from lowering the corporate tax rate and reducing the tax code’s bias against new investment.

Now let’s take the next step.

If changes in tax policy lead to increases in economic output, that also means a greater amount of taxable income.

So the Tax Foundation also can tell us the degree to which the aforementioned tax cuts will change revenue after 10 years. As you can see, most tax cuts result in less revenue, but in some cases there’s a considerable amount of revenue feedback. And if policy makers shift toward expensing, the long-run effect is more tax revenue.

Now let’s look from the other perspective.

What happens to the economy if various tax hikes are imposed?

As you can see, some tax increases have relatively modest effects on economic output while others significantly discourage productive behavior.

And when you feed the growth effects back into the model, you then can see the likely real-world effect of those tax increases on tax revenue.

So if policy makers impose a relatively benign tax hike, such as scaling back the state and local tax deduction, they will collect a considerable amount of revenue. But if they increase top tax rates on personal income or corporate income, a lot of the projected revenue evaporates. And if they exacerbate the tax bias against new investment, the net effect is less revenue.

By the way, these charts show why the class-warfare tax policies of Hillary Clinton and Bernie Sanders are so misguided. The amount of economic damage per dollar collected would be ridiculous.

Such tax increases wouldn’t be good for rich people, of course, but the real lesson is that the rest of us will be adversely affected because of a slower-growing economy.

The bottom line is that poor people and middle-class people have much more opportunity and prosperity with a Hong Kong-style tax system instead of a punitive French-style tax system.

To conclude, let’s now consider a few caveats.

If you examine the broad measures of what causes prosperity, tax policy is just one piece of the puzzle. The burden of government spending also is important, as is trade policy, regulatory policy, monetary policy, property rights, and the rule of law.

So it’s possible for a nation to be relatively prosperous with bad tax policy so long as it has free-market policies in other areas. It’s also possible for a nation with a good tax system to be poor and stagnant if other economic policies are statist and interventionist.

But if the goal is faster growth and more broadly shared prosperity, why not seek good policy in all areas?

The bottom line is that supply-side tax policies can contribute to better economic performance. In an ideal world, those policies also are politically popular. But even if they aren’t, the policy-making community should strive to educate the populace on what works, not abandon good policy for the sake of short-term political expediency.

P.S. Even international bureaucracies acknowledge the Laffer Curve, which means they understand that changes in tax policy can lead to changes in taxable income.

Read Full Post »

The long-term trend in China is positive. Economic reforms beginning in the late 1970s have helped lift hundreds of millions of people out of abject poverty.

And thanks to decades of strong growth, living standards for ordinary Chinese citizens are far higher than they used to be. There’s still quite a way to go before China catches up to western nations, but the numbers keep improving.

That being said, China’s economy has hit a speed bump. The stock market’s recent performance has been less than impressive and economic growth has faltered.

Is this the beginning of the end of the Chinese miracle?

If you asked me about six months ago, I would have expressed pessimism. The government was intervening in financial markets to prop up prices, and that was after several years of failed Keynesian-style spending programs that were supposed to “stimulate” growth.

But maybe my gloom was premature.

An article in The Economist examines the new “supply-side” focus of China’s leader (h/t: Powerline).

Mr Xi has seemed to channel the late American president. He has been speaking openly for the first time of a need for “supply-side reforms”—a term echoing one made popular during Reagan’s presidency in the 1980s. It is now China’s hottest economic catchphrase (even featuring in a state-approved rap song, released on December 26th: “Reform the supply side and upgrade the economy,” goes one catchy line). …Mr Xi’s first mentions of the supply side, or gongjice, in two separate speeches in November, were not entirely a surprise. For a couple of years think-tanks affiliated with government ministries had been promoting the concept (helped by a new institute called the China Academy of New Supply-Side Economics).

Sounds encouraging, though it’s important to understand that there’s a big difference between rhetoric and reality.

Talking about “gongjice” is a good start, but are Chinese officials actually willing to reduce government’s economic footprint?


Their hope is that such reforms will involve deep structural changes aimed at putting the economy on a sounder footing, rather than yet more stimulus. …Mr Xi’s aim may be to reinvigorate reforms that were endorsed by the Communist Party’s 370-member Central Committee in 2013, a year after he took over as China’s leader. They called for a “decisive” role to be given to market forces

Wow, the communists in China want free markets. Maybe there’s hope for some of America’s more statist politicians!

All kidding aside, there’s some evidence that officials in Beijing realize that the Keynesian experiment of recent years didn’t work any better than Obama’s 2009 spending binge.

Here’s more from the article.

Those who first pushed supply-side reform onto China’s political agenda want a clean break with the credit-driven past. Jia Kang, an outspoken researcher in the finance ministry who co-founded the new supply-side academy, defines the term in opposition to the short-term demand management that has often characterised China’s economic policy—the boosting of consumption and investment with the help of cheap money and dollops of government spending.The result of the old approach has been a steep rise in debt (about 250% of GDP and counting) and declining returns on investment. Supply-siders worry that it is creating a growing risk of stagnation, or even a full-blown economic crisis. Mr Jia says the government should focus instead on simplifying regulations to make labour, land and capital more productive. Making it easier for private companies to invest in sectors currently reserved for bloated state-run corporations would be a good place to start, some of his colleagues argue.

This is music to my ears.

Assuming President Xi is willing to adopt the types of reforms advocated by Mr. Jia, China’s economy will have a very bright future.

The key goal for policy makers in Beijing should be to improve China’s economic freedom score over the next 10 years by as much as it improved between 1980 and 2005.

In other words, if China adopts genuine free markets like Hong Kong and Singapore (and, to a lesser extent, Taiwan), then it will simply be a matter of time before living standards reach – and exceed – levels found in western nations.

I’ll close by outlining two challenges for Beijing.

First, entrenched interest groups will be an obstacle to pro-growth reform. In this sense, politics in China is very similar to politics in Greece, America, France, and South Africa. The sad reality is that too many people – all over the world – think it’s morally acceptable to obtain unearned wealth via the coercive power of government. Though there are reasons to be optimistic because a strong majority of Chinese people have expressed support for free markets.

Second, even if China’s leaders overcome the interest groups and adopt good long-run policy, there’s still the challenge of short-term dislocation and instability caused by so-called stimulus programs and easy-money policy from the central bank. Just like you can’t un-ring a bell, you can’t magically undo the malinvestments caused by those policies. So Beijing will need to weather a temporary economic storm at the same time it engage in long-run reform.

P.S. If you want to know a recipe for Chinese stagnation, simply look at the IMF’s recommendations.

P.P.S. Some senior Chinese officials have a very astute understanding of why welfare states don’t work.

Read Full Post »

When I compared the tax reform proposals of various 2016 presidential candidates last month, Ben Carson got the best grade by a slight margin.

But I’ve now decided to boost his overall grade from a B+ to A-, or perhaps even A, because he’s finally released details and that means his grade for “specificity” jumps from a C to A-.

Here’s some of what’s been reported in the Wall Street Journal.

Republican presidential candidate Ben Carson on Monday called for imposing a 14.9% flat tax rate on income, ending taxes on capital gains and dividends and abolishing the charitable deduction and all tax credits.

By the way, the reporter goofed. Carson is proposing to end double taxation of dividends and capital gains, but all income would be taxed. What the reporter should have explained is that capital and business income would be taxed only one time.

But I’m digressing. Let’s review some additional details.

Mr. Carson’s flat tax would apply only to income above 150% of the poverty level… In some respects, Mr. Carson’s plan is similar to those of the other candidates, all of whom want to lower tax rates… But he goes farther, particularly with his willingness to rip up parts of the tax system that have been in place for a century. …In addition to eliminating the charitable deduction and investment taxation, Mr. Carson would also repeal the estate tax, the mortgage-interest deduction, the state and local tax deduction,  depreciation rules and the alternative minimum tax.

Wow, no distorting preferences for charity or housing. And no double taxation of any form, along with expensing instead of depreciation. Very impressive.

Carson has basically put forth a pure version of the plan first proposed by economists at Stanford University’s Hoover Institution.

Perhaps most important of all, Carson’s plan is a flat tax and just a flat tax. He doesn’t create any new taxes that could backfire in the future.

Here’s what the Carson campaign wrote about his flat tax compared to the plans put forth by Rand Paul and Ted Cruz.

Unlike proposals advanced by other candidates, my tax plan does not compromise with special interests on deductions or waffle on tax shelters and loopholes. Nor does it falsely claim to be a flat tax while still deriving the bulk of its revenues through higher business flat taxes that amount to a European-style value-added tax (VAT). Adding a VAT on top of the income tax would not only impose an immense tax increase on the American people, but also become a burdensome drag on the U.S. economy.

I would have used different language, warning about the danger of a much-higher future fiscal burden because Washington would have both an income tax and a VAT, but the bottom line is that I like Carson’s plan because the worst outcome is that future politicians might eventually recreate the current income tax.

What I don’t like about the Paul and Cruz plans, by contrast, is that future politicians could much more easily turn America into France or Greece.

Here’s my video that explains why the flat tax is the best system (at least until we shrink the federal government to such a degree that we no longer need any form of broad-based taxation).

P.S. If you want to get hyper-technical, Carson’s plan may not be a pure flat tax because he would require a very small payment from everybody (akin to what Governor Bobby Jindal proposed). Though if the “de minimis” payment is a fixed amount (say $50 per adult) rather than a second rate (say 1% on the poor), then I certainly would argue it qualifies as being pure.

P.P.S. Carson still has a chance to move his overall grade to A or A+ if he makes the plan viable by proposing an equally detailed plan (presumably consisting of genuine entitlement reform and meaningful spending caps) to deal with the problem of excessive government spending.

Read Full Post »

Since I’m a big fan of the Laffer Curve, I’m always interested in real-world examples showing good results when governments reduce marginal tax rates on productive activity.

Heck, I’m equally interested in real-world results when governments do the wrong thing and increase tax burdens on work, saving, investment, and entrepreneurship (and, sadly, these examples are more common).

My goal, to be sure, isn’t to maximize revenue for politicians. Instead, I prefer the growth-maximizing point on the Laffer Curve.

In any event, my modest hope is that politicians will learn that higher tax rates lead to less taxable income. Whether taxable income falls by a lot or a little obviously depends on the specific circumstance. But in either case, I want policy makers to understand that there are negative economic effects.

Writing for Forbes, Jeremy Scott of Tax Notes analyzes the supply-side policies of Israel’s Benjamin Netanyahu.

Netanyahu…argued that the Laffer curve worked, and that his 2003 tax cuts had transformed Israel into a market economy and an engine of growth. …He pushed through controversial reforms… The top individual tax rate was cut from 64 percent to 44 percent, while corporate taxes were slashed from 36 percent to 18 percent. …Netanyahu credits these reforms for making Israel’s high-tech boom of the last few years possible. …tax receipts did rise after Netanyahu’s tax cuts. In fact, they were sharply higher in 2007 than in 2003, before falling for several years because of the global recession. …His tax cuts did pay for themselves. And he has transformed Israel into more of a market economy…In fact, the prime minister recently announced plans for more cuts to taxes, this time to the VAT and corporate levies.

Pretty impressive.

Though I have to say that rising revenues doesn’t necessarily mean that the tax cuts were completely self-financing. To answer that question, you have to know what would have happened in the absence of the tax cut. And since that information never will be available, all we can do is speculate.

That being said, I have no doubt there was a strong Laffer Curve response in Israel. Simply stated, dropping the top tax rate on personal income by 20 percentage points creates a much more conducive environment for investment and entrepreneurship.

And cutting the corporate tax rate in half is also a sure-fire recipe for improved investment and job creation.

I’m also impressed that there’s been some progress on the spending side of the fiscal ledger.

Netanyahu explained that the public sector had become a fat man resting on a thin man’s back. If Israel were to be successful, it would have to reverse the roles. The private sector would need to become the fat man, something that would be possible only with tax cuts and a trimming of public spending. …Government spending was capped for three years.

The article doesn’t specify the years during which spending was capped, but the IMF data shows a de facto spending freeze between 2002 and 2005. And the same data, along with OECD data, shows that the burden of government spending has dropped by about 10 percentage points of GDP since that period of spending restraint early last decade.

Here’s the big picture from the Fraser Institute’s Economic Freedom of the World. As you can see from the data on Israel, the nation moved dramatically in the right direction after 1980. And there’s also been an upward bump in recent years.

Since I’m not an expert on Israeli economic policy, I don’t know the degree to which Netanyahu deserves a lot of credit or a little credit, but it’s good to see a country actually moving in the right direction.

Let’s close by touching on two other points. First, there was one passage in the Forbes column that rubbed me the wrong way. Mr. Scott claimed that Netanyahu’s tax cuts worked and Reagan’s didn’t.

Netanyahu might have succeeded where President Reagan failed.

I think this is completely wrong. While it’s possible that the tax cuts in Israel has a bigger Laffer-Curve effect than the tax cuts in the United States, the IRS data clearly shows that Reagan’s lower tax rates led to more revenue from the rich.

Second, the U.S. phased out economic aid to Israel last decade. I suspect that step helped encourage better economic policy since Israeli policy makers knew that American taxpayers no longer would subsidize statism. Maybe, just maybe, there’s a lesson there for other nations?

Read Full Post »

During last night’s Democratic debate, Senator Bernie Sanders said he would not raise tax rates as high as they were in the 1950s. And if Twitter data is accurate, his comment about being “not that much of a socialist compared to [President] Eisenhower” was one of the evening’s most memorable moments.

But a clever line is not the same as smart policy. Promising not to raise top tax rates to 90 percent or above is hardly a sign of moderation from the Vermont politician.

Fortunately, not all Democrats are infatuated with punitive tax rates.

Or at least they didn’t used to be. When President John F. Kennedy took office, he understood that the Eisenhower tax rates (in fairness to Ike, he’s merely guilty of not trying to reduce confiscatory tax rates imposed by FDR) were harming the economy and JFK argued for across-the-board tax rate reductions.

…an economy hampered by restrictive tax rates will never produce enough revenues to balance our budget just as it will never produce enough jobs or enough profits. Surely the lesson of the last decade is that budget deficits are not caused by wild-eyed spenders but by slow economic growth and periodic recessions and any new recession would break all deficit records. In short, it is a paradoxical truth that tax rates are too high today and tax revenues are too low and the soundest way to raise the revenues in the long run is to cut the rates now.

Here’s a video featuring some of President Kennedy’s wisdom on lower tax rates.

If that wasn’t enough, here’s another video featuring JFK’s wisdom on taxation.

By the way, if Senator Sanders really wants the rich to pay more, one of the lessons reasonable people learned from the Kennedy tax cuts is that upper-income taxpayers respond to lower tax rates by earning and reporting more income. Here’s a chart from a study I wrote almost 20 years ago.

Last but not least, let’s preemptively address a likely argument from Senator Sanders. He might be tempted to say that he doesn’t want the 90-percent tax rate of the Eisenhower years, but that he’s perfectly content with the 70-percent top tax rate that existed after the Kennedy tax cuts.

But if that’s the case, instead of teaching Sanders a lesson from JFK, then he needs to learn a lesson from Ronald Reagan.

Read Full Post »

Is “supply-side economics” a bad thing or good thing?

It depends on what one means by the phrase. If it means that all tax cuts are self financing or that low tax burdens are the sole key to prosperity, then critics are right about it being a form of “voodoo economics.” See this Kevin Williamson column for more details.

But if the term is simply a shorthand way of saying that low marginal tax rates on productive behavior are a good thing because of better incentives for work, saving, investment, and entrepreneurship (not to mention tax compliance and good government), then supply-side economics should be non-controversial. See this piece by Alan Reynolds for more details.

As you might expect, folks on the left prefer the first definition of supply-side economics and they are instinctively hostile to big tax cuts. Especially during an election cycle.

Here’s the basic argument, from an article by John Cassidy in The New Yorker. He focuses his ire on Governor Bush, but his comments could just as easily been directed against other GOP candidates.

Here’s his basic premise.

…the Republican Party is heading on economic policy: back to the old-time religion of tax cuts. …Jeb Bush, the G.O.P. establishment’s standard-bearer, announced, as the centerpiece of his 2016 campaign, a plan to cut federal income-tax rates across the board. …wouldn’t this plan inflate the deficit, which President Obama and Congress have just spent five years trying to reduce, and also amount to another enormous handout to the one per cent? Not in the make-believe world of “voodoo economics”.

Mr. Cassidy is particularly incensed by the notion that some people believe tax cuts “pay for themselves” by generating sufficiently large amounts of additional taxable income.

The “voodoo” accusation arose from the claim that, because the policies would encourage people to work harder and businesses to invest more, a lot more taxable income would be produced, and the reductions in tax rates wouldn’t lead to a commensurate reduction in the amount of tax revenues that the government collected. Indeed, some early voodoo economists, such as Arthur Laffer, claimed that there wouldn’t be any drop in revenues. By 1988…more than half a decade of gaping budget deficits had discredited the most extreme and foolhardy version of voodoo economics.

For what it’s worth, there are several problems with the above passages.

First, while some GOPers did make exaggerated claims about the power of tax cuts, the Reagan White House never claimed the tax cuts would by self financing and instead made the very reasonable argument that lower tax rates would improve economic performance.

Second, the lower tax rates on upper-income taxpayers did lead to huge increases in taxable income and big increases in tax revenue, so there are a few examples where lower tax rates “pay for themselves.”

Third, the 1980-1982 double-dip recession was the main reason for higher deficits. Once the Reagan tax cuts were implemented, red ink began to shrink and even the Congressional Budget Office projected deficits would continue falling if Reagan’s policies were left on auto-pilot.

But let’s argue about the present rather than the past. Citing the work of some pro-Bush economists, Cassidy argues that tax cuts won’t generate as much growth as Governor Bush says he will deliver.

…the four conservative luminaries whom the Bush campaign rounded up to advise him…said that Bush’s tax plan would raise the growth rate of the economy by 0.5 per cent a year, and that the regulatory changes he is proposing would add another 0.3 per cent to the annual growth rate. But because the annual growth rate over the past five years has been 2.2 per cent, that gets us to three per cent growth, not the four per cent that Bush is promising to deliver.

Since economists are lousy forecasters, I won’t pretend to know how much additional growth the Bush economic plan would produce. But I’ll be the first to admit that Cassidy has found a gap between Bush’s rhetoric and the numbers produced by his advisers.

But does that mean big tax cuts are implausible and unrealistic?

Cassidy certainly would like readers to conclude that Bush’s plan doesn’t add up.

…the economists’ paper…makes the familiar argument that tax cuts, by stimulating growth, will lead to “revenue feedbacks.” On this basis, which is known on Capitol Hill as “dynamic scoring,” the economists reduce the estimated fiscal cost of the Bush tax cuts by two-thirds. But even a third of $3.6 trillion is a lot of red ink.

Though he (sort of) acknowledges that the Bush folks have a counter-argument.

So are the economists actually contradicting Bush and saying that his plan would expand the deficit? Not quite. …they write, “The remaining revenue loss would be offset by reasonable, incremental feedback effects from the tax and regulatory reforms, meaningful spending restraint across the federal budget…” Of course, Bush hasn’t said yet where he would cut spending

I don’t know if Governor Bush intends to produce a detailed list of ways to restrain government spending. Nor do I know whether he would follow through if he got elected (his record in Florida can be interpreted in different ways).

But I know that it’s actually very simple to have large tax cuts along with concomitant spending restraint.

And Bush’s economic advisers also understand. Take a look at these passages from their report. Citing a version of my Golden Rule, they point out that huge savings are possible simply by reducing how fast the government’s budget expands every year.

Budget discipline and economic prosperity go hand in hand. …federal spending restraint is essential to maximizing economic growth. …the Governor’s economic reforms require strong fiscal discipline on the federal budget ledger’s spending side. …the required budget goal can be achieved by reducing the growth in federal outlays from its current upward trajectory by one percentage point per year. From 2017 to 2025, federal expenditures are projected to increase at an annual rate of 4.2 percent. Limiting the increase to 3.2 percent will produce over $400 billion in budget savings in 2025 and $1.4 trillion in savings between 2017 and 2025.

Needless to say, we should have big – and immediate – reductions in government spending.

And if government is allowed to expand, it would be better if the budget grew at the rate of inflation (2 percent) rather than 3.2 percent.

That being said, it’s remarkable that even a little bit of spending restraint is capable of generating huge savings over a 10-year period. And those savings make big tax cuts very plausible. Even for the folks who myopically fixate on red ink when they should be worried about the overall burden of government spending.

So the real issue is not whether sizable tax cuts are plausible. It’s whether advocates of good tax policy are willing to impose accompanying discipline on the spending side of the fiscal ledger.

That means a President like Ronald Reagan or Bill Clinton rather than George Bush or Barack Obama.

Interestingly, Jeb Bush admits spending grew too fast while his brother was in office. Check out what he said toward the end of this interview.

For what it’s worth, I think the Bush White House was just as guilty as the GOP Congress, if not more, but that’s another fight over what happened in the past.

What really matters is that if Jeb Bush (or any other candidate for President) is serious about charting a different path and putting government on a diet, then big tax cuts are very realistic.

Read Full Post »

In my 2012 primer on fundamental tax reform, I highlighted the three biggest warts in the current system.

1. High tax rates that penalize productive behavior such as work and entrepreneurship.

2. Pervasive double taxation that undermines saving and investment.

3. Corrupt loopholes and cronyism that lure people into using resources inefficiently.

These problems all need to be addressed, along with additional problems with the internal revenue code, such as worldwide taxation and erosion of constitutional freedoms and civil liberties.

Based on these criteria, I’ve already reviewed the tax reform plan put forth by Marco Rubio. And I’ve analyzed the proposal introduced by Rand Paul.

Now let’s apply the same treatment to the “Reform and Growth Act of 2017” that former Florida Governor Jeb Bush has unveiled in today’s Wall Street Journal.

Bush identifies three main goals, starting with lower tax rates.

First, I want to lower taxes and make the tax code simple, fair and clear. …We will cut individual rates from seven brackets to three: 28%, 25% and 10%. At 28%, the highest tax bracket would return to where it was when President Ronald Reagan signed into law his monumental and successful 1986 tax reform.

This is a positive step, effectively wiping out the tax-rate increases imposed by Presidents George H.W. Bush, Bill Clinton, and Barack Obama.

Then Governor Bush takes aim at tax loopholes.

Second, I want to eliminate the convoluted, lobbyist-created loopholes in the code. For years, wealthy individuals have deducted a much greater share of their income than everyone else. We will retain the deductibility of charitable contributions but cap the deductions used by the wealthy and Washington special interests, enabling tax-rate cuts across the board for everyone.

This also is a step in the right direction, though it’s unclear what Bush is proposing – if anything – for other big tax loopholes such as the mortgage interest deduction, the healthcare exclusion, the state and local tax deduction, and the municipal bond exemption.

The final big piece of Jeb’s plan deals with America’s punitive treatment of business income.

Third, I believe that the tax code should no longer be an impediment to the nation’s competitiveness with China, Europe and the rest of the world. …To stop American companies from moving out of the country, I will cut the corporate tax rate from 35%—the highest in the industrial world—to 20%, which is five percentage points below China’s. We will end the practice of world-wide taxation on U.S. businesses, which fosters the insidious tactic called corporate “inversions.” …We will also allow businesses to fully and immediately deduct new capital investments—a critical step to increase worker productivity and wages.

All of these reforms are very good for growth.

A lower corporate tax rate, particularly combined with territorial taxation and “expensing” of investment expenditures, will make American companies far more competitive.

More important, these reforms will fix flaws in the tax code that reduce capital formation. And that will mean more investment and higher wages for American workers.

There are other positive features mentioned in the column that are worth celebrating. Governor Bush’s plan eliminates the death tax, which is an especially punitive form of double taxation.

His proposal also gets rid of the alternative minimum tax (AMT), which is a convoluted part of the tax code seemingly designed to grab more money from taxpayers in a very complicated fashion.

Now let’s move to a part of Bush’s plan that seems bad, but arguably is good. He’s proposing to get rid of interest deductibility for companies, which will increase double taxation (remember, investors who buy corporate bonds pay tax on the interest payments they receive from firms).

…we will eliminate most corporate tax deductions—which is where favor-seeking and lobbying are most common—and remove the deduction for borrowing costs. That deduction encourages business models dependent on heavy debt.

So why is this feature arguably good when one of the key goals of tax reform is eliminating double taxation?

For two reasons. First, we already have double taxation of dividends (i.e., equity-financed investment), so imposing double taxation on borrowing (i.e., debt-financed investment) creates a level playing field and addresses the bias for debt in the tax code.

To be sure, it would be best to level the playing field by having no double taxation of any kind, but presumably the Bush team also was paying attention to revenue constraints.

And this is the second reason why this portion of the plan arguably is good. The revenue implications of this change are non-trivial, so one could argue that it is helping to finance pro-growth changes such as a lower corporate tax rate and immediate expensing of business investment.

Let’s close by highlighting some unambiguously worrisome features of the Bush plan.

According to his column, an additional 15 million Americans no longer will have any income tax liability, largely because the plan almost doubles the standard deduction. It’s good for people not to have to pay tax, of course, but we already have a system where almost half of all households are exempt from the income tax. So the concern is that we have a growing share of the population that perceives government as a no-cost dispenser of goodies.

And one of those goodies is the Earned Income Tax Credit, which is a form of income redistribution operated through the tax code. And Bush is proposing to expand the EITC, though there aren’t any details about this part of his plan.

Presumably Bush is including these provisions to somewhat fend off the class-warfare attack that his plan provides big tax cuts for the “rich” while not doing enough for the rest of the population. Yet upper-income taxpayers already pay the lion’s share of the income tax.

Even the IRS has acknowledged that the top 3 percent pay more than half the burden!

So a fair tax cut, by definition, will benefit the rich since they’re the ones who are carrying the load.

In any event, the purpose of good tax policy is to generate faster growth by improving incentives for work, saving, investment, and entrepreneurship, and that’s where you get the big benefits for lower- and middle-income taxpayers.

Simply stated, the close you get to a Hong Kong-style flat tax, the closer you get to robust Hong Kong-type growth rates.

The bottom line is that Bush’s tax plan isn’t a touchdown. Like the Rubio plan and Paul plan, it’s not a Hall-Rabushka flat tax, which is the gold standard for tax reform. But it’s a big step in that direction. Bush takes the ball from the wrong side of the field and puts it on the right side of the field.

If implemented (and accompanied by the spending restraint needed to make the plan sustainable), Bush’s proposal would be a significant boost for the American economy and American taxpayers.

Read Full Post »

Every so often, I’ll assert that some statists are so consumed by envy and spite that they favor high tax rates on the “rich” even if the net effect (because of diminished economic output) is less revenue for government.

In other words, they deliberately and openly want to be on the right side (which is definitely the wrong side) of the Laffer Curve.

Critics sometimes accuse me of misrepresenting the left’s ideology, to which I respond by pointing to a poll of left-wing voters who strongly favored soak-the-rich tax hikes even if there was no extra tax collected.

But now I have an even better example.

Writing for Vox, Matthew Yglesias openly argues that we should be on the downward-sloping portion of the Laffer Curve. Just in case you think I’m exaggerating, “the case for confiscatory taxation” is part of the title for his article.

Here’s some of what he wrote.

Maybe at least some taxes should be really high. Maybe even really really high. So high as to useless for revenue-raising purposes — but powerful for achieving other ends. We already accept this principle for tobacco taxes. If all we wanted to do was raise revenue, we might want to slightly cut cigarette taxes. …But we don’t do that because we care about public health. We tax tobacco not to make money but to discourage smoking.

The tobacco tax analogy is very appropriate.

Indeed, one of my favorite arguments is to point out that we have high taxes on cigarettes precisely because politicians want to discourage smoking.

As a good libertarian, I then point out that government shouldn’t be trying to control our private lives, but my bigger point is that the economic arguments about taxes and smoking are the same as those involving taxes on work, saving, investment.

Needless to say, I want people to understand that high tax rates are a penalty, and it’s particularly foolish to impose penalties on productive behavior.

But not according to Matt. He specifically argues for ultra-high tax rates as a “deterrence” to high levels of income.

If we take seriously the idea that endlessly growing inequality can have a cancerous effect on our democracy, we should consider it for top incomes as well. …apply the same principle of taxation-as-deterrence to very high levels of income. …Imagine a world in which we…imposed a 90 percent marginal tax rate on salaries above $10 million. This seems unlikely to raise substantial amounts of revenue.

I suppose we should give him credit for admitting that high tax rates won’t generate revenue. Which means he’s more honest than some of his fellow statists who want us to believe confiscatory tax rates will produce more money.

But honesty isn’t the same as wisdom.

Let’s look at the economic consequences. Yglesias does admit that there might be some behavioral effects because upper-income taxpayers will be discouraged from earning and reporting income.

Maybe…we really would see a reduction of effort, or at least a relaxation of the intensity with which the performers pursue money. But would that be so bad? Imagine the very best hedge fund managers and law firm partners became inclined to quit the field a bit sooner and devote their time to hobbies. What would we lose, as a society? …some would presumably just move to Switzerland or the Cayman Islands to avoid taxes. That would be a real hit to local economies, but hardly a disaster. …Very high taxation of labor income would mean fewer huge compensation packages, not more revenue. Precisely as Laffer pointed out decades ago, imposing a 90 percent tax rate on something is not really a way to tax it at all — it’s a way to make sure it doesn’t happen.

While I suppose it’s good that Yglesias admits that high tax rates have behavioral effects, he clearly underestimates the damaging impact of such a policy.

He presumably doesn’t understand that rich people earn very large shares of their income from business and investment sources. As such, they have considerable ability to alter the timing, level, and composition of their earnings.

But my biggest problem with Yglesias’ proposals is that he seems to believe in the fixed-pie fallacy that public policy doesn’t have any meaningful impact of economic performance. This leads him to conclude that it’s okay to rape and pillage the “rich” since that will simply mean more income and wealth is available for the rest of us.

That’s utter nonsense. The economy is not a fixed pie and there is overwhelming evidence that nations with better policy grow faster and create more prosperity.

In other words, confiscatory taxation will have a negative effect on everyone, not just upper-income taxpayers.

There will be less saving and investment, which translates into lower wages and salaries for ordinary workers.

And as we saw in France, high tax rates drive out highly productive people, and we have good evidence that “super-entrepreneurs” and inventors are quite sensitive to tax policy.

To be fair, I imagine that Yglesias would try to argue that these negative effects are somehow offset by benefits that somehow materialize when there’s more equality of income.

But the only study I’ve seen that tries to make a connection between growth and equality was from the OECD and that report was justly ridiculed for horrible methodology (not to mention that it’s hard to take serious a study that lists France, Spain, and Ireland as success stories).

P.S. This is my favorite bit of real-world evidence showing why there should be low tax rates on the rich (in addition, of course, to low tax rates on the rest of us).

P.P.S. And don’t forget that leftists generally view higher taxes on the rich as a precursor to higher taxes on the rest of the population.

P.P.P.S. In the interests of full disclosure, Yglesias says I’m insane and irrational.

Read Full Post »

When I debate class warfare issues, here’s something that happens with depressing regularity.

I’ll cite research from a group like the Tax Foundation on how an overwhelming share of the income tax is borne by upper-income taxpayers.

The statist I’m arguing with will then scoff and say the Tax Foundation is biased, thus implying that I’m sharing bogus data.

I’ll then respond that the group has a very good reputation and that their analysis is directly based on IRS data, but I may as well be talking to a brick wall. It seems leftists immediately close their minds if information doesn’t come directly from a group that they like.

So I was rather happy to see that the Internal Revenue Service, in the Spring 2015 Statistics of Income Bulletin, published a bunch of data on how much of the income tax is paid by different types of taxpayers.

I’ll be very curious to see how they respond when I point out that their favorite government agency admits that the bottom 50 percent of earners only pay 2.8 percent of all income tax. And I’ll be every more curious to see how they react when I point out that more than half of all income taxes are paid by the top 3 percent of taxpayers.

There’s a famous saying, generally attributed to Daniel Patrick Moynihan, that “Everyone is entitled to his own opinion, but not his own facts.”

With this in mind, I’m hoping that this data from the IRS will finally put to rest the silly leftist talking point that the “rich” don’t pay their “fair share.”

This doesn’t mean, by the way, that the debate about policy will be settled.

Getting statists to accept certain facts is just the first step.

But once that happens, we can at least hope that their minds will be opened to subsequent steps, such as understanding the economic impact of punitive tax rates, recognizing that high tax rates won’t necessarily collect more revenue, or realizing that ordinary workers suffer when harsh tax policies reduce economic vitality.

Though I’m not holding my breath and expecting miracles. After all, some leftists openly state that they don’t care if the economic damage of high tax rates is so significant that government doesn’t collect any tax revenue.

You can see an example of one of these spite-motivated people at the 4:20 mark of the video I narrated on class-warfare taxation.

P.S. Shifting to another tax topic, some of you may have heard about the massive data breach at the IRS. Here’s some of what CNN is reporting.

The Internal Revenue Service believes that a major cyber breach that allowed criminals to steal the tax returns of more than 100,000 people originated in Russia, Rep. Peter Roskam confirmed to CNN on Thursday. …The IRS announced Tuesday that organized crime syndicates used personal data obtained elsewhere to access tax information, which they then used to file $50 million in fraudulent tax refunds.

I suppose I could use this opportunity to take a few potshots at the IRS, but there’s a far more important issue to raise.

I’m guessing the IRS probably has the best computer security of any tax bureaucracy in the world. Yet even all the IRS’s expertise couldn’t stop hackers from obtaining sensitive information.

Now let’s contemplate something truly frightening. The Obama Administration wants the United States to be part of an OECD pact that obligates participating nations to promiscuously share information with dozens of other governments, including untrustworthy, hostile, and/or corrupt regimes such as Russia and China, not to mention make information available to jurisdictions that presumably will have very little technical capacity to guard data from hackers and identity thieves. Here’s the list of participating nations on the OECD website, and it includes Azerbaijan, Cameroon, Greece, Indonesia, Mexico, Nigeria, Romania, Saudi Arabia, and Ukraine.

Yet none of this reckless endangerment would be an issue if we had a simple territorial tax system like the flat tax. Under such a simple and fair system, only income inside America’s borders would be taxed (unlike the wretched system of worldwide taxation we have now), so there would be no need to have risky information-swapping deals with dodgy foreign governments.

P.P.S. Senator Rand Paul is one of the few lawmakers fighting to protect Americans from having their information shared with foreign governments.

P.P.P.S. Shifting back to the original topic of class-warfare taxation, here’s a lesson on the Laffer Curve I offered to President Obama.

Read Full Post »

The American Enterprise Institute has published a comprehensive budgetary plan entitled, “Tax and spending reform for fiscal stability and economic growth.”

Authored by Joseph Antos, Andrew G. Biggs, Alex Brill, and Alan D. Viard, all of whom I know and admire, this new document outlines a series of reforms designed to restrain the growth of government and mitigate many of the tax code’s more punitive features.

Compared to current law, the plan is a huge improvement.

But huge improvement isn’t the same as perfect, so here’s my two cents on what’s really good, what’s partially good, and what has me worried.

I’ll start with something that’s both good and bad.

According to the latest CBO estimates, federal tax revenues for 2015 will absorb 17.7 percent of GDP and spending will consume 20.4 percent of economic output. Now look at this table showing the impact of the AEI proposal. As you can see, the burden of taxes and spending will both be higher in the future than today.

That’s obviously bad. One would think a conservative organization would present a plan that shrinks the size of government!

But here’s the catch. Under current law, the burden of government is projected to climb far more rapidly, largely because of demographic changes and poorly designed entitlement programs. So if we do nothing and leave government on auto-pilot, America will be saddled with a European-sized welfare state.

From that perspective, the AEI plan actually is good since it is based on reforms that stop most – but not all – of the already-legislated expansions in the size of the public sector.

So here’s the bottom line. Compared to what I would like to see, the AEI plan is too timid. But compared to what I fear will happen, the AEI plan is reasonably bold.

Now let’s look at the specific reforms, staring with tax policy. Here’s some of what’s in the report.

The goal of our tax reform is to eliminate the income tax’s inherent bias against saving and investment and to reduce other tax distortions. To achieve this goal, the income tax system and the estate and gift taxes would be replaced by a progressive consumption tax, in the form of a Bradford X tax consisting of a…37 percent flat-rate firm-level tax on business cash flow and a graduated-rate household-level tax, with a top rate of 35 percent, on wages and fringe benefits.

At the risk of oversimplifying, the AEI folks decided that it was very important to solve the problem of double taxation and not so important to deal with the problem of a discriminatory and punitive rate structure. Which is sort of like embracing one big part of the flat tax while ignoring the other big part.

We’d have a less destructive tax code than we have now, but it wouldn’t be as good as it could be. Indeed, the plan is conceptually similar to the Rubio-Lee proposal, but with a lot more details.

Not that I’m happy with all those additional details.

To address environmental externalities in a more cost-effective and market-based manner, energy subsidies, tax credits, and regulations would be replaced by a modest carbon tax. The gasoline tax would be increased to cover highway-related costs.

I’m very nervous about giving Washington a new source of revenue. And while I’m open (in theory) to the argument that a carbon tax would be a better (less worse) approach than what we have now, I’m not sure it’s wise to trust that politicians won’t pull a bait and switch and burden us with both a costly energy tax and new forms of regulatory intervention.

And I definitely don’t like the idea of a higher gas tax. The federal government should be out of the transportation business.

There are also other features that irk me, including the continuation of some loopholes and the expansion of redistribution through the tax code.

Child and dependent care expenses could be deducted… A 15 percent refundable credit for charitable contributions… A 15 percent refundable credit for mortgage interest… A refundable credit for health insurance…the EITC for childless workers would be doubled relative to current law.

Though I should also point out that the new tax system proposed by AEI would be territorial, which would be a big step in the right direction. And it’s also important to note that the X tax has full expensing, which solves the bias against investment in a depreciation-based system.

But now let’s look at the most worrisome feature of the plan. It explicitly says that Washington should get more money.

… we also cannot address the imbalance simply by cutting spending… The tax proposals presented in this plan raise necessary revenues… Over time, tax revenue would gradually rise as a share of GDP… The upward path of tax revenue is necessary to finance the upward path of federal spending.

This is very counterproductive. But I don’t want to regurgitate my ideological anti-tax arguments (click here if that’s what you want). Let’s look at this issue from a strictly practical perspective.

I’ve reluctantly admitted that there are potential tax-hike deals that I would accept, at least in theory.

But those deals will never happen. In the real world, once the potential for additional revenue exists, the appetite for genuine spending restraint quickly evaporates. Just look at the evidence from Europe about the long-run relationship between taxes and debt and you’ll see that more revenue simply enables more spending.

Speaking of which, now let’s shift to the outlay side of the fiscal ledger.

We’ll start with Social Security, where the AEI folks are proposing to turn Social Security from a substandard social insurance program, which is bad, to a flat benefit, which might even be worse since it involves a shift to a system that is even more focused on redistribution.

The minimum benefit would be implemented immediately, increasing benefits for about one third of retirees, while benefits for middle- and high-earning individuals would be scaled down to the wage-indexed poverty level between now and 2050.

Yes, the system they propose is more fiscally sustainable for government, but what about the fact that most workers are paying record amounts of payroll tax in exchange for a miserly monthly payment?

This is why the right answer is personal retirement accounts.

The failure to embrace personal accounts may be the most disappointing feature of the AEI plan. And I wouldn’t be surprised if the authors veered in this unfortunate direction because they put the cart of debt reduction ahead of the horse of good policy.

To elaborate, a big challenge for real Social Security reform is the “transition cost” of financing promised benefits to current retirees and older workers when younger workers are allowed to shift their payroll taxes to personal accounts. Dealing with this challenge presumably means more borrowing over the next few decades, but it would give us a much better system in the long run. But this approach generally isn’t an attractive option for folks who fixate on near-term government debt.

That being said, there are spending reforms in the proposal that are very appealing.

The AEI plan basically endorses the good Medicare and Medicaid reforms that have been part of recent GOP budgets. And since those two programs are the biggest drivers of our long-run spending crisis, this is very important.

With regards to discretionary spending, the program maintains sequester/Budget Control Act spending levels for domestic programs, which is far too much since we should be abolishing departments such as HUD, Agriculture, Transportation, Education, etc.

But since Congress presumably would spend even more, the AEI plan could be considered a step in the right direction.

Finally, the AEI plan calls for military spending to consume 3.8 percent of economic output in perpetuity. National defense is one of the few legitimate functions of the federal government, but that doesn’t mean the Pentagon should get a blank check, particularly since big chunks of that check get used for dubious purposes. But I’ll let the foreign policy and defense crowd fight that issue since it’s not my area of expertise.

P.S. The Heritage Foundation also has thrown in the towel on personal retirement accounts and embraced a basic universal flat benefit.

P.P.S. On a completely different topic, here’s a fascinating chart that’s being shared on Twitter.

As you can see, the United States is an exception that proves the rule. I don’t know that there are any policy implications, but I can’t help but wonder whether America’s greater belief in self-reliance is linked to the tendency of religious people to believe in individual ethics and moral behavior.

Read Full Post »

In my ultimate fantasy world, Washington wouldn’t need any sort of broad-based tax because we succeeded in shrinking the federal government back to the very limited size and scope envisioned by our Founding Fathers.

In my more realistic fantasy world, we might not be able to restore constitutional limits on Washington, but at least we could reform the tax code so that revenues were generated in a less destructive fashion.

That’s why I’m a big advocate of a simple and fair flat tax, which has several desirable features.

The rate is as low as possible, to minimize penalties on productive behavior.

There’s no double taxation, so no more bias against saving and investment.

And there are no distorting loopholes that bribe people into inefficient choices.

But not everyone is on board, The class-warfare crowd will never like a flat tax. And Washington insiders hate tax reform because it undermines their power.

But there are also sensible people who are hesitant to back fundamental reform.

Consider what Reihan Salam just wrote for National Review. He starts with a reasonably fair description of the proposal.

The original flat tax, championed by the economists Robert Hall and Alvin Rabushka, which formed the basis of Steve Forbes’s flat-tax proposal in 1996, is a single-rate tax on consumption, with a substantial exemption to make the tax progressive at the low end of the household-income distribution.

Though if I want to nit-pick, I could point out that the flat tax has effective progressivity across all incomes because the family-based exemption is available to everyone. As such, a poor household pays nothing. A middle-income household might have an effective tax rate of 12 percent. And the tax rate for Bill Gates would be asymptotically approaching 17 percent (or whatever the statutory rate is).

My far greater concerns arise when Reihan delves into economic analysis.

…the Hall-Rabushka tax would be highly regressive, in part because high-income households tend to consume less of their income than lower-income households and because investment income would not be taxed (or rather double-taxed).

This is a very schizophrenic passage since he makes a claim of regressivity even though he acknowledged that the flat tax has effective progressivity just a few sentences earlier.

And since he admits that the flat tax actually does tax income that is saved and invested (but only one time rather than over and over again, as can happen in the current system), it’s puzzling why he says the system is “highly regressive.”

If he simply said the flat tax was far less progressive (i.e., less discriminatory) than the current system, that would have been fine.

Here’s the next passage that rubbed me the wrong way.

…there is some dispute over whether ending the double taxation of savings would yield significant growth dividends. Chris William Sanchirico of Penn Law School takes a skeptical view in a review of the academic research on the subject, in part because cutting capital-income taxation as part of a revenue-neutral reform would require offsetting increases in labor-income taxation, which would dampen long-term economic growth in their own right.

I’m not even sure where to start. First, Reihan seems to dismiss the role of dynamic scoring in enabling low tax rates on labor. Second, he cites just one professor about growth effects and overlooks the overwhelming evidence from other perspectives. And third, he says the flat tax would be revenue neutral, when virtually every plan that’s been proposed combines tax reform with a tax cut.

On a somewhat more positive note, Reihan then suggests that lawmakers instead embrace “universal savings accounts” as an alternative to sweeping tax reform.

Instead of campaigning for a flat tax, GOP candidates ought to consider backing Universal Savings Accounts (USAs)… The main difference between USAs and Roth IRAs is that “withdrawals could be made at any time for any reason,” a change that would make the accounts far more attractive to far more people. …Unlike a wholesale shift to consumption taxation, USAs with a contribution limit are a modest step in the same general direction, which future reformers can build on.

I have no objection to incremental reform to reduce double taxation, and I’ve previously written about the attractiveness of USAs, so it sounds like we’re on the same page. And if you get rid of all double taxation and keep rates about where they are now, you get the Rubio-Lee tax plan, which I’ve also argued is a positive reform.

But then he closes with an endorsement of more redistribution through the tax code.

Republicans should put Earned Income Tax Credit expansion and other measures to improve work incentives for low-income households at the heart of their tax-reform agenda.

I want to improve work incentives, but it’s important to realize that the EIC is “refundable,” which is simply an inside-the-beltway term for spending that is laundered through the tax code. In other words, the government isn’t refunding taxes to people. It’s giving money to people who don’t owe taxes.

As an economist, I definitely think it’s better to pay people to work instead of subsidizing them for not working. But we also need to understand that this additional spending has two negative tax implications.

  1. When politicians spend more money, that either increases pressure for tax increases or it makes tax cuts more difficult to achieve.
  2. The EIC is supposed to boost labor force participation, but the evidence is mixed on this point, and any possible benefit with regards to the number of people working may be offset by reductions in actual hours worked because the phase out of the EIC’s wage subsidy is akin to a steep increase in marginal tax rates on additional labor supply.

In any event, I don’t want the federal government in the business of redistributing income. We’ll get much better results, both for poor people and taxpayers, if state and local government compete and innovate to figure out the best ways of ending dependency.

The rest of Reihan’s column is more focused on political obstacles to the flat tax. Since I’ve expressed pessimism on getting a flat tax in my lifetime, I can’t really argue too strenuously with those points.

In closing, I used “friendly fight” in the title of this post for a reason. I don’t get the sense that Mr. Salam is opposed to good policy. Indeed, I would be very surprised if he preferred the current convoluted system over the flat tax.

But if there was a spectrum with “prudence” and “caution” on one side and “bold” and “aggressive” on the other side, I suspect we wouldn’t be on the same side. And since it’s good for there to be both types of people in any movement, that’s a good thing.

P.S. I got a special treat this morning. I was at Reagan Airport for a flight to Detroit at the same time as a bunch of America’s World War II vets arrived on an Honor Flight to visit the WWII Memorial.

Here’s my rather pathetic attempt to get a photo of one of the vets being greeted.

Since I’ll never be in demand as a photographer, you should watch this video to learn more about this great private initiative to honor World War II veterans.

Read Full Post »

« Newer Posts - Older Posts »

%d bloggers like this: