Author Archive
Entitlements vs. Liberty
A reporter asked me about the rise in entitlement programs and the problems created with so many people suckling on the federal teet. I’ve reported that the federal government has more than 2,000 different subsidy programs.
Another way to track the growth of America’s subsidy culture is to look at the usage frequency of “entitlement” over time using a Google tool that shows word usage in books published in the United States.
The first chart shows the sharp rise in the use of “entitlement” in the 1970s (and a curious fall since 2000).
The second chart shows an antonym: liberty. It’s usage fell throughout the 20th century, and it plunged in the 1970s. However, a hopeful sign is the upward spike in “liberty” in the last year of the chart, which was 2008. Was that a sign of the beginning of the revolt that would become the tea party?
Competitiveness: Let Markets Lead the Way
The American Enterprise Institute’s Kevin Hassett held a conference the other day on the idea of international “competitiveness.” He invited me to comment on his new co-authored paper that tries to nail down the murky meaning of the word.
The paper suggests that for a solid definition of “competitiveness,” we should look to the literature on Tiebout competition, which is competition between local jurisdictions for inflows of labor and capital.
Kevin and co-authors suggest that as global labor and capital mobility have increased, countries are now competing with each other the same way that local jurisdictions do. In Global Tax Revolution, Dan Mitchell and I discuss why Tiebout competition is a positive force promoting fiscal reforms worldwide. This is competitiveness in a good way.
By contrast, Paul Krugman wrote an excellent article in 1994 criticizing the vacuous way that “competitiveness” was thrown around by pundits such as Robert Reich and Lester Thurow. Books by such authors suggest that the global economy is a giant wrestling match, and that other countries will slam Team America to the mat unless we have more government planning and subsidies.
At the AEI forum, I noted that America does have to adapt to the realities of globalization, but most of that adaptation can and should occur in the private sector. For example, America needs larger and more efficient seaports to handle rising volumes of international trade. But rather than shoveling more taxpayer money into our government seaports, we should privatize them so that they can expand in response to rising market demands.
The World Economic Forum publishes a well-known index of country competitiveness. Kevin and coauthors think the index is dubious, but the WEF report is packed with interesting data. One WEF indicator of competitiveness (page 391) is “quality of seaports.” Hong Kong is ranked #1, and its seaport is privately financed, owned, and operated. American seaports are ranked #22, and they are generally government-owned.
The upshot is that when thinking about America’s “competitiveness”—however it is defined—we should think about the proper roles of the public and private sectors. The public sector can pursue tax reform to make us more of a magnet for capital and skilled labor. But when it comes to such things as infrastructure, education, and investing in “industries of the future,” the government should get out of the way and let entrepreneurs and markets drive America’s prosperity in the global economy.
Warren Buffett’s Tax Story Is Bogus
For years, Warren Buffett has been claiming that his secretary pays a higher tax rate than he does. Recently, President Obama has taken that claim and run with it. I don’t know Mr. Buffett’s particular tax situation, but I do know that his claim as a general matter is bogus.
Let’s look at some numbers. The first chart shows IRS data for income tax rates by income group for 2009. These are average effective tax rates, calculated as income taxes paid divided by adjusted gross income (AGI). The chart shows that taxpayers with incomes above $500,000 had tax rates averaging about 25 percent. Middle-income taxpayers had tax rates of half of that or less. A few years ago, Buffett claimed that his secretary earned $60,000 and paid a 30 percent tax rate. But looking just at income taxes, that seems way off. (Note that this data doesn’t include the “refundable” portion of tax credits, which wipes out taxes for many people at the bottom end).
Perhaps Buffett was referring to the fact that his secretary pays a heavy load of payroll taxes in addition to income taxes. But when you look at data which includes all federal taxes, the system is still highly graduated with much higher rates at the top end.
Chart 2 shows CBO data for 2007 on average effective tax rates, including essentially all federal taxes—individual income, corporate income, payroll, and excise. Buffett’s secretary would fit into the fourth group in the chart, where the average tax rate was 17.4 percent. So if she is really paying 30 percent, then Buffett needs to show her some of his tax-reduction tricks. Note in the chart that Buffett’s peers in the top 1 percent paid an average rate of 29.5 percent, which is double the rate paid by middle-income taxpayers.
In 2007, Buffett said that he paid a 17.7 percent tax rate. Alan Reynolds notes that Buffett earns large amounts of capital gains, which are taxed at a maximum federal rate of 15 percent. People in the top income groups do report a lot of capital gains, which reduces their overall effective tax rate. However, capital gains are included in chart 1, above, and you can see that the top income groups still pay much higher tax rates than others on average. One reason is that a large amount of income at the top is small business income, which is hit by ordinary income tax rates of up to 35 percent.
You have to go to the extreme top end of the income spectrum in order for capital gains realizations to really push down overall effective tax rates. The IRS publishes data for the 400 highest-income taxpayers. For these taxpayers, the average effective income tax rate in 2008 was 18.1 percent.
Since the beginning of the income tax, we have nearly always had special treatment of capital gains for some very good reasons, as I discuss here. I point out that virtually all high-income nations recognize that capital gains are different and that special rules are needed. A number of OECD nations have long-term capital gains tax rates of zero, including New Zealand and the Netherlands.
Another important aspect to this debate regards the link between capital gains and dynamism in the economy and dynamism in tax payments. The political left makes it seem as if there were a permanent aristocracy at the top end of the income spectrum in America. However, IRS data show the exact opposite—the top 400 are a highly dynamic group. Notice first in IRS Table 1 that 57 percent of AGI for these taxpayers is capital gains. That is a key reason why the people in this group are constantly changing—large capital gains realizations are occasional events that rocket people to the top of the AGI heap. One example is when an entrepreneur sells her successful and longstanding business and retires.
The last table in the IRS document reveals the dynamism. The IRS traced the identities of all taxpayers who showed up in the top 400 anytime between 1992 and 2008. The IRS found that there were a huge 3,672 different taxpayers who appeared during that timeframe. Of these 3,672, fully 73 percent only appeared once in the top 400! And 85 percent appeared only once or twice.
So at the top end of our capitalist system is a continual generation of new wealth and new wealthy people, and that dynamism reflects the still-energetic and free-wheeling nature of our economy.
Peter Schiff: For Jobs, Look to Microeconomics
Peter Schiff’s testimony to a House committee yesterday on the nation’s economic crisis provides a refreshing contrast to the Keynesian-dominated commentary that saturates the mainstream media.
Peter talks about how:
- The president’s jobs plan would create perverse hiring and firing incentives
- Infrastructure investment needs to earn a positive net return else it’s not worth doing.
- The minimum wage increases unemployment for low-skill workers
- Regulation and litigation reduce hiring
- Extended unemployment benefits exacerbate unemployment.
It’s all Econ 101 microeconomics, but it’s often forgotten these days by economists and pundits who only see the world through the lens of “aggregate demand.”
Capital Gains Taxes: Washington Post Omissions
Washington Post reporters write a few thousand words on capital gains taxes today, and they somehow forget to mention the key economic factors in favor of a lower rate.
One factor is that the double taxation of corporate equity under an income tax system creates a serious economic distortion. Corporate profits are taxed at the business level and then again at the individual level by taxes on dividends and capital gains. Providing a lower rate for dividends and gains at the individual level is one way to partly alleviate the distortion.
Another factor is that inflation causes investment returns to be overtaxed in an income tax system without special rules to compensate. If someone buys a stock for $10 and sells it a few years later for $15, some portion of the tax paid will be tax on inflation. The effect of taxing people on inflationary gains is to reduce real returns and distort the tax code against investment.
These problems have led virtually every industrial nation to adopt special rules for taxing long-term capital gains. Most countries have either a reduced individual rate or a partial exclusion. About a dozen advanced economies — for example, the Netherlands and New Zealand — have long-term capital gains tax rates of zero. The Post managed to miss this international reality in its reporting.
The following chart from Global Tax Revolution shows capital gains tax rates in the high-income nations of the OECD. The chart is a little dated now, but it makes the point that our federal capital gains tax rate of 15 percent is pretty average — it is not some sort of unique right-wing giveaway to rich people, as the Post story implies.
Davis-Bacon Rules Damage D.C.
The Washington Post reports on a Labor Department decision that applies pro-union Davis-Bacon rules to the CityCenter development in Washington D.C. The ruling could push up costs on the project by $20 million by forcing firms to pay artificially high wages.
The paper says that “area real estate developers and construction executives who have partnered with the District say the ruling, if upheld, is likely to inflate costs on a wide range of projects by as much as 15 percent.” In turn, that could have “unprecedented, significant [and] adverse citywide cost impact upon every economic development project in the District’s portfolio,” said a deputy mayor of the city. So while Democrats in Congress are demanding government action to fix the nation’s supposedly crumbling infrastructure, here the Obama administration has thrown up a new hurdle to investment.
Davis-Bacon rules usually apply to federally funded construction, thus pushing up the costs of public projects. Nationwide, economists at the Beacon Hill Institute found that Davis-Bacon rules cost federal taxpayers about $9 billion annually. For example, repairs to National Park facilities cost more than they should, thus reducing the amount of maintenance the agency can do within its budget. However, the D.C. ruling stretches the Davis-Bacon rules even further because CityCenter is a privately funded project.
In an essay at www.DownsizingGovernment.org, economist Charles Baird notes that passage of Davis-Bacon in 1931 was motivated by the faulty economic idea that the government should try to keep wages high during an economic downturn. But Baird describes another reason why Davis-Bacon was misguided from the start—the racist intentions of the bill’s supporters:
Congress wanted to keep black workers from competing for jobs that had hitherto been done by white unionized labor. The racist motivation behind the legislation is plain when reading the Congressional Record of the debate in 1931.
Total State Spending Has Not Been Cut
Expressing his Keynesian view of the economy, Federal Reserve Board Chairman Ben Bernanke said this yesterday:
While the weakness of the housing sector and continued financial volatility are two key reasons for the frustratingly slow pace of the recovery, other factors also may restrain growth in coming quarters. For example, state and local governments continue to tighten their belts by cutting spending and reducing payrolls in the face of ongoing budgetary pressures…
Mr. Bernanke made a boo-boo. Overall state and local government spending has not been “cut” any year in the last decade. In recent years, spending has been flat at about $2.2 trillion, but it has not been cut.
I think the Keynesian formulation that government spending equals economic growth is bizarre. But even if true, Bernanke’s concern that state and local governments aren’t profligate enough is strange because spending is up about 60 percent over the last decade, as shown in the chart below. The chart shows “total expenditures” for state and local governments from BEA Table 3.3. The figure for 2011 is the 2nd quarter value, which is up 3.1 percent over 2nd quarter 2010. So, despite Benanke’s claim, spending is (unfortunately) growing again.
Obama’s Job Speech Full of Bad Ideas
I note on National Review today that President Obama’s “jobs” package is full of bad ideas, including:
- A temporary payroll tax cut. This is not a tax cut at all because the president would “pay for it” with tax hikes later on. And if it’s temporary, it won’t encourage businesses to hire additional workers anyway.
- More federal infrastructure. When the federal government spends on infrastructure, it often misallocates the funds. The list of federal infrastructure boondoggles and cost overruns is endless — in public housing, dam-building, Corps of Engineers projects, bridges to nowhere, high-speed rail, etc. Instead, what we need is higher-quality infrastructure spending financed and built by the private sector. We need private airports, private air-traffic control, and private toll highways.
- A federal infrastructure bank. Such a financial scheme would reduce transparency in federal spending, which would go directly against a key Obama promise of increased budget transparency.
- Federal jobs training programs. Since the 1960s, federal jobs-training programs simply haven’t worked.
- New business tax credits. New tax credits for hiring will distort business decisionmaking and, by making the tax code more complicated, such credits would encourage more tax cheating. They would be the exact sort of tax loophole that Obama claims to hate.
- Crony capitalism. When Obama talks about “government and business working side-by-side,” it sounds to me like an invitation to corruption.
- Extending unemployment insurance. Such subsidies would help keep the unemployment rate high.
Rather than all this big-government micromanagement, federal policymakers should pursue a large and clean corporate tax rate cut. Obama did talk vaguely about corporate-tax reform tonight, but I’ll believe that when I see it.
For Jobs, Cut the Corporate Tax Rate
As we wait for President Obama’s big “jobs” speech tonight, here are a few thoughts.
The way to think about jobs is to think first about investment. Workers are expensive, so businesses don’t hire them willy nilly. Instead, businesses seeking new markets build factories and buy machines. Then they hire the number of workers they need to run the new machines and maximize their profits.
If President Obama wants more hiring, he should make it more profitable for businesses to invest in the United States. The simplest and most direct way to do that would be to chop America’s uniquely high corporate tax rate of 40 percent, which includes the 35 percent federal rate and the average state rate. That reform could be combined with cuts to federal spending—such as business subsidies–so as not to increase the deficit.
A corporate rate cut makes political sense for Obama because it would be both pro-business and pro-labor. The nonpartisan Joint Committee on Taxation ran two macroeconomic models in 2005 and found that a corporate rate cut would “provide incentives for increased investment in corporate capital. Over time, this increased investment results in more goods and services and higher total output. It also results in higher labor productivity, leading to increased wages and employment.”
How big a rate cut do we need? According to KPMG, the global average corporate tax rate fell over the last decade from 32 percent to just 25 percent. Thus, cutting our rate by at least 15 percentage points would match the global average, and it would be bold stroke by Obama to get the economy booming again before the upcoming election
Spending in the Tax Code
The IRS made payments of $4.2 billion last year in refundable tax credits to illegal aliens, according to an audit by the Treasury’s Inspector General. “Refundable” tax credits are cash subsidies — federal outlays — given to people who don’t pay any income tax.
Even by Washington standards, flushing $4.2 billion down the drain in a single year is pretty impressive. And what’s weird in this case is that federal law is apparently ambiguous about whether or not these payments should have been made.
The larger problem here is that the overall cost of refundable tax subsidies has skyrocketed in recent years. The chart shows the outlay portions of the largest two refundable tax credits—the earned income tax credit (EITC) and the child tax credit (CTC). (This is fiscal year federal budget data).
- The EITC has grown in cost from $4.4 billion in 1990, to $26.1 billion in 2000, and to an estimated $44.9 billion in 2011.
- The CTC was enacted in 1997, and then its cost rose from $0.8 billion in 2000 to an estimated $22.9 billion in 2011.
Note that the $4.2 billion paid to illegal aliens is not the only rip-off element of these refundable tax subsidies. For decades, auditors have been finding an enormous amount of errors and fraud in EITC payments. The IRS currently estimates that the error and fraud rate in the EITC is between 24 and 29 percent, or more than $10 billion a year in waste.
The CTC and EITC should be scrapped. The CTC started out as a Republican effort to distort the tax code in a socially conservative manner, and it has now morphed into a large welfare program. As for the EITC—any program that hands out one-quarter of its spending erroneously and fraudulently is grossly unfair to the taxpayers who are footing the bills.
Federal Infrastructure Spending: How About This Boondoggle?
President Obama is planning to deliver a big speech on jobs and the economy. His wish list for Congress will likely include more government infrastructure spending. (Infrastructure spending is also on Rachel Maddow’s wish list).
So that citizens know what the president is talking about, they should review the success of the government’s past infrastructure projects. Here’s one to consider:
It’s the Yuma Desalting Plant in Arizona, built by the federal Bureau of Reclamation at a taxpayer cost of $245 million. After completing the plant in 1993, Uncle Sam said: “Whoops, we don’t need it after all.” The plant has sat idle for almost two decades, and taxpayers are getting hit for $6 million a year to maintain it.
It gets worse. The purpose of the Yuma plant is to reverse some of the environmental damage done by government-subsidized irrigation farming. As irrigation waters reflow back into Western rivers, they boost saline levels and can make the water useless for downstream users. The Yuma plant was supposed to desalinate some of the irrigation flow into the Colorado River, but the government spent more money to build a separate 73-mile canal to drain water straight to the ocean.
I imagine that irrigation farming makes economic sense in many places. The problem is that the federal government has vastly subsidized dams and irrigation infrastructure in the West without regard to economics or sound environmental practices. Check out the costly environmental mess created by federal irrigation subsidies in the San Joaquin Valley of California. Or consider the environmental problems in the Florida Everglades caused by federal sugar subsidies and Corps of Engineers infrastructure, which, once again, taxpayers are helping to pay to clean up.
Billions of dollars of infrastructure spending by the Bureau of Reclamation has gone into white elephant projects. Imagining that more federal infrastructure will be a panacea for the economy is a liberal fairy tale, detached from the actual experience of most federal agencies over the last century.
Federal Spending Hits $4.1 Trillion
If you looked at the new CBO report on the budget, you may have noticed that federal spending this year will be $3.6 trillion.
In fact, federal spending this year will top $4 trillion. But virtually all reporters and budget wonks (including me) routinely use the lower number when discussing total federal spending. I don’t think the higher $4 trillion number even appears anywhere in the CBO report.
The $3.6 trillion figure is “net” outlays. But “gross” outlays, or total spending, is quite a bit higher. The difference is caused by “offsetting collections” and “offsetting receipts.” These are revenue inflows to the government that are netted against spending at the program level, agency level, or government-wide level. Some examples are national park fees, Medicare premiums, and royalties earned on mineral deposits. There are hundreds of these cash inflows to the government that offset reported spending.
Details on these revenue offsets can be found in Chapter 16 of OMB’s Analytical Perspectives (pdf). In fiscal year 2010, net federal outlays were $3.456 trillion, but gross outlays were $4.057 trillion. Thus, gross outlays were 17 percent larger than widely reported net outlays.
In FY 2011, OMB expects gross outlays to be about 15 percent larger than net outlays. Thus, gross outlays this year will be $4.1 trillion, compared to net outlays of $3.6 trillion. As a share of GDP, gross outlays will be about 27.3 percent of GDP, compared to net outlays of 23.8 percent.
Accounting for offsets in this manner is a long-standing convention, but it is one of the sneaky ways that Washington tries to hide its large intrusion into the economy. Certainly, the CBO and OMB should include more prominent presentations of gross outlays in their regular budget updates.
For citizens and reporters, a rule-of-thumb to remember is that total federal spending is 3 to 4 percentage points of GDP larger than usually reported by officials.
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