Archive for the ‘Tax and Budget Policy’ Category
Tax Complexity: Am I a Liar?
Andrew Sullivan cited an op-ed of mine last week regarding the complexity of the tax code.
One person commenting on Andrew’s article said:
I am a corporate tax lawyer with 25 years’ experience. I can’t prove it, but in my experience the vast majority of the complexity of the tax law has nothing to do with tax breaks. It has to do with providing precise rules to deal with an infinite variety of structures and transactions, in the face of taxpayers and their tax counsel who are determined to minimize their tax bill. Rules relating to tax breaks are insignificant in volume compared to the rules relating to consolidated tax returns, corporate reorganizations, foreign tax credits, taxation of the foreign subsidiaries of U.S. corporations (Subpart F) and hundreds of other things.
The Cato Institute article you link to is filled with lies and half-truths (which is about what I would expect from a Cato Institute article on taxes). The ‘tax rules’ do not span 73,608 pages and do not cover nine feet of shelf space. The standard CCH edition of the Code is 5,500 pages long, but that is highly misleading. That volume is targeted at tax practitioners and includes old statutory provisions that have been repealed or revised. Because of the obscure way that the regs are paginated, it is not easy to tell how many pages they are, but I would estimate it at about 30,000 pages, which includes proposed regs and the preambles to regulations. The entire set of Code and regs takes up about 18 inches on my shelf. To give you an idea about how much the Code and regs have expanded over the years, my set from 1987 takes up around 10 inches.
The volume that Chris Edwards describes in the Cato article probably refers to the bound CCH Standard Federal Tax Reporter, which may indeed cover nine feet and contain 73,608 pages. However, that volume is exclusively designed for practitioners and includes not only the Code and regs, but also commentary written by CCH and annotations from case law.
I don’t understand why people make such snarky comments when they clearly haven’t done their homework. Let me note first that I mainly agree with the writer’s first paragraph, at least with respect to the business tax code. He points to what I call “homemade” loopholes, which are different from the loopholes specifically legislated by Congress for special interests. Homemade loopholes stem from the inherent complexity of taxing business income, and they are an important reason why chopping the high U.S. corporate tax rate would create a large dynamic response from businesses. That is, it would not be worth the cost or legal risk for businesses to invent so many tax avoidance tricks if we had a much lower corporate tax rate. If we cut the rate, the U.S. corporate tax base would expand automatically as homemade loopholes shrank.
Now, about those “lies.” CCH itself publicizes the data I used showing federal tax rules spanning 73,608 pages. The CCH folks have been publishing information on federal taxation since 1913, so they know what they are talking about. Note that I said tax “rules” not tax “code.” The total rules that tax practitioners have to take into account are lengthier than just the code and regulations, and that’s what the broader CCH publication captures.
By the way, my “nine feet of shelf space” comes straight from the IRS National Taxpayer Advocate. This official watchdog agency cites (on pages 4/5) the nine-foot CCH Standard Federal Tax Reporter as one of their metrics of tax complexity. In the past, I’ve called CCH analysts to discuss with them the meaning of their published page counts.
It is true that average households don’t get into the nitty gritty of those nine feet of rules. But many thousands of highly paid professionals do have to on behalf of their individual and business tax clients. That is part of the reason why the current federal tax system is so wasteful. It consumes the time and energy of a huge number of skilled people, probably including the grumpy tax lawyer who called me a liar.
If the CCH page count doesn’t convince Mr. Grumpy that the tax system is wasting a lot of human effort, here is one more IRS Advocate factoid for him to consider (page 5):
Two companies publish newsletters daily that report on new developments in the field of taxation; the print editions often run 50-100 pages and the electronic databases contain substantially more detailed information.
U.S. Conference of Catholic Bishops and Spending Cuts
House Budget Committee chairman Paul Ryan (R-WI) and Speaker John Boehner (R-OH) are pushing back against criticism from the U.S. Conference of Catholic Bishops over the GOP’s proposed cuts to domestic spending programs. They should.
The USCCB’s criticism comes at a time when it’s appropriately fighting the Obama administration’s mandate that Church-affiliated employers must provide health insurance that covers birth control. As a Catholic, it pains me that the bishops apparently do not recognize that a central government that is big and powerful enough to spend billions of other people’s dollars on housing, food, and health care programs, which the bishops support, is inevitably going to shove its tentacles into areas where they’re not wanted. In other words, if you play with fire, there’s a good chance you’re going to get burnt.
The bishops have now sent four letters to Congress that call on policymakers to “create a ‘circle of protection’ around poor and vulnerable people and programs that meet their basic needs and protect their lives and dignity.” Oh please. Even if it were the proper role of the federal government to fund such programs, the government’s efforts have been inefficient and often counterproductive. If anything, the massive federal welfare state that has sprung up over the past five decades has stripped countless Americans of their dignity by making them reliant on the cold hand of the bureaucrat.
Note this paragraph from a USCCB letter that argues against cuts to housing programs:
Read the rest of this post »
World Bank: Anti–Money Laundering Rules Hurt the Poor
I’ve complained many times about the pointless nature of anti–money laundering laws. They impose very high costs and force banks to spy on their customers, but they are utterly ineffective as a weapon against criminal activity. Yet politicians and bureaucrats keep making a bad system worse, and the latest development is a silly scheme to ban $100 bills!
It also seems that poor people are the main victims of these expensive and intrusive laws. According to a new World Bank study, half of all adults do not have a bank account, with 18 percent of those people (click on the chart below for more info) citing documentation requirements—generally imposed as part of anti–money laundering rules—as a reason for being unable to participate in the financial system.
But this understates the impact on the poor. Of those without bank accounts, 25 percent said cost was a factor, as seen in the chart below. One of the reasons that costs are high is that banks incur regulatory expenses for every customer, in large part because of anti–money laundering requirements, and then pass those costs on to consumers.
Federal Funds for Cleaning Up Abandoned Mines
An article in the Wall Street Journal offers another example of the problem with the federal government tackling issues that should be left to the states to resolve. Congress passed a law in 1977 requiring coal companies to pay a fee that was to be used to help the states clean up abandoned mines. As is often the case, the distribution of funds to the states has been distorted by politics:
Wyoming officials figured they would get large payouts every year because their state was producing so much coal. But the money had to be “appropriated” by Congress, meaning lawmakers had to vote each year on who would receive it. That often didn’t happen, so a lot of the money sat unused, including hundreds of millions of dollars that Wyoming officials believed belonged in their state.
In 2006, as parts of the law were set to expire, Sen. Mike Enzi (R., Wyo.) won passage of a measure that allowed the money to flow as “mandatory” spending, meaning it didn’t have to be voted on by Congress each year. In addition, it allowed Wyoming, three other states and three Native American tribes to use their money, including funds not distributed in prior years, with virtually no strings attached. Those four states and three tribes were certified as having taken care of their most severe abandoned coal mine problems. Other states had to use the money more narrowly for mine problems.
The next year, the Wyoming legislature voted to spend $50 million in coal-mine funds to build a new science, technology, engineering and math building at the university. Groundbreaking for the building, to be named after Mr. Enzi, is slated to begin this year.
Federal and state officials from Wyoming argue that if their coal companies generated the fees, Wyoming should get the money. The Obama administration argues that the funds were supposed to be used for cleaning up abandoned mines, not renovating a basketball area at the University of Wyoming, which is what the state’s legislature intends to spend $10 million in federal mine cleanup money on.
Both sides have a point, but I think there’s a better, simpler solution: let Wyoming and the rest of the states with abandoned mines decide how to clean them up. Why must the fee (i.e., tax) money be laundered through Washington where it’s inevitably going to be manipulated by parochial-minded politicians? The answer is that it needn’t, but getting the politicians in Washington to part with a pot of money is like trying to take a bone from a bulldog. And for all their complaining about federal involvement in state affairs, state politicians love getting money from Washington to spend because it allows them to avoid having to directly ask their taxpayers to pony up.
See this Cato essay for more on fiscal federalism. See here for more on downsizing the Department of the Interior.
Milton Friedman on Tax Freedom Day
The Tax Foundation reported that Tuesday was Tax Freedom Day (TFD), which is the day that Americans stop “working for the government” through their tax payments and start working for themselves.
TFD is calculated by taking total federal, state, and local taxes and dividing by national income to get a ratio representing the share of income that the average person pays in all taxes. That ratio is applied to the 365-day calendar. This year the ratio is 29.2 percent, which translates into April 17 for TFD. Time to party!
But maybe not quite yet…
When I worked at Tax Foundation in 1993, I mailed a letter to Milton Friedman asking about his view on TFD. He kindly responded with a letter and a 1974 Newsweek article in which he proposed a “Personal Independence Day.” That day would be based on total government spending, which is larger than total taxes, and thus our day to celebrate freedom from the government hasn’t yet arrived this year.
In his letter to me, Friedman stressed that total spending is the important variable in assessing the burden of government: “If government spends an amount equal to 50 percent of the national income, only 50 percent is left to be available for private purposes, and that is true however the 50 percent that government spends is financed.” And while some economists focus on how government borrowing may “crowd out” private investment, Friedman said, “What does the crowding out is government spending, however financed, not government deficits.”
In its TFD report, Tax Foundation includes a supplemental calculation looking at spending. The thinktank figures that Americans will work until May 14 this year to be free from the burden of federal, state, and local spending. The Foundation is lacking a snappy name for that important day, but now we are reminded that Friedman has already suggested one.
Friedman hoped that “Personal Independence Day” would complement our national Independence Day of July 4. The latter is the day we celebrate independence from the “Royal Brute of Britain,” as Tom Paine called him in Common Sense. But for Paine and the other Founders, the deeper goal of July 4, 1776 was to create a limited government to ensure the maximum space for the exercise of individual freedom. As Paine noted, private “society in every state is a blessing, but government, even in its best state, is but a necessary evil.”
So Milton Friedman’s Personal Independence Day can be our annual reminder that while our forefathers gave the boot to the “crowned ruffians” of Old Europe, we’ve still got work to do in limiting the power grabbing of our own elected ruffians in Washington.
Time for Me to Defend My Work on Tax Havens
A few days ago, I explained why I’m a big fan of tax competition. Simply stated, we need to subject governments to competitive pressure to at least partially offset the tendency of politicians to over-tax and over-spend.
Tax havens play an important role in this liberalizing process, largely because they do not put themselves under any obligation to enforce the bad tax laws of other jurisdictions. They also use privacy laws to protect their sovereign control of what gets taxed inside their borders (this is what separates a “tax haven” from a more conventional low-tax jurisdiction). This means they are fiscal safe zones, particularly for people who want to protect their assets from the pervasive double taxation that exists in so many nations.
Not everybody agrees with my analysis (gee, what a surprise). To cite one example, the petty bureaucrats at the OECD got so agitated at me in 2009 (when I was offering advice to representatives of so-called tax havens while standing in a public lobby of a public hotel) that they threatened to have me thrown in a Mexican jail.
Now I have a new critic, though hopefully someone who would never consider thuggish tactics to suppress dissent. Ann Hollingshead writes for the Task Force on Financial Integrity and Economic Development, which (notwithstanding the name of the organization) seems to favor bigger government.
Anyhow, she wrote an article specifically criticizing my work on tax havens. So I figured it was time for a fisking, which means a point-by-point rebuttal. Here’s how she begins, and I’ll follow up her points with my responses.
Officially Dan Mitchell is a Senior Fellow at the Cato Institute, a conservative public policy research organization, and a researcher on tax reform. Unofficially, he has (perhaps ironically?) called himself the “world’s self-appointed defender of so-called tax havens.”
No irony on my part. As I have openly stated, tax havens are a key part of tax competition, which is a necessary (though sadly not sufficient) process to restrain the greed of the political class.
Oddly enough, Mitchell and I agree on many of the facts about these havens. We both have observed, for example, that there are buildings in Delaware and the Cayman Islands that house thousands of corporations. Mitchell concludes there is nothing wrong with either; I conclude there is something wrong with both. Mitchell also agrees that the United States“could be considered the world’s largest tax haven.” On that topic, he’s even cited my paper on non-resident deposits in secrecy jurisdictions. In his comment, he does not take issue with my methodology or my results, but rather concludes that my finding that the United States is the largest holder of non-resident deposits “makes the case for pro-market policies.” I, on the other hand, have argued that these findings support across the board reform, rather than that limited to traditional offshore financial centers.
Fair enough. We both recognize that the United States is a big tax haven. But we have different conclusions. I think it is unfortunate that only non-resident foreigners can benefit from these policies, while Ann wants to crack down on small low-tax jurisdictions such as Monaco, Bermuda, Liechtenstein, and the Cayman Islands, as well as big nations such as the United States. Sadly, Ann’s side has somewhat prevailed, and many of the havens have agreed to become deputy tax collectors for nations with bad tax law.
So how is it that two (relatively intelligent?) people can draw such different conclusions? I would argue our differences lie not in our facts, or perhaps even our economics, but in our underlying philosophical and theoretical differences.
I guess I should be happy that she holds out the possibility that I’m “relatively intelligent.”
Fleecing the Taxpayer in Las Vegas
Today POLITICO Arena asks:
Are the GSA/Las Vegas spending scandals a major political headache for the Obama administration, since they happened on its watch? Or can Democrats distance themselves from the seemingly renegade agency?
My response:
What?! Government waste, fraud, and abuse?! I’m shocked! Shocked!
This could be a political headache for the Obama administration, but only if Republicans play it right — so Obama probably doesn’t have much to worry about. The basic principle could not be simpler: as Milton Friedman so often put it, no one spends someone else’s money as carefully as he spends his own. That applies in spades to government.
So here’s the political point. Democrats, unlike Republicans (at least nominally), belong to the party of government. For every problem, they see not a private but a government solution. Market competition disciplines private abuses — not perfectly, to be sure, but far better than whatever controls there may be in the public sector. That’s one reason we should turn to government not as a first but as a last resort. You don’t like being abused as a taxpayer? Then don’t vote for the party of government.
The Joy of Tax
To celebrate Tax Day, NPR gives us a peppy, upbeat interview with the commissioner of the IRS, Douglas Shulman. Shulman enthuses:
“When people hear the letters, ‘I-R-S,’ sometimes they have a negative connotation,” Shulman says. “But 80 percent of Americans get an average of a $3,000 refund. So most people actually have a very pleasant experience with us.”
Alas, 80 percent of Americans are hornswoggled into giving the IRS an interest-free loan for up to 15 months, and then — or so the IRS assures us — they’re very happy to get their own money back, a year later, with no interest.
It reminds me of the maxim of Jean-Baptiste Colbert, minister of finance under the absolutist Louis XIV:
The art of taxation consists in so plucking the goose as to obtain the largest amount of feathers with the least possible amount of hissing.
When you establish withholding so that most taxpayers don’t realize how much they’re paying, and then you “give” them a refund, apparently you can minimize the hissing. And I suppose that’s why Shulman tells NPR:
You hope every day’s going to be a good day in the morning when you wake up. When you’re IRS commissioner, most days are good days.
When you’re the taxpayer, not so much.
Obamanomics on Display
Today POLITICO Arena asks:
Is the Buffett Rule a step toward tax fairness? Or, as Hill Republicans argue, is it a gimmick that would do nothing to boost job growth or make a real dent in paying down the nation’s ballooning debt? Which side of the argument will win politically in November?
My response:
Not only will the “Buffett Rule” not reduce the national debt, but because it’s meant to offset the revenue lost from changes in the Alternative Minimum Tax, the combined effect will be to increase the debt. To quote from Saturday’s Wall Street Journal: “The Joint Tax Committee—the official scoring referee on tax bills—calculates that the combination of AMT repeal for the middle class and the Buffett tax would add $793.3 billion to the debt over the next decade.”
Far worse than that, as a tax on capital, the Buffett Rule will drive investment, and jobs, overseas. But will ”fairness” win in November, even if not this week in Congress? As a Democratic wag once said, “You can fool all of the people some of the time, and some of the people all of the time, and that’s good enough.” We shall see.
The Laffer Curve Shows that Tax Increases Are a Very Bad Idea – even if They Generate More Tax Revenue
The Laffer Curve is a graphical representation of the relationship between tax rates, tax revenue, and taxable income. It is frequently cited by people who want to explain the common-sense notion that punitive tax rates may not generate much additional revenue if people respond in ways that result in less taxable income.
Unfortunately, some people misinterpret the insights of the Laffer Curve. Politicians, for instance, tend to either pretend it doesn’t exist, or they embrace it with excessive zeal and assume all tax cuts “pay for themselves.”
Another problem is that people assume that tax rates should be set at the revenue-maximizing level. I explained back in 2010 that this was wrong. Policy makers should strive to set tax rates at the growth-maximizing level. But since a growth-generating tax is about as common as a unicorn, what this really means is that tax rates should be set to produce enough revenue to finance the growth-maximizing level of government – as illustrated by the Rahn Curve.
That’s the theory of the Laffer Curve. What about the evidence? Where are the revenue-maximizing and growth-maximizing points on the Laffer Curve?
Well, ask five economists and you’ll get nine answers. In part, this is because the answers vary depending on the type of tax, the country, and the time frame. In other words, there is more than one Laffer Curve.
With those caveats in mind, we have some very interesting research produced by two economists, one from the Federal Reserve and the other from the University of Chicago. They have authored a new study that attempts to measure the revenue-maximizing point on the Laffer Curve for the United States and several European nations. Here’s an excerpt from their research.
Figure 6 shows the comparison for the US and EU-14. …Interestingly, the capital tax Laffer curve is affected only very little across countries when human capital is introduced. By contrast, the introduction of human capital has important effects for the labor income tax Laffer curve. Several countries are pushed on the slippery slope sides of their labor tax Laffer curves. …human capital turns labor into a stock variable rather than a flow variable as in the baseline model. Higher labor taxes induce households to work less and to acquire less human capital which in turn leads to lower labor income. Consequently, the labor tax base shrinks much more quickly when labor taxes are raised.
There’s a bit of jargon in this passage, so here are the charts from Figure 6. They look complex, but here are the basic facts to make them easy to understand.
The top chart shows the Laffer Curve for labor taxation, and the bottom chart shows the Laffer Curve for capital taxation. And both charts show different curves for the United States and an average of 14 European nations. Last but not least, the charts show how the Laffer Curves change is you add some real-world assumptions about the role of human capital.
Some people will look at these charts and conclude that there should be higher tax rates. After all, neither the U.S. or E.U. nations are at the revenue-maximizing point (though the paper explains that some European nations actually are on the downward-sloping portion of the curve for capital taxes).
But let’s think about what higher tax rates imply, and we’ll focus on the United States. According to the first chart, labor taxes could be approximately doubled before getting to the downward-sloping portion of the curve. But notice that this means that tax revenues only increase by about 10 percent.
This implies that taxable income would be significantly smaller, presumably because of lower output, but also perhaps due to some combination of tax avoidance and tax evasion.
The key factoid (assuming my late-at-night, back-of-the-envelope calculations are right) is that this study implies that the government would reduce private-sector taxable income by about $20 for every $1 of new tax revenue.
Does that seem like good public policy? Ask yourself what sort of politicians are willing to destroy so much private sector output to get their greedy paws on a bit more revenue.
What about capital taxation? According to the second chart, the government could increase the tax rate from about 40 percent to 70 percent before getting to the revenue-maximizing point.
But that 75 percent increase in the tax rate wouldn’t generate much tax revenue, not even a 10 percent increase. So the question then becomes whether it’s good public policy to destroy a large amount of private output in exchange for a small increase in tax revenue.
Once again, the loss of taxable income to the private sector would dwarf the new revenue for the political class. And the question from above bears repeating. What should we think about politicians willing to make that trade?
And that’s the real lesson of the Laffer Curve. Yes, the politicians usually can collect more revenue, but the concomitant damage to the private sector is very large and people have lower living standards. So that leaves us with one final question. Do we think government spending has a sufficiently high rate-of-return to justify that kind of burden? This Rahn Curve video provides the answer.
Welfare and Private Charity
A new policy paper from my colleague Michael Tanner analyzes the growth in the American welfare state and concludes that “throwing money at the problem has neither reduced poverty nor made the poor self-sufficient.” Michael makes an important point that—in my experience—most journalists don’t seem to appreciate:
In addition, whatever the intention behind government programs, they are soon captured by special interests. The nature of government is such that programs are almost always implemented in a way to benefit those with a vested interest in them rather than to actually achieve the programs’ stated goals… Among the nonpoor with a vital interest in antipoverty programs are social workers and government employees who administer the programs and business people, such as landlords and physicians, who are paid to provide services to the poor. Thus, anti-poverty programs are usually more concerned with protecting the prerogatives of the bureaucracy than with actually fighting poverty.
That’s one reason why you have federal officials actually celebrating the fact that more and more Americans are signing up for food stamps. Sure, adding millions of people to the food stamps roll is good for the Department of Agriculture’s budget, but is it good for the country? Perhaps if one thinks that government bureaucracies are ideally suited to provide for the less fortunate. However, that’s a tough claim to make given the fraud, abuse, and wasteful bureaucratic overhead costs associated with the government model. And let’s not forget that the government is not a charity; rather, it must resort to compulsion and force in order to carry out its politically-inspired objectives.
Instead of celebrating government dependency, we ought to be celebrating those private charities that are effectively meeting the needs of the less fortunate through voluntary donations. For example, Congressman Ron Paul (R-TX) recently went to the House floor to laud a private charity called Convoy of Hope. From Paul’s speech:
Unlike government bureaucracies and many top-heavy private charities, Convoy of Hope applies a uniquely results-oriented approach to serving people. You won’t find bloated salaries or patronage jobs at Convoy of Hope, nor will you find tony offices in New York or Los Angeles like so many nonprofits. In fact, the organization regularly spends only about 10% of its budget on overhead (a very low ratio in the nonprofit world), while employing a small staff of approximately 85. Watchdog group Charity Navigator consistently gives Convoy of Hope high marks for both its financial acumen and transparency.
ALEC’s Rich States, Poor States
The American Legislative Exchange Council (ALEC) released the fifth edition of its “Rich States, Poor States” report yesterday. For fiscal wonks the report is a fun read, as it is chock full of tax and economic comparisons between the 50 states.
The first part of the report is a “Supply Side 101” lesson on the advantages of low marginal tax rates and the mobility of labor and capital. One point that policymakers often overlook is that a high tax rate on one tax base tends to shrink not just that tax base, but other tax bases as well. Thus, high income tax rates shrink reported incomes, and in turn that shrinks both income and payroll tax bases. Similarly, high corporate income tax rates shrink the corporate tax base and the individual and payroll tax bases as corporate investment, hiring, and wage growth are reduced.
The ALEC report explores these sorts of effects in detail for death taxes, which are taxes on estates and inheritances. States that impose death taxes induce people with substantial assets to relocate to states without those burdens. When people move, the death-tax states lose not just death-tax revenues, but also revenues from income taxes and other taxes. They also lose the productive contributions that high-earners often make in their communities, such as their aid to start-up businesses and charities.
I agree with the ALEC report’s authors—Art Laffer, Steve Moore, and Jon Williams—that taxpayers can be very responsive to marginal tax rates, especially over the longer term. I might quibble with them, however, with the overwhelming importance they seem to assign to the effect of state tax rates on economic growth as compared to other state policy factors such as regulatory burdens. The authors present statistical tables showing that high-tax states tend to grow more slowly than low-tax states. But in those correlations, I wonder whether tax rates are serving as proxies for broader state policy environments? In other words, states with high taxes often tend to be the states that impose an array of anti-market policies. Low-tax states often tend to be more broadly growth-friendly.
The second part of the ALEC report presents state-by-state policy and economic data. Here, the authors do examine numerous non-tax factors. State right-to-work laws, for example, affect business location decisions in labor-intensive industries that are prone to unionization. With policy levers such as right-to-work laws, worker compensation costs, and the quality of state legal systems, state policymakers have the power to attract or repel business investment and thus spur or hinder economic growth.
There are substantial differences in income levels and economic growth performance across the states, and those differences stem partly—or mainly—from state policy differences. As such, it is the job of state policymakers to explore and pursue reforms that can make residents of their states more prosperous. The ALEC report provides a useful prod to state governments to roll up their sleeves and get to work.
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