‘Tax Cuts’ and Welfare Spending
A story in the Washington Post today is headlined: “Obama Would Keep $85 Billion in Tax Breaks for Working Poor.”
The “tax breaks” in question are expansions in the earned income tax credit and the child tax credit. The Post story repeatedly calls the expansions “tax breaks” and “tax cuts.” The budget expert quoted in the story calls them “tax cuts,” and so does a House staffer and a spokesperson for the president.
But these are not tax cuts. They are expansions in the refundability of provisions in the tax code. That means that households that pay no federal income tax will receive larger welfare checks from the government under these Obama proposals.
Obama has proposed a slew of “tax cuts” that are partly welfare payments. The chart below shows the share of the 2010-2019 dollar values of these proposals that are actually increased federal spending, and not reductions in taxes. (Calculated from OMB’s May summary tables).
The Post reporter and the budget analyst quoted in the story are both fiscal experts, and they know that these “tax cuts” are not really tax cuts. But there is a growing problem in fiscal discussions that words are getting flipped upside down to mean the opposite of what a layman would understand them to mean. A classic example is how the dollar value of true tax cuts is nearly always referred to in news articles as a “cost” rather than a “saving.”
Steny Hoyer’s use of the phrase “paid for” in the health debate is another example of how Washington-speak is confusing the heck out of people.
Filed under: Health, Welfare & Entitlements; Tax and Budget Policy
The Post and Times Push for Cap and Trade
Since the June House vote on the Waxman-Markey “cap-and-trade” bill, lawmakers from both chambers have backed significantly away from the legislation. The first raucous “town hall” meetings occurred during the July 4 recess, before health care. Voters in swing districts were mad as heck then, and they’re even more angry now. Had the energy bill not all but disappeared from the Democrats’ fall agenda, imagine the decibel level if members were called to defend it and Obamacare.
But none of this has dissuaded the editorial boards of the The New York Times and Washington Post. Both newspapers featured uncharacteristically shrill editorials today demanding climate change legislation at any cost.
The Post, at least, notes the political realities facing cap-and-trade and resignedly confesses its favored approach to the warming menace: “Yes, we’re talking about a carbon tax.” The paper—motto: “If you don’t get it, you don’t get it”—argues that in contrast to the Boolean ball of twine that is cap-and-trade, a straight carbon tax will be less complicated to enforce, and that the cost to individuals and businesses “could be rebated…in a number of ways.”
Get it? While ostensibly tackling the all-encompassing peril of global warming, bureaucrats could rig the tax code in other ways to achieve a zero net loss in economic productivity or jobs. Right. Anyone who makes more than 50K, or any family at 100K who thinks they will get all their money back, please raise you hands.
The prescription offered by the Times, meanwhile, is chilling in its cynicism and extremity. It embraces the fringe—and heavily discredited—idea of “warning that global warming poses a serious threat to national security.” It bullies lawmakers with the threat that warming could induce resource shortages that would “unleash regional conflicts and draw in America’s armed forces.”
(Note to the Gray Lady: This is why we have markets. Not everyone produces everything, especially agriculturally. For example, it’s too cold in Canada to produce corn, so they buy it from us. They export their wheat to other places with different climates. Prices, supply, and demand change with weather, and will change with climate, too. Markets are always more efficient than Marines, and will doubtless work with or without climate change.)
Appallingly, the piece admits that “[t]his line of argument could also be pretty good politics — especially on Capitol Hill, where many politicians will do anything for the Pentagon. … One can only hope that these arguments turn the tide in the Senate.” In other words: the set of circumstances posited by the national-security strategy are not an object reality, but merely a winning political gambit.
There’s no way that people who see through cap-and-trade are going to buy the military card, but one must admire the Times’ stratagem for durability. Militarization of domestic issues is often the last refuge of the desperate. How many lives has this cost throughout history?
Nevertheless, one must wonder at the sudden and inexplicable urgency that underpins the positions of both these esteemed newspapers. Global surface temperatures haven’t budged significantly for 12 years, and it’s becoming obvious that the vaunted gloom-and-doom climate models are simply predicting too much warming.
Still, one must admire the Post and Times for their altruism. The economic distress caused by a carbon tax, militarization, or any other radical climatic policy certainly won’t be good for their already shaky finances, unless, of course, the price of their support is a bailout by the Obama Administration.
Now that’s cynical.
For Financial Stability, Fix the Tax Code
There seems to be near universal agreement that the excessive use of debt among both corporations, particularly banks, and households contributed to the severity of the financial crisis. However, other than the occasional refrain that banks should hold more capital, there has been little discussion over why corporations choose to be so highly leveraged in the first place. But then such a discussion might lead us to the all too obvious answer — the federal government, via the tax code, encourages, even heavily subsidizes corporate leverage.
Cato scholar and banking analyst Bert Ely has estimated that the subsides for debt have historically resulted in an after tax cost of debt of 3 to 5 percent, compared to an after tax cost of equity of 12 to 15 percent. With differences of this magnitude, it should not be surprising that financial companies and corporations in general become highly leveraged.
For corporations, this massive difference in cost between debt and equity financing results primary from the ability to deduct interest expenses on debt, while punishing equity due to the double-taxation of dividends along with taxing capital gains.
If we are going to use the tax code to subsidize debt and tax equity, we shouldn’t act surprised when firms load up on the debt and reduce their use of equity — making financial crises all too frequent and severe.
Kennedy’s Health Bill: A First Look
A draft of Sen. Ted Kennedy’s health care reform bill is finally available, and it is difficult to overstate how far he would move us to a government-run health care system. An initial read-through reveals among the key provisions:
- An individual mandate, requiring that every American purchase a “qualified” insurance plan. (Sec. 161(a)) The mandate will be enforced through the tax code with Americans required to pay a penalty if they fail to comply. In an extraordinary delegation of congressional authority, the Kennedy bill would give the Secretaries of Treasury and Health and Human Services the power to determine what this penalty should be. Individuals would be required to submit information on their insurance status over the previous year to the Secretary of HHS, along with “any such other information as the Secretary may require.” (Sec. 6055(b)(2) and (3)). Individuals who already have insurance could keep it. However, if they changed plans (or presumably changed jobs), their new insurance would have to meet the definition of “qualified.”
- A “pay or play” employer mandate requiring employers to provide all workers with health insurance and pay a minimum amount of the premium, or pay a tax (Sec 162). Again, the amount of the new tax is left to the discretion of the Secretaries of HHS and Treasury. Some small employers would be exempt from the mandate, but the size of those firms remains TBA. (Sec. 3113(g)) Companies with fewer than 250 workers would be forbidden to self-ensure. (Sec. 2720)
- A new federal bureaucracy, the Medical Advisory Council, which would determine what benefits will be required to be part of your “qualified” insurance plan. (Sec. 3103(h) and (i)). Lest anyone think Congress won’t get involved. The Council’s decisions can be disapproved by Congress if, say, they don’t mandate inclusion by a favored provider group or disease constituency. (Sec 3103(g)).
- Massive new federal subsidies. Medicaid would be expanded to individuals earning 150 percent of the poverty level, and the federal government would pay all incremental costs of the increased enrollment. (Sec 152.) Single, childless adults would become eligible for Medicaid. Even more egregious, individuals and families with incomes between 150-500 percent of the poverty level ($110,250 for a family of four) would be eligible for subsidies on a sliding scale-basis.(Sec. 3111(b)(1)(A-G)).
- Insurers would be required to accept all applicants regardless of their health (guaranteed issue) and forbid insurers from basing insurance premiums on risk factors (Community rating). There does not appear to be any exception for lifestyle factors, such as smoking, alcohol or drug use, diet, exercise, etc. Thus, not only will the young and healthy be forced to pay higher premiums to subsidize the old and unhealthy, but the responsible will be forced to pay more to subsidize the irresponsible.
- A “public option” operating in competition with private insurance (Section 31__). How this plan would be funded, the level of premiums, etc. is left mostly TBA. In response to criticism, the Kennedy bill does require that the public plan pay providers 10 percent above Medicare reimbursement rates. (Sec 31__(B)). That would still allow for a considerable degree of cost-shifting to private insurance. And, we should recall that such promises are ephemeral. When Medicare began, proponents promised it would reimburse at the same rate as insurance. That promise didn’t last long.
- States would be prodded to set up “gateways,” similar to Massachusetts’ “connector.” (Sec 3104(a)) If a state fails to do so, the federal government will set one up for them. (Sec. 3104(d)) The federal government would provide grants to states to help them set up these gateways. The amount of the grants is, you guessed it, left to the discretion of the Secretary of HHS. Gateways may also fund their operations by assessing a surcharge on insurers. Sec. 3101(b)(5)(A)/
- A new federal long-term care program (Sec 171).
Kennedy does not include any estimate of how much his plan would cost, nor any proposal for how to pay for it.
More details will undoubtedly emerge, but it is very clear that the Kennedy plan would put one-sixth of the US economy and some of our most important, personal, and private decisions firmly under the thumb of the federal government.
Revenge of the Laffer Curve
Steve Moore and Art Laffer have an excellent column in today’s Wall Street Journal. They explain that high-tax states drive repel entrepreneurs and investors, leading to a pronounced Laffer Curve effect. Productive people either leave the state or choose to earn and report less taxable income. And because growth is weaker than in low-tax states, there also is a negative impact on lower-income and middle-class people:
Here’s the problem for states that want to pry more money out of the wallets of rich people. It never works because people, investment capital and businesses are mobile: They can leave tax-unfriendly states and move to tax-friendly states. …Updating some research from Richard Vedder of Ohio University, we found that from 1998 to 2007, more than 1,100 people every day including Sundays and holidays moved from the nine highest income-tax states such as California, New Jersey, New York and Ohio and relocated mostly to the nine tax-haven states with no income tax, including Florida, Nevada, New Hampshire and Texas. We also found that over these same years the no-income tax states created 89% more jobs and had 32% faster personal income growth than their high-tax counterparts. …Dozens of academic studies — old and new — have found clear and irrefutable statistical evidence that high state and local taxes repel jobs and businesses. …Examining IRS tax return data by state, E.J. McMahon, a fiscal expert at the Manhattan Institute, measured the impact of large income-tax rate increases on the rich ($200,000 income or more) in Connecticut, which raised its tax rate in 2003 to 5% from 4.5%; in New Jersey, which raised its rate in 2004 to 8.97% from 6.35%; and in New York, which raised its tax rate in 2003 to 7.7% from 6.85%. Over the period 2002-2005, in each of these states the “soak the rich” tax hike was followed by a significant reduction in the number of rich people paying taxes in these states relative to the national average.
Interestingly, the Baltimore Sun last week published an article noting that the soak-the-rich tax imposed last year is backfiring. There are fewer rich people, less taxable income, and lower tax revenue. To be sure, some of this is the result of a nationwide downturn, but the research cited by Moore and Laffer certainly suggest that the state revenue shortfall will continue even after than national economy recovers:
A year ago, Maryland became one of the first states in the nation to create a higher tax bracket for millionaires as part of a broader package of maneuvers intended to help balance the state’s finances and make the tax code more progressive. But as the state comptroller’s office sifts through this year’s returns, it is finding that the number of Marylanders with more than $1 million in taxable income who filed by the end of April has fallen by one-third, to about 2,000. Taxes collected from those returns as of last month have declined by roughly $100 million. …Karen Syrylo, a tax expert with the Maryland Chamber of Commerce, which lobbied against the millionaire bracket, said she has heard from colleagues who are attorneys and accountants that their clients moved out of state to avoid the new tax rate. She said that some Maryland jurisdictions boast some of the highest combined state and local income tax burdens in the country. “Maryland is such a small state, and it is so easy to move a few miles south to Virginia or a few miles north to Pennsylvania,” Syrylo said. “So there are millionaires who are no longer going to be filing Maryland tax returns.”
With President Obama proposing higher tax rates for the entire nation, perhaps this is a good time to remind people about the three-part video series on the Laffer Curve that I narrated. If you have not yet had a chance to watch them, the videos are embedded here for your viewing pleasure:
AEI Tax Forum
Photo by Peter Holden Photography for AEI
I was a panelist at an American Enterprise Institute forum today discussing the proliferation of federal tax credits, particularly for low-income families.
AEI scholars Kevin Hassett, Larry Lindsey, and Aparna Mathur have a draft paper that looks at the idea of consolidating current individual credits into one supercredit. The idea would be to simplify the system and reduce the economic distortions created by these credits, which are valued at about $170 billion in 2009.
My observations included:
- Obama’s Make Work Pay credit is valued at about $60 billion per year, much of which is ”refundable.” (That means it is partly a spending increase not a tax cut). Coincidentally, Obama’s proposed tax hikes for higher-income individuals are also about $60 billion per year. So Obama is damaging the economy with “Make Work Not Pay” tax increases at the top in order to fund dubious work incentives at the bottom. It makes no economic sense.
- The AEI scholars provide interesting calculations about how we could make the $170 billion of redistribution in these credits simpler. That’s fine as far as it goes, but I’d like to end the redistribution altogether. Let’s provide a large basic exemption in the tax code for folks at the bottom, but we don’t need any complex credits. Instead, let’s repeal federal policies that damage the budgets of struggling families at the bottom, such as import barriers that raise the price of clothing and federal milk cartels that raise the price of dairy products.
- Here’s my compromise redistribution plan. Let’s chop the $170 billion in tax credits in half and use the extra funds to cut the corporate income tax rate. With a purely static calculation, that would allow cutting the corporate rate from 35% to 25%. Assuming some behaviorial feedbacks, the $85 billion in credit savings would easily allow us to reduce the corporate rate to 20% or so.
- What do corporate taxes have to do with the workers who currently get all these tax credits? As Hassett and Mathur explained in a 2006 paper, corporate tax cuts would increase investment, improve productivity, and that in turn would raise wages of average American workers. We don’t need President Obama’s fancy new Make Work Pay credits. Instead, we need to cut the corporate tax rate to make the economy boom and raise worker’s wages and incomes in the private marketplace.
Obama Taking on ‘Tax Havens’
Jeff Zeleny at the New York Times Caucus Blog reports, “President Obama will present a set of proposals on Monday aimed at changing international tax policy, calling for the elimination of benefits for companies and wealthy individuals that harbor their cash in offshore accounts.”
Cato scholars have long made arguments in defense of tax havens. In The Wall Street Journal, Senior Fellow Richard Rahn outlined the policy the federal government should be taking instead:
The correct policy for the United States to follow is to reduce its corporate tax rate to make it internationally competitive, and to move toward a tax system that does not punish savings and productive investment so severely. We know from the experiences of many countries that reducing tax rates and simplifying the tax code improve both tax compliance and economic growth. Tax protectionism should be rejected because it is at least as destructive to economic growth and job creation as are tariffs on goods and services.
Cato scholar Daniel J. Mitchell narrated a three part video series on the subject, presenting the economic and moral cases for tax havens, and a final video that punctured myths associated with the practice.
Mitchell spoke on Capitol Hill last month about the role of tax havens and in Foreign Policy magazine, Mitchell explained why tax havens are a blessing.
Filed under: International Economics and Development; Tax and Budget Policy
New at Cato, Tax Day Edition
Here are a couple of dishes Cato Institute scholars cooked up for Tax Day:
- Writing for National Review Online, Chris Edwards warns against the dangers of rapidly increasing government spending:
When filling out your tax forms, you might want to think for a second about where all that money is going. After federal spending roughly doubled in the Bush years, it is growing by leaps and bounds under President Obama. What’s more, the federal government is increasing the scope of its activities — it is intervening in many areas that used to be left to state and local governments, businesses, charities, and individuals.
There are now a staggering 1,804 subsidy programs in the federal budget. Hundreds of programs were added this decade, and the recent stimulus bill added even more. The result is that we are in the midst of the largest federal gold rush at taxpayer expense since the 1960s.
- At Townhall, Dan Mitchell rails against the current tax code:
Beginning as a simple two-page form in 1913, the internal revenue code has morphed into a complex nightmare that simultaneously hinders compliance by honest people and rewards cheating by Washington insiders and other dishonest people.
But that is just the tip of the iceberg. The tax code also penalizes economic growth, distorts taxpayer behavior, undermines American competitiveness, invites corruption and promotes inefficiency.
- At CNSNews.com, Edwards argues that policymakers should give Americans the low and simple tax code that they deserve.
- Also, don’t miss the new Cato video that reveals how troubling the American tax system really is.
Our Troubling Tax System
The U.S. tax code gets more complex every year. It violates civil liberties and, left unchanged, will leave the United States at a powerful competitive disadvantage in years to come, say Cato scholars in this new Cato video.
According to tax expert Chris Edwards, the tax system is growing at startling levels — there are now about 70,000 pages of tax regulations and $300 billion in compliance costs — and it’s only going to get worse.
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