Barro on the Fiscal Crisis and How We Got Here

Robert Barro is one of those economists whose ideas deserve careful consideration.  In “Robin Hood Can't Lead Us Out of the Debt Hole,” he provides a summary of how the United States got into the current economic mess, the relative effectiveness of government actions, and provides thoughts on policy that would help clean up the mess.  I particularly like his ideas on tax reform, which I quote in part.

One possible package of reforms would include setting the U.S. corporate and estate tax rates permanently to zero. These taxes are inefficient and generate little revenue. Also, to restore a more efficient allocation of capital across the economy, we should phase out—gradually—tax preferences for home-mortgage interest, state and local income taxes, and employee fringe benefits. Marginal income tax rates should also be lowered across the board. Finally, to raise additional revenue to meet entitlement obligations, we could adopt some kind of broad-based, flat-rate consumption tax such as a value-added tax of the kind used in Europe. In this country, a rate of 10% with few exemptions should raise around 5% of GDP annually.
The political danger of a value-added tax is that it is so efficient at raising money it will encourage governments to grow even larger. That's why it only makes sense as one component of a fiscal reform, including reductions in the long-term path of entitlement outlays.

Lowering the corporate to zero makes sense for at least two reasons.  First, there is a difference between the incidence of a tax, who writes the check and the burden of that tax, who ultimately pays it.  In the long run, that burden falls mostly on consumers.  Lowering the corporate tax rate to zero would acknowledge that economic fact.  Second, it would take an arrow out of the political quiver of corporations that benefit the most politically entrepreneurial business leaders.  A similar arrow would be removed from politician’s quiver.  Politicians would lose some ability to bribe or extort businesses to further a politician’s or group of politician’s policies.  Investment decisions would more closely be linked to the fundamental profitability of projects. 

Lowering estate taxes to zero would free estates to allocate funds to the best possible investments not the best investment given tax treatment.  Again the economic efficiency would increase.  
Read more!

California Tries to Tax Out-of-State Internet Merchants

(HT Drudge Report) By a 1992 Supreme Court decision, Internet merchants do not have to collect sales taxes in states if they do not have a physical presence in that state.  Legally, consumers are still required to pay the tax but collection is problematic.  The California legislature passed and Governor Brown signed a bill that attempts to circumvent the decision by taxing out-of-state merchants through affiliates that have a physical presence in California.  Most affiliates are related to out-of-state merchants through click through advertising.  Internet merchants located outside of California hate the legislation and instate merchants love it.

I will not offer an opinion about the merit of the legislation.  I do wish to comment on the difficulty of taxing highly mobile businesses and households.  Amazon and Overstock.com announced that they were immediately cutting ties to all California affiliates.  California expected to collect $200 million annually.  With the largest Internet marketer pulling out, that total will be smaller. 

The affiliates are also responding.  There are 25,000 affiliates in California and they pay $152 million in state income taxes last year.  Many have already announced that they will leave California and the state will lose their tax revenues.  Consumers will pay a higher price because at least part of the tax will be passed on to them.  There is a difference between the incidence of the tax, who writes the check to the government, and the burden of the tax.  Economic literature suggests that consumers will pay part of the burden through higher prices as part or all of the tax is passed on to consumers. 

Instate merchants view the tax as a fairness issue because they believe that they pay the sales tax that out-of-state merchants avoid but there is now question that they will gain sales as the price of products on out-of-state Internet merchants rise relative to their prices.

States that place high taxes on high income households or corporation will see these entities exit for states with lower taxes.  Countries that place high taxes on high income households or corporations will see these entities exit for countries with lower taxes.  Low income households and small corporations have less ability to “vote with their feet.”  Many complain that this phenomenon will create a raise to the bottom in which government will be deprived of necessary resources.  Certainly pressure will increase to make government smaller, but it will also increase to make government more efficient and that is good.

For more information information see, “California tells online retailers to start collecting sales taxes from customers,” “New Internet Tax Grab Will Burden Companies and Your Portfolio,” “Web retailers say they'll fight new California sales tax,” and “Sales Tax on the Internet.”
Read more!

Bauman, the Stand-up Economist, Updated

(Edited 2/2/2011) Yoram Bauman, the stand-up economist, is a funny man and a good economist, and apparently, that is not an oxymoron.  Watch his new video for two reasons.  First, Bauman humorously explains Mankiw’s ten principles of economics, and second, he gives an example of an external cost and why markets cannot solve the problem.  The standard solutions are a tax on the good producing the pollutant or a cap-and-trade system.  He then pushes a carbon tax as a replacement to some part of the current tax system such as the corporate tax or the payroll tax. 

I am skeptical about some results that climate scientist reach.  Data may be corrupted by the urban heat island effect.  Proxies used to estimate past temperatures beyond fifty years do not seem to be statistically robust.  I also believe that the opportunity cost of alternative energy is well above the $.30 per gallon tax he seems to support, meaning that the cost of solving the problem is greater than the cost of the problem.  Finally, I doubt that unilateral action by the United States would significantly reduce global carbon emissions; it is a global emissions problem without a global enforcement mechanism.  With all my doubts, I still favor a carbon tax as a substitute to some other portion of our tax code.  It is a better, meaning less distorting tax.
Read more!

Kerry Avoids Yacht Tax

I don't blame anyone for avoiding taxation legally and this is just what Senator John Kerry has done by docking his new and really cool yacht in Rhode Island rather than in his home state of Massachusetts and thereby saving $437,500 in sales tax and an annual excise tax of about $70,000.  Apparently, he is not the only person to note that Rhode Island repealed its Boat Sales and Use Tax in 1993 and has since become a haven for tax avoiding yacht owners.  I just wish that he and other tax avoiding legislators would put two and two together to realize that high taxes lower incentives to work and to produce.

HT Drudge Report) Laura Raposa provides the details of the purchase in "Sen. John Kerry skips town on sails tax."  Kerry's yacht certainly deserves the title of luxury. 

Kerry’s luxe, 76-foot New Zealand-built Friendship sloop with an Edwardian-style, glossy varnished teak interior, two VIP main cabins and a pilothouse fitted with a wet bar and cold wine storage - was designed by Rhode Island boat designer Ted Fontaine.

Replace this text with...
Read more!

Reynolds on Unemployment and the Economy

Alan Reynolds, a senior fellow with the Cato Institute had a different take on why the recent unemployment data has been interpreted so negatively (Wall Street Journal, "Don't Believe the Double Dippers").  It's the political spin and it comes from both sides of the aisle.

Using all of this statistical trickery to convert a weak job market into an imminent recession has become a bipartisan political strategy. Robert Reich and other big government Democrats play the "double dip" card to peddle more deficit spending on refundable tax credits and transfer payments. Conservative Republicans often become double-dippy for very different reasons—to argue (quite plausibly) that hundreds of billions in "stimulus spending" has proven counterproductive so far, contributed to the debt, and will eventually lead to higher taxes.

Reynolds does an excellent job describing various measures of unemployment (U2, U4, and U6) and the "Job Opening and Turnover Survey."  His interpretation is well worth the read.

In addition to interpreting the employment data, he describes the general economic outlook.  If it were a weather forecast, he would report that the sky is not falling, but the dawn is overcast.    

Those who want to know what is going on must sift through all of this bipartisan gloom to distinguish between (1) agenda-driven dire warnings and (2) the boring reality of a sluggish recovery being partially paralyzed by ominous threats of punitive taxes and onerous regulation.

Read more!

Missouri Powerball

Chris Shaw won the Missouri Powerball lottery.  His winnings were reported as $258 by the state.  The figure is misleading; it is the future value of an annuity with annual payments over thirty years.  The lump sum or present value of his winnings is $125 million and this is the proper method of valuation. 

Truth in Lending laws prohibit lenders from misquoting the true interest rate on a loan by attaching up front fees on the loan and then lowering the quoted interest rate.  The laws require that lenders calculate and report the annual percentage rate which is calculated by a standardized formula that takes into account up front fees. 

The government at all levels seems preoccupied with practices of firms operating in a competitive market but never question their own actions.  In this case, the state of Missouri established a lottery, limited competition, advertised the lottery as a way to win millions and encouraged or at least tolerated misreporting of winnings.  Lotteries are a regressive taxes paid almost entirely by the poor and uneducated.  Almost all lottery participants are net losers.  The lottery as a tax fails to meet any criterion of fairness proposed by economists.  They are popular with users be better served if they were run in a competitive market environment that forced firms to pay out a larger percentage of its revenues to lottery participants. 
Replace this text with...
Read more!

The Tea Party and the Ricardian Equivalence Hypothesis

People in the Tea Party movement believe that the government has grown too large and that taxes are too high.  Their interpretation of Bush and Obama administrations' policies has created consternation among most democrats and many republicans.  Most recently, President Obama described his frustration with tax protesters ("Obama says he's amused that Tea Partiers haven't thanked him for tax cuts").

MIAMI – President Barack Obama said Thursday that he's amused by the Tea Party tax protests that took place around Tax Day and that contrary to claims of demonstrators, he has cut taxes.

"You would think they'd be saying thank you," he said at a fundraiser in Miami.

Setting aside any debate about the impact of the administration's policy until now, the president does not seem to be as farsighted as members of the Tea Party who realize that tax rates must rise to pay for a sustained increase in government expenditures. 
In 1974, Robert Barro published the "Ricardian Equivalence Hypothesis" which states that interest rates and aggregate demand do not change based on funding of government expenditures by taxes or debt.  A tax cut today will create a deficit that must be paid in the future and tax payers respond to cuts in taxes with an equivalent increase in savings. 

Today's economic outlook differs from the conditions in the hypothesis.  We have not replaced tax funding of government expenditures with debt funding.  Instead, the administration and the Congress have dramatically raised government spending and expanded healthcare entitlements creating what appears to be a permanent increase in government expenditures.  Under these conditions, a permanent increase in government expenditures would increase interest rates and not increase aggregate demand.  Tea Party members rationally conclude that their taxes will increase in the future.
Read more!

Can Reduction in School Funding Cost Taxpayers?

(HT Drudge Report)  Government budgets from the local to the federal level are bleeding red ink and many new proposals are being considered.  The Klamath County School District in Klamath Falls, Oregon is considering a four day school week as a way to save $6.3 million dollars or about 10% of the budget.  Apparently, the budget cuts would largely come from wages paid to classified staff: teaching assistants, cooks, custodians, secretaries, bus drivers, etc.  These workers are understandably concerned about the proposed cuts.

I have a somewhat different concern.  While the district will reduce expenditures students, parents and other taxpayers may be made worse off.  The student work week has evolved to fit around a traditional nine to five, Monday through Friday work week.  Has evolved efficiently?  If it has, then some thought was given to the length of time that children can learn during a day.  I am not sure students can remain focused during a longer school day.  It also seems plausible that the new school week will cost parents, the tax payers, more in increased baby sitting costs and loss wages than the district saves in expenditures.  Productivity of workers outside of the school district may decline as parents struggle to mange their children's activities from work.  Finally, if learning does decline, society may lose some of the positive externalities associated with education such as more skilled workers earning higher incomes. 
Replace this text with...
Read more!

A Health-Coverage Tax and Its Burden

Ed Perkins, a travel writer for the Chicago Tribune, sniffs out a scam but I believe attributes it to the wrong party in "New charge on dinner tab is in bad taste."  Perkins believes that restaurateurs are scamming customers by adding a charge to their bill to cover the new tax on owners for the "Healthy San Francisco" health-coverage system.  I agree that someone is running a scam, but it is politicians who sold the tax as a new business tax that was somehow independent of prices consumers pay.  The restaurants are engaging in a political protest and economic education.  Perkins writes 

Nothing succeeds in the travel industry like a bad idea. The latest hidden mandatory add-on is a "health" charge added to restaurant bills. As far as I know, this scam cropped up first in San Francisco, but you can count on it to spread.

The rationale for this one is to cover the employers' mandatory contribution to the City's "Healthy San Francisco" health-coverage system. The charge actually is levied on employers, but at least some restaurants are adding a few dollars or percentage points to each customer's bill to cover this charge.

The economic impact of the tax is relatively straight forward involving three steps.  First, San Francisco restaurants become somewhat less competitive losing a little business to restaurants in surrounding communities. 


I will explain the second step with a graph.  The numbers are fictional but the direction of the movement of equilibrium prices and quantities are predicted by widely accepted economic theory.  As pictured in the above graph, the original equilibrium before the tax results in an equilibrium price of $22.50 dollars per meal with 32,500 meals per week consumed.  The city government imposed a tax of $5.00 per meal.  The restaurateurs added the tax to their cost structure which helped determine their supply of meals.  Supply shifted inward from S1 to S2.  The vertical distance between the two supply curves is the $5.00 tax.  The new equilibrium shown by the intersection of S2 and demand is at a price of $25.00 per meal with 27,500 meals per week consumed.  Consumers now pay $2.50 more per meal than they paid prior to the tax.  That is their burden of the new tax.  The restaurateurs receive $25.00 per meal but must subtract out the $5.00 tax.  Net the tax, they receive $20.00 per meal, $2.50 less than they received prior to the tax.  In my simple model, the burden of the tax is shared evenly between the restaurateurs and their consumers.



The long-run outcome shifts the burden to the tax entirely or almost entirely to the consumer.  This is because restaurants compete in something close to a perfectly competitive market.  As they adapt to new costs, including the tax, their supply curves becomes perfectly elastic, or something approximating a perfectly elastic.  Without the tax, the long-run equilibrium price was $22.50 per meal as determined by the intersection of demand and S1.  With the tax the new equilibrium is at $27.50 per meal as determined by the intersection of demand and S2.  The consumer pays $27.50 per meal and the restaurants receive $22.50, the price they received before the tax.  But the restaurateurs still have good reason to oppose the new tax.  Prior to the tax, they were selling 32,500 meals per week, after the tax, sales fall to 22,500. 

I did not pay attention to the political debate surrounding the implementation of the health-coverage tax, and I am assuming that politicians used an age old tactic of telling consumers that a tax will be paid for business and not them.  Maybe politicians are more honest in San Francisco.  If my assumption is incorrect, I apologize to these politicians.   
Read more!

An Item for the Tea Party Agenda

Seismic economic events have shaken Washington.  Republicans, who were largely blamed for the crisis, were flattened in a political quake.  The victorious Democrats acted on their mandate of change but the change they enacted or proposed deepened huge deficits and did not restore full employment demanded by an angry electorate.  The Tea Party Revolt rose from the rubble to shock both parties and it is building political pressure along fault lines that may result in as big as a political quake in November 2012 as hit Washington in 2010.  The remarkable success of the spontaneously generated Tea Party has led many to suggest a course of action that they should follow.  This is my unsolicited advice. 

The Tea Party might cause Washington to sway toward fiscal responsibility, but it will not permanently alter spending habits which are firmly built on long standing foundational incentives between voters and their representatives.  One of the footings is that constituents like taxes raised in other districts spent in theirs and every politician knows it.  Using the House of Representatives as an example, nearly all the benefits of a government funded project in a district are enjoyed by those living in it while the taxes raised to fund the project are distributed more evenly between all 435 districts.  So long as a project has $1 dollar of benefit locally to $435 of cost nationally, a congressman will support it.  The story in the Senate is only slightly better where a senator has incentive to vote for a project if it has $1 of benefit in her state to $50 of cost nationally.  Stevens' bridge to nowhere and Murtha's airport to the same location illustrate the problem.  Voter support for these perverse incentives is summarized in the oft heard comment, "I don't agree with many of my congressman's positions but he really brings home the bacon”?  We love pork in our districts but we hate it in other's. 

A modification to the tax code would break this perverse incentive.  It is based on the benefit principle of taxation, the idea that those receiving the benefits of expenditures should pick up the tab. The income tax code should be modified to reflect expenditures in each congressional district with the exception of those for defense and university research. The modification should change tax rates evenly through all brackets making the tax structure less progressive in districts with high expenditure to taxes paid ratios and more progressive in districts with low ratios.  If a congresswoman brings home twice the average level of expenditures, her constituents’ tax rates should be twice the national average. A natural constituency opposing wasteful spending within each district would quickly materialize because the constituents would now pay for the pork.
Read more!

Harkin on the Relationship of Men and Government

When I was in my early twenties and still a liberal Democrat I read "Capitalism and Freedom" by Milton Friedman and hated it.  On the first page he dissected President John Kennedy's statement, "Ask not what your country can do for you--ask what you can do for your country."  My friend and mentor Del Gardner, who had traveled with Milton Friedman as a graduate student at Chicago asked me the source of my disdain.  I said that Friedman had read too much into a plea for patriotism. 

Yesterday, I read a statement by Senator Thomas Harkin of Iowa ( Christina Crippes, "Harkin favors taxing stock transactions," The Hawk Eye, or Ryan J. Donmoyer, "Wall Street Transaction Tax Proposed by Democrats (Update4)," Bloomberg, December 3, 2009) who attempted to justify a tax on each transaction of stock, futures, options and swaps, by saying,

Let me put it bluntly, we need this revenue, which would amount to as much as $100 billion or more annually. We need it to reduce the deficit as well as to pay for new legislation to create jobs and put people back to work.  We need a shift of priorities to this: Ask not what America can do for Wall Street. Ask what Wall Street can do for America.

A flood of memories poured through my thoughts.  It has been a long while since I have been a liberal Democrat and almost as long since I began to enjoy Friedman's quote, but the accuracy of Friedman's vision again struck me.  Friedman wrote of Kennedy's statement,

Neither half of the statement expresses a relation between the citizen and his government that is worthy of the ideals of free men in a free society.  The paternalistic "what your country can do for you" implies that government is the patron, the citizen the ward, a view that is at odds with the free man's belief in his own responsibility for his own destiny.  The organismic, "what you can do for your country" implies that government is the master or the deity, the citizen, the servant or the votary.  To the free man, the country is the collection of individuals who compose it, not something over and above them.  He is proud of a common heritage and loyal to common traditions.  But he regards government as a means, an instrumentality, neither a grantor of favors and gifts, nor a master or god to be blindly worshipped and served. 

Can it be any clearer that Harkin views investors as servants or votary and the government as the master or deity?

Harkin seems to have as bad an understanding of the economics of the proposal as of the relationship between man and government stating a historical precedence for the tax rather than an economic justification.

Until 1966, the United States taxed all stock transactions and transfers. Indeed, Congress doubled the transaction tax rate during the Great Depression in order to finance economic recovery initiatives.

Someone might ask Senator Harkin why he wishes to emulate a policy enacted during the longest period of high unemployment in our nation's history.  He should know that if you want less of something you tax it.  To repeat a theme of an earlier post (The Crisis Paradox), Robert Higgs  wrote that regime uncertainty created by less secure property rights, higher taxes, and other measures is an explanation of the Depression's duration (Higgs, Robert, "Regime Uncertainty," The Independent Review, Vol. I, No. 4, Spring 1997). 
Read more!

The Forgotten Man and Health Care Reform

I must admit to occasional disappointment in the economic views of Americans expressed through surveys.  Many hold normative beliefs that are different than mine, and of course mine are correct.  More importantly, many opinions appear to be based on bad economic reasoning.  As our elected representatives debate health care reform, a Rasmussen survey as of January 4, 2010 finds that 42 percent support the legislation while 53 percent oppose, but how opinions shift based on the method of funding is the basis of my disappointment.  A Rasmussen Reports article based on a national survey in "Voters Agree Only on Taxing The Rich To Pay for Health Care Plan" finds that those surveyed are more likely to support health care reform if someone else, namely the "rich," pay for it and are more likely to oppose reform if they must pay or their potential benefits are cut.

When it comes to paying for the cost of the proposed health care reform plan, voters are okay with taxing the rich but strongly reject cuts in Medicare and excise taxes on “Cadillac” health plans provided by employers.

Sixty-four percent (64%) of all voters favor imposing an income tax surcharge on individuals who earn more than $500,000 a year and couples who earn more than $1 million a year. Just 35% are opposed.

However, a proposal to enact a significant excise tax on the most expensive health insurance plans provided by employers is supported by just 32% of voters. It is opposed by 59%...

Both versions of the legislation propose reducing spending on Medicare by several hundred billion dollars. Just 33% support this approach, while 57% are opposed.

I am reminded of William Graham Sumner's essay, "The Forgotten Man," reproduced in Amity Shlaes' memorable history of the Great Depression, "The Forgotten Man..."

As soon as A observes something which seems to him to be wrong, from which X is suffering, A talks it over with B, and A and B then propose to get a law passed to remedy the evil and help X.  Their law always proposes to determine...what A, B, and C shall do for X."  But what about C?  There was nothing wrong with A and B helping X.  What was wrong was the law, and the indenturing of C to the cause.  C was the forgotten man, the man who paid, "The man who never is thought of."

Some hold the normative belief that we, meaning the rich, should insure the poor and those who do not want to buy insurance at the going price.  There is no virtue in A or B as they bemoan C's greed while taking her money to help X who is ungrateful for the payment of medical services he now claims are his entitlement.  C's opinion is ignored or unimportant.

From a positive perspective, A and B seem to have forgotten that people respond to incentives.  X, the person suffering, has no incentive to conserve on the expenditures of medical services freely bestowed on him.  If costs are to be controlled, government health care regulators must do it.  The regulators will give these committees a pleasant name like the United Kingdom's National Institute for Clinical Excellence or NICE, but after the first death of a patient denied treatment by the the medical board, even if the denial is just and medially correct for "society," will be known as a death committee by that person's survivors.  These committees will serve us all.

C and her contribution to the market economy really are forgotten.  Do A, B or X believe that C will do nothing to protect her interests?  She will invest less because her income has fallen and because of greater uncertain about her future tax burden.  The economy suffers when investment falls and the rich are an important part of investors.  If A, B, and X are lucky, some of her investment might slide into the underground economy to avoid taxation, but that will lower government tax receipts.  C might also spend more time at the beaches and ski resorts and less time working.  She might hire an accountant or lawyer to help her avoid taxes if they are not at the beaches or ski resorts because of their reduced incentive to work. 

We like the goods and services that high income earners provide including medical care.  We like the innovation that their investments fund.  We need more of them.  Why do we treat them so badly through the federal tax code?
Read more!

The Health Care Sausage Factory

Despite very good economic advisors, the Obama administration seems enmeshed in 1960's economics that assumes that markets fail and the a benevolent government is needed to act in the public interest to set things straight. This system of beliefs cannot be based on an empirical investigation. Much of what critics claim as a market failure, increasing cost of medical care, can be attributed to government tax policy, and as always passing new legislation includeds a grabbag of favors. An article titled, "ObamaCare's Longshoremen Rules," in the Wall Street Journal's Review and Outlook section describes a few of the concessions made to special interest groups.

President Obama praised the Senate yesterday for clearing a 60-40 procedural vote on his health plan in the dead of night and "standing up to the special interests who've prevented reform for decades and who are furiously lobbying against it now." They're furiously lobbying all right—not against ObamaCare but for the sundry preferences in the Senate bill.

Start with the special tax carve-outs included in the "manager's amendment" that Harry Reid dropped Saturday morning. White House budget director Peter Orszag has claimed that the bill's 40% excise tax on high-cost insurance plans is key to reducing health costs. Yet the Senate Majority Leader's new version specifically exempts "individuals whose primary work is longshore work." That would be the longshoremen's union, which has negotiated very costly insurance benefits. The well-connected dock workers join other union interests such as miners, electrical linemen, EMTs, construction workers, some farmers, fishermen, foresters, early retirees and others who are absolved from this tax...

The Reid bill also gives a pass on the excise tax to the 17 states with the highest health costs. This provision applied to only 10 states in a prior version, but other Senators made a fuss. So controlling health costs is enormously important, except in the places where health costs need the most control.

Naturally, the Secretary of Health and Human Services will decide how to measure "costs" and therefore which 17 states qualify. (Prediction: Swing states that voted for Mr. Obama in 2008 or have powerful Democratic Senators.)

These 11th-hour indulgences make a hash of Mr. Orszag's cost-control theories and Mr. Obama's cost-control claims. Their spin has been that wise men would convene and make benevolent decisions about everyone's health care based only on evidence and the public good. But as the Reid bill shows, politics will always dominate when Washington is directing a U.S. health industry that is larger than the economy of France...

The press corps is passing this favoritism off as sausage-making necessary to "make history," but that's an insult to sausages. What this special-interest discrimination illustrates in how all health-care choices will soon be made as Washington expands its political control over one-seventh of the U.S. economy.

Read more!

Mankiw on the ITC as a Fiscal Stimulus

Greg Mankiw describes "Nine Observations about Investment," on Greg Mankiw's Blog. In the fourth observation, he explains why he believes that an investment tax credit would be an effective fiscal stimulus. I quote the first four.

1. Above is a chart of the growth rate, from four quarters earlier, of real investment in equipment and software. Notice the left scale. Investment spending is very volatile. This is one of the standard stylized facts about the business cycle.

2. Investment has been particularly weak during this economic downturn. Weak residential investment is not a surprise, as the downturn was started by events in the housing market. But as this graph shows, business investment has also been very weak. Indeed, by the metric used in this graph, it is far weaker than in previous deep recessions, such as 1982.

3. Why is business investment so weak? Part of the reason is that the downturn is severe and investment responds to the overall economy. Part of the reason is that the credit crunch makes financing more difficult. Part of the reason is that the policy environment seems adverse to business. I am referring here to a group of policies that include higher minimum wages, the seeming retreat from free trade, proposed mandates to provide employees health insurance, higher prospective energy costs from climate change regulation, and the likelihood of higher future tax rates resulting from the huge fiscal imbalance we are now experiencing. All of these factors have worked in concert to depress business investment.

4. The recent weakness of business investment was one of unstated reasons why, in my recent NY Times column, I suggested that an investment tax credit (ITC) might have been a better form of fiscal stimulus than what we in fact were given. Given the amount of money being spent on stimulus, the ITC could have been sizable. The measure of investment used in the chart above is about $1 trillion per year. So, to give a very rough example, if Congress had passed a 20 percent ITC in 2009, 10 percent in 2010, it would have cost the Treasury about $300 billion. Essentially, the Treasury would have picked up 20 percent of the cost of all of these investments if done this past year, and half that amount next year.

Read more!

Tax Cheats or Avoiders

The IRS is establishing a new unit to catch rich international investors attempting to use law to avoid taxes through investments in trusts, real estate and closed corporations.  At one point, the article uses the phrase, "tax cheat" to describe people involved in activities that is better called tax avoidance.  A tax cheat does not pay taxes he or she knows are legally due. 

People respond to incentives, and both the demeaning language used to describe these international investors and the bill may decrease incentives to invest internationally and domestically.  Imagine that you are an international investor and you have read the following article (Kim Dixon, Reuters, "Exclusive: IRS hires "hundreds" for new wealth unit").  How would it affect your investment strategies?

WASHINGTON (Reuters) - A new Internal Revenue Service unit set up to catch rich tax cheats hiding their wealth in complex business entities is rapidly taking shape with the hiring of hundreds of employees.

The IRS high wealth unit, part of a broader effort to combat international tax evasion, is focusing on "the entire web of business entities controlled by a high wealth individual," IRS Commissioner Doug Shulman told a tax conference this week.

Another IRS official told Reuters "hundreds" of people have already been hired to staff the new unit, including some from within the agency.

"We have drawn top talent within the IRS that have expertise involving wealthy individuals as well as examination of their related entities," said Mae Lew, an IRS special counsel.

The high-wealth unit is focusing on trusts, real estate investments, privately held companies and other business entities controlled by rich individuals.

While use of sophisticated legal structures can be legal, in other instances they "mask aggressive tax strategies," Shulman said.

Tax authorities in Japan, Germany and the UK have also created similar units.

The U.S. House of Representatives on Thursday approved a $387 million boost for the IRS for the fiscal year that started October 1, in part to fund the high-wealth unit. The Senate is expected to vote on the measure on Sunday.

Read more!

Glaeser on the Home Buyers' Tax Credit

Edward Glaeser, described the bad incentives created by the Home Buyers' Tax Credit in "Attack of the Home Buyers' Tax Credit," written for the New York Times.  Glaeser creatively applies economic tools to problems.  

One reason to fret about federal anti-recessionary fixes is that they often last long after the crisis that justified their creation.

According to Case-Shiller data, housing prices have been rising since May, yet Congress has just extended and expanded last year’s home buyers’ tax credit. They’ve made the program more regressive by upping the income limit for families from $150,000 to $225,000.

Even more problematically, the new, but definitely not improved, tax credit now offers up to $6,500 to current homeowners who have lived in their houses for at least five of the last eight years and buy new homes.

Who but a real estate agent could love this policy?...

Certainly, extending the tax credit to current owners doesn’t increase homeownership. I believe that our government bears some responsibility for the housing bubble because it encouraged Americans to leverage themselves to the hilt to buy homes. But just because I’d like to do less to encourage homeownership doesn’t lead me to favor more handouts that don’t increase homeownership.

A buyers’ credit that goes to everyone creates a strong incentive for purely mindless house swapping. If my cousin and I sell our houses this year, and then move back three years later, we can make $13,000. In some such transactions, people may decide to flout the law and continue to live in their old houses, pocketing quick money for a sham deal...

It subsidizes existing owners to trade up or down, which implicitly encourages people to pull up roots and sever their connections with their existing community. If you ever thought that encouraging civic engagement through housing policy was a good thing, then the current policy will push in exactly the opposite direction.

There is also no reason to think that a tax credit that encourages house-trading among current owners will help the overall housing market. A subsidy for existing homeowners provides an equal incentive for buying and selling. There will be no net decrease in the vacant housing inventory; basic economics suggests that any policy that provides equal incentives to buy and sell will do little to increase housing prices.

Increasing the scope of the program will also significantly increase its cost.

Recently, first-time home buyers have been accounting for close to one-half of home purchases, but before the tax credit particularly subsidized new home buyers, their share was lower. In 2006, only 36 percent of home purchases were first-time buyers, and a tax credit for existing owners will surely move us in that direction. If 40 percent of future transactions involve existing owners who can take advantage of the benefit, then giving the tax credit to existing homeowners could easily burn through $5 billion in five months.

The best thing about extending the home buyers’ tax credit is that it does at least have an expiration date; it is currently set to end in May 2010. Unfortunately, the events of the last week lead me to suspect that the tax credit will continue to exist, like a B-movie zombie, long after it should have settled in its grave.

Read more!

Cassidy on Health Care

(HT Wall Street Journal, "Confessions of an ObamaCare Backer")  John Cassidy of The New Yorker makes a valuable contribution to the health care debate in, "Some Vaguely Heretical Thoughts on Health-Care Reform."  He begins by stating his normative priors.  While they are not mine, they are logical and well ordered.

I regard an expansion of the government safety net as ethically essential, economically justified, and long overdue. It is indefensible for a country as rich as the United States to fail to provide adequate health care for many of its citizens. In extending our health-care system, all we are doing is catching up with Otto Von Bismarck’s Germany, which recognized a hundred and twenty-five years ago that universal health and disability coverage, along with old age pensions and a system of public education, were essential elements of a modern society.

He believes that the bill may be the best that the Obama administration can achieve but that it only deals with one of two problems, coherent universal coverage.

Moreover, given the reluctance of “Blue Dog” Democrats, such as Nebraska Senator Ben Nelson, to support anything that smacks of big government, and President Obama’s determination to coöperate with moderate Republicans, the proposed reform may be the most that can be accomplished today. But we will be dealing with its consequences for decades to come, and I think it’s important to be clear about what the reform amounts to.

Let’s remind ourselves of the basics. There are two big (and linked) problems with the current health-care system. It excludes 46.3 million Americans, according to the Census Bureau, and it is inordinately expensive. The proposed reform purports to tackle both of these problems; in fact, it only addresses the first one in any systematic manner. The future cost savings that the Administration and its congressional allies are promising to deliver are based on wishful thinking and sleight of hand. Over time, the reform, as proposed, would almost certainly add substantially to the budget deficit, thereby worsening the long-term fiscal crisis that the country faces. Financing this measure alone wouldn’t break the U.S. Treasury. Other elements of the fiscal picture, such as the looming increases in interest payments on the national debt and an explosive growth in Medicare spending as the baby boomers retire—are far larger. But the numbers involved in health-care reform are still significant—perhaps one per cent of annual G.D.P.

Cassidy believes group coverage and third party payment are largely responsible for the escalation of medical costs.  I stated much the same in "Rationing Health Care."

The Pelosi bill, in particular, wouldn’t do much, if anything, to address the overall escalation in health-care costs, much of which is rooted in the nature of insurance, where individuals consume costly health services, and different people—the other members of their risk pool—pay for them. This is the “moral hazard” problem that the economist Kenneth Arrow identified as long ago as 1963. (For an easy-to-understand account of Arrow’s argument, see this riveting new book on market failure.) In the past twenty years, many ideas have been tried in the effort to restrict the growth of spending within a private insurance system, the most notable of which was the creation of H.M.O.s. Some have enjoyed temporary success. None have worked for long.

He also explains the political reasons that the attempts to pass a health care bill that is budget neutral will likely fail.  Oh how I wish that I would have used a Cadillac in my example rather than a BMW.  

According to the C.B.O., in summary, many more people will, with government assistance, buy private insurance coverage (some twenty-one million) and many others (about fifteen million) will become newly eligible for Medicaid, which is wholly financed by the taxpayer. Surely, this will cost considerable sums of money and add to the deficit. Or will it? The Democrat-controlled C.B.O. says that the Pelosi plan will actually reduce the deficit by a hundred and four billion dollars between 2010 and 2019, thereby satisfying President Obama’s claim that the reform will be deficit neutral. Furthermore, the C.B.O. suggests that the legislation’s impact on the deficit will continue to be negative in the following decade, from 2019 to 2029. I wish I could believe these figures, but I don’t.

Two large items underpin the Administration’s math: five hundred and seventy-two billion dollars of tax increases over ten years, and roughly the same amount of cost savings on Medicare and other existing government health programs. Most of the revenue increase would come from levying a 5.4 per cent surcharge on Americans individuals who earn more than five hundred thousand dollars a year and joint filers that earn more than a million dollars. I am a big supporter of progressive taxation, but at some point it becomes politically unsustainable. If health-care reform goes through, and the Bush tax cuts expire in 2011, top earners will face a marginal tax rate of forty-five per cent at the federal level. Add in state and local taxes, plus Social Security and Medicare payments, and wealthy people in New York, say, would be facing tax rates of about sixty per cent. As sure as night follows day, this would generate more tax evasion and a political backlash. Without a doubt, the next Republican-controlled Congress would reverse the changes.

If it decides to forgo soaking the rich, the Administration could return to its earlier proposal, which was included in a Senate Finance Committee bill that Senator Max Baucus put forward, to tax firms that provide their employees with costly “Cadillac” health-care plans. “A policy such as this is probably the number one item that health economists across the ideological spectrum believe is likely to stem the explosion of health-care costs,” Christine Romer, the chair of the White House Council of Economic Advisers, said in a recent speech. But this idea wouldn’t work politically, either. To raise enough revenue, the tax on swanky insurance plans would have to be set as high as forty per cent. When labor unions, some of whose members enjoy coverage in these plans, learned about this punitive levy they objected loudly, prompting Pelosi to drop the idea, which, broadly speaking, amounts to taxing the upper middle class to provide benefits for the lower middle class.

I particularly agree with the quote by Christine Romer.  If the goal is to increase the number of people insured, like Melissa Thomasson, I would prefer granting tax subsidies for private purchasers of health insurance rather than taxing employer provided plans. 

Cassidy concludes,

So what does it all add up to? The U.S. government is making a costly and open-ended commitment to help provide health coverage for the vast majority of its citizens. I support this commitment, and I think the federal government’s spending priorities should be altered to make it happen. But let’s not pretend that it isn’t a big deal, or that it will be self-financing, or that it will work out exactly as planned. It won’t.

Many Democratic insiders know all this, or most of it. What is really unfolding, I suspect, is the scenario that many conservatives feared. The Obama Administration, like the Bush Administration before it (and many other Administrations before that) is creating a new entitlement program, which, once established, will be virtually impossible to rescind. At some point in the future, the fiscal consequences of the reform will have to be dealt with in a more meaningful way, but by then the principle of (near) universal coverage will be well established. Even a twenty-first-century Ronald Reagan will have great difficult overturning it.

That takes me back to where I began. Both in terms of the political calculus of the Democratic Party, and in terms of making the United States a more equitable society, expanding health-care coverage now and worrying later about its long-term consequences is an eminently defensible strategy. Putting on my amateur historian’s cap, I might even claim that some subterfuge is historically necessary to get great reforms enacted. But as an economics reporter and commentator, I feel obliged to put on my green eyeshade and count the dollars.

Read more!

Chicago and Tax Cheats

(HT Drudge) Cook County is asking neighbors to turn in their tax-cheating neighbors. Andrew Greiner of nbcchicago writes in "Rats! City to Pay for Informing on Tax Cheats," that

Chicago and Cook County residents aren’t the only ones about to get shocking tax news; the city is debuting a “tax whistle-blower” plan that could turn neighbor against neighbor in Chicago’s business community.

The folks at city hall will pay cash bounties to informants who turn in business tax cheats around the city. The reward would amount to some sort of percentage of the tax money that the city recovers.

"It's just another way of bringing people into compliance," Revenue Department spokesman Ed Walsh told the Sun-Times.

I find the county's action both distasteful and understandable. What do you think?

Replace this text with...
Read more!

William Saleten contributed a fun and provocative article for Slate titled, "Liquid Candy: The new addiction is taxing addictions." His cynicism about the motivation of politicians seems justifiable. Recognizing the political desire to tax, he sees improving health by taxing soda as a positive externality of closing budget deficits, an afterthought.

Now a new class of addictive products has been devised. They're ingeniously easy to produce. Just take any addictive substance already on the market and invite politicians to tax it. The new addiction is taxing addictions...

The quickest way to a politician's heart is to dangle money...

The latest sign of this trend is a report issued last week by the Center for Science in the Public Interest, which lobbies for regulation of harmful products. The press release announcing the report is headlined, "Taxing Soda Could Trim State Deficits (and Waistlines), Says Report."...

The release goes on to talk about the public health benefits of reduced soda consumption. But that rationale, which used to be primary, has now been reduced to a parenthetical afterthought. The CSPI report itself is broken down into three sections. The first section header says, "State Budgets Are in Trouble." The second says, "Taxing Soft Drinks Would Reduce Budget Woes." The third says, "Obesity, Soft-Drink Taxes and Health."

Come on, Senator. You need the money. If you leave it on the table, somebody else will take it. Just visit our calculator and try a sample. It's like taking candy from a baby. In fact, it is taking candy from a baby. And (parenthetically) that's a good thing.

Taxing soda to improve health is yet another nanny state activity. The state does not need to regulate its citizens' diets. We are perfectly able to make choices to maximize our well being, which may not always mean lengthening our years on earth. Riding a Motorcycle is more dangerous than driving a car, but many find the pleasure/danger tradeoff acceptable. Driving an SUV is certainly safer than driving a smart car, but at the margin, some place fuel economy or protecting the environment above safety.

Nor do I believe that taxing soda will do much to increase health like raising taxes on cigarettes because soda has closer substitutes than cigarettes. Rather than buying a soda, consumers might buy a sugary fruit drink, sweet tea, a candy bar or chocolate chip cookie. They are unlikely to buy carrots.

Because sodas have reasonable substitutes, a new tax might not raise as much money in the long run as anticipated. Consumers may adapted by switching purchases to less taxed goods. Even if it increases tax revenues, I prefer fewer taxes with larger bases.

Read more!

Health Care: A Misdemeanor for Not Paying Health Care Tax

In general, economists believe that individuals should control their resources in pursuit of their self interest through markets. Markets sometimes fail because of externalities, the lack of market provision of public goods, market power and asymmetry of information. Based on normative beliefs, some believe that goods such as health care should be provided for all through government financing, another way of saying that the government should require some people to pay for medical bills of others. A health care reform bill before the Joint Committee on Taxation proposes a tax penalty for people who do not buy health insurance and incarceration for those who fail to pay the tax. Carrie Budoff Brown of Politico writes in "Ensign receives handwritten confirmation," that

This doesn't happen often enough.

Sen. John Ensign (R-Nev.) received a handwritten note Thursday from Joint Committee on Taxation Chief of Staff Tom Barthold confirming the penalty for failing to pay the up to $1,900 fee for not buying health insurance.

Violators could be charged with a misdemeanor and could face up to a year in jail or a $25,000 penalty, Barthold wrote on JCT letterhead. He signed it "Sincerely, Thomas A. Barthold."

The note was a follow-up to Ensign's questioning at the markup.

The first link is to a copy of the handwritten, and the second, to an article about Ensign's questioning of the tax, euphemistically called a fee in the note.

This tax would fall heavily on young, healthy tax payers who do not purchase health insurance. Within a market, they are consumers who derive more satisfaction by buying goods other than health care. Under universal coverage, the law considers these consumers free riders.

Replace this text with...
Read more!