Strangely Liberating

Working on my taxes recently reminded me of a fun discussion I had with the late Stephen Williams, a judge on the United States Court of Appeals for the District of Columbia. (He’s pictured above.) I never met him and we mainly corresponded by email. After I told him that in December 2017 I had doubled my usual charitable contribution to the Institute for Justice so that I could get the tax deduction one last time (due to the 2017 tax cut law), we went back and forth.

Here’s the email thread with Steven in box quotes:

Last chance for taking deduction because of increase in the standard
deduction/exemption?

Steve

 

Yes on both. My state and local tax deduction is limited to $10K, our mortgage balance is so low that our annual mortgage interest is less than $3K, and my normal charitable deductions are around $2K. So I don’t come close to $24K.

Best,

D.

So here’s the big question on the tax-elasticity of donations:  Will you maintain your historic level?  (Of course one swallow doesn’t make a summer, or one donor a supply curve.)

Steve

Dear Steve,

Hey, I thought I was talking to a judge, not a literate economist. 🙂

That IS the question, isn’t it. I’m not sure of the answer. 2019 will tell. One little difference I’ve noted already: In 2018 I’ve given small amounts (I think $50 in each case) to 2 go fund me sites (one a woman who is a friend of a friend of a friend facing cancer with few financial resources and one a state employee in Montana who quit his job rather than cooperate with ICE in turning in workers). I probably would have given to neither of those causes but instead would have looked around for a tax-deductible charity that mimicked, as close as possible, the same ends. Not worrying about the tax consequences felt strangely liberating.

Best,

David

I especially like your last sentence!

Steve

As it turns out, I was back a little higher in 2019 than in my normal pre-2017 charitable contributions.

I said time would tell. Well, 2020 shouted. Going through our charitable that can be deducted, I found a little over $3,000. But my wife and I each gave between $3,000 and $4,000 to various people who suffered hardship because of the lockdowns. And yes, it was strangely liberating to do it with no thought of tax consequences.

 

 

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Romney’s child allowance proposal

Mitt Romney has proposed a child allowance of $4200/year for children under age 6 and $3000/year for children age 6 to 17, which is gradually phased out for people making over $200,000 (depending on the child’s age.) It is to be paid for without boosting the budget deficit, by reducing certain other poverty programs and also eliminating certain tax deductions, such as what’s left of the SALT deduction. (This last element is one of my favorite parts of the plan.)

I don’t know enough about the plan to have a firm opinion, but from a utilitarian perspective it seems to have some positive features:

Equity: The net effect is to shift money from the affluent to the poor, which probably results in a significant gain in aggregate utility.  (Yes, we can’t measure utility, but it seems likely that this factor is a net plus.)

Efficiency: It’s hard to say whether Romney’s plan improves or reduces efficiency, and that’s where I’ll focus the rest of the post.  But the mere fact that “it’s hard to say” is a sort of plus for the plan, because the equity considerations seem to be pretty clearly utility improving. With most welfare proposals, greater equity comes at a cost of lower efficiency.  I think it’s fair to say that either Mitt Romney is a very clever guy, or he has smart advisors, or both. At the end I’ll suggest a modification that would boost the equity of the plan, without any clear loss in efficiency.

1. Some conservatives like the fact that these child benefits would boost the birth rate, pointing to the fact that people say they want more children than they actually have.  I don’t share their worry that the birth rate is too low, and I don’t trust polls.  Some conservatives worry that paying poor people to have kids would cause so-called “inferior” people to reproduce.  I also don’t share this worry.  For me, the effect on births is a non-factor.

2.  Work disincentives can come from either the income or the substitution effects.  The substitution effect in Romney’s proposal is small, as parents don’t lose the child allowance until their income rises to well above $200,000.  So on that basis it won’t discourage poor people from getting a working class job.  There is a very mild work disincentive for upper middle class people experiencing the phase-out of the benefit.  The income effect refers to the fact that poor people might no longer work because they feel they can live on the child allowance without working (perhaps combined with other programs like food stamps.)  It seems to me that this disincentive would be quite modest for the size of benefits proposed by Romney.  Still, in net terms there’s probably a mild work disincentive from the issues I’ve discussed thus far.

3.  Many of the other provisions actually boost efficiency.  Several other (inefficient) poverty programs are either reduced or eliminated.  Furthermore, there’s a substantial gain from reducing the complexity of both the welfare system and the income tax system.  Eliminating the SALT deduction also discourages wasteful state and local spending.  So the various provisions that pay for the benefit have a significant positive impact on economic efficiency.

Combining points #2 and #3, I see no clear evidence of either an overall gain or loss of efficiency.  And again, the equity benefits seem pretty clear to me.

One final comment.  Why not make the child allowance fully universal, and then slightly boost the payroll tax (on wage income only) on people making over $200,000 a year to pay for it?  On an equity basis, that would redistribute money from the very rich down to the upper middle class, as people with very high wage income would pay more extra tax than they’d gain from the child allowance, while the opposite is true for the upper middle class—those making modestly above $200,000.

On efficiency grounds, my proposed modification would make the income tax system much simpler, so that’s a net gain.  The increase in the payroll tax rate would be smaller than the implicit marginal income tax during the phaseout range of Romney’s proposal (which mostly applies to people in the $200,000s), so extremely affluent people would face slightly higher MTRs while modestly affluent people would face significantly lower MTRs.  Overall, I doubt there’d be much change in economic efficiency, maybe even an increase.

 

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The equity and efficiency of SALT cap repeal

There’s currently some discussion in Washington DC about repealing the limitation on the deductibility of state and local taxes (from one’s federal taxes.) Back in 2018, the US government began limiting SALT deductions on federal income taxes to no more than $10,000/taxpayer. Repeal of this provision would have effects on both economic efficiency and economic equity:

Efficiency:

Repeal would cause many more people to itemize their taxes, which would increase the time and money costs of preparing taxes. It would also drive a wedge between the local cost of state and local spending and the total cost. Thus 70% of the cost of a $1 billion government project in New York or California might be paid for by local taxpayers, while the other 30% would be paid for by taxpayers in all 50 states. This would push states toward projects that don’t pass cost/benefit analysis, but that might seem desirable if one ignores the external costs imposed on out-of-state residents.  An example might be high-speed rail in California.

Equity:

Repeal of the SALT limitation would reduce taxes on upper income taxpayers. Because there is no free lunch, other taxpayers would have to pick up the slack.  If we run large budget deficits, then future taxpayers would absorb the bill.

PS.  Because I live in California, I would pay less in taxes if SALT limits were repealed.  However, my taxes would become much more complicated in terms of required record keeping, so I doubt I’d be any happier.  Don’t just think in terms of “who pays”; a successful country is one that avoids lots of needless deadweight losses.

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Connect the dots

In recent months, a number of important firms have announced they are relocating from California to Texas. An article by Peter Yared discussing this trend had a graphic that caught my eye:

The movement of these industries is toward three states that have one thing in common—no state income tax. And these are the only three states with no income tax in the southeastern quadrant of the US—say Texas to Florida and south of the Ohio River.

Progressives often discount the supply side effects of tax changes, pointing to examples such as Kansas where tax cuts had little effect.  But Kansas lacks the sort of big cities that would typical draw these firms and its tax cuts were relatively modest.  If you are looking for a low tax state on the Great Plains, South Dakota has no state income tax at all.  The top rate in Kansas (5.7%) is higher than in Massachusetts (5.0%).  That won’t get the job done.

Miami clearly benefits from a mild climate, but Tennessee and Texas have climates that are only average for a southern state.

I’m certainly not a rabid supply sider who thinks that tax rates are all important.  But a person would have to be pretty blind to ignore the migration of firms from places like New York, New Jersey and California, to lower tax places.

Interestingly, Washington State has no income tax, which is unique for a northern state with a big city.  Washington is also home to the two of the three richest people on the planet (the other–Elon Musk–just announced he’s moving from California to Texas.)  Beyond these anecdotes, Washington is also experiencing rapid population growth, which is unique for a northern state with a big city.  Indeed it’s growing even faster than Oregon, which has a slightly nicer climate.

There’s no doubt that climate has been reshaping America in the decades since air conditioning was invented, with people moving to warmer locations.  But for the first time ever (AFAIK), California saw its population fall last year, and it has a delightful climate (even with the recent forest fires.)  High tax Hawaii also lost population.

So while people are gradually moving to warmer locations, state tax policies explain why certain states attract a disproportionate share of the migrants.  Indeed, last year more that half of the US population growth occurred in just two states—Texas and Florida.  I believe that’s the first time that has ever happened.  Add in Tennessee and Washington and you are at nearly two thirds of the nation’s population growth.  Recent limits on the deductibility of state and local taxes has exacerbated this trend.

PS.  Technically, Tennessee has no wage tax.  However, they do tax interest and dividends at 1%.  But even that small tax is being phased out at the end of this year.

PPS.  Yes, housing policies are another big factor in migration—especially for the middle class.

Happy Holidays everyone!

 

 

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If you are not taxing consumption . . .

. . . then you are not taxing who you think you are taxing. I was reminded of this point by a recent tweet I saw:

Progressives tend to favor higher income tax rates on the rich.  I prefer a progressive consumption tax.  It might be worth noting that if the top rate of income tax were increased, President Trump still would have paid roughly $750 in income taxes in 2016.  In contrast, he probably would have paid much more in taxes with a progressive consumption tax, at least if his lifestyle is as lavish as has been reported.

Just to be clear, I don’t believe that tax policy decisions should depend on how it impacts Trump—that would be absurd.  My point is that when people get outraged about what they see as a gross inequity, it’s important not to just lash out blindly, rather one should think clearly about who actually bears the burden of different types of taxes.  In general, it’s NOT the person (or company) that writes the check.

There are technical problems with taxing consumption.  But there are often even bigger technical problems in taxing income, wealth and other alternatives.  For instance, there is the question, “Is X a consumer or an investment good?”  But the exact same dilemma crops up with income taxes.

 

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Three Economists Walk Into a Discussion, Part 1

On September 15, the Stanford Institute for Economic Policy had a virtual discussion about both Covid-19 and the views of the two major presidential candidates. The moderator was Gopi Shah Goda of SIEPR and the two interviewees were Kevin Hassett, who had been chairman of the Council of Economic Advisers under President Trump and Austan Goolsbee, who had had the same job under President Obama.

I watched it live.

I’ll hit some highlights and make some comments. This is Part 1.

At 4;24, Goda asks: “What are the right economic policies to provide relief to those whose livelihoods have been adversely affected by the pandemic and stimulate the economy? How much spending should we do in the short run on Covid relief issues like extended and extra unemployment and stimulus payments?”

She started with Kevin, and I got my first big disappointment. Notice that she asked two questions. Kevin, though, answered only the second. He gave a big number for spending and didn’t mention any other means of relief: deregulating, letting people work in occupations without having to get a license, allowing restaurants to sell food, allowing restaurants to open, getting the FDA to allow people to use home tests for the coronavirus.

And his number for additional federal spending was big: $1.5 to 2.5 trillion.

Goolsbee’s answer was what I would have predicted: lots more federal spending and a big bailout of state and local government.

14:50: Kevin defines classical liberals like me out of the discussion with “I don’t think there’s anyone who thinks there shouldn’t be state and local aid.”

15:10: Austan gets it right: There are a great number of people who are opposing state and local aid.

17:10: Austan has a funny line that riffs on the old can opener joke: “This is not just ‘assume we have a can opener; let’s assume we have the greatest of all can openers.’” Then he says that you wouldn’t want to use the price system to allocate the vaccine.

23:43: Goda asks about the differences between the two candidates’ tax policies.

24:20: Austan says that Biden wants to raise taxes on high-income people and on corporations. What’s important, he says, is what the money is used for. If the added revenue were used to provide universal child care, that would be very pro-growth, says Austan.

But wait. This is not a discussion between politicians. This is a discussion between economists. What’s the market failure that would justify government provision of child care? Austan doesn’t  even mention one. If my wife and I, when we were younger, had wanted to hire child care so she could work, we would have compared her after-tax income to our net-of-child-care-tax-credit cost of hiring child care. I showed in a piece in the Journal of Policy Analysis and Management in the late 1980s that the structure of the tax credit at the time could be seen as a way of offsetting the distorting high marginal tax rate of the second earner, typically the women. But Austan isn’t making that argument; in fact, for high earners, he wants an even higher marginal tax rate. Moreover, various changes in the tax law have been the tax credit much less pro-growth.

At about the 25:00 point, they get into a real substantive discussion about what happened to real wages and real family incomes after the tax cut. They literally disagreed about what the numbers were. Austan said that the effects of the tax cut on real median family incomes were disappointing. Kevin said that in a debate with Austan in Philadelphia a few years earlier, he had predicted that real median family income would rise by $4,000 and that the data that just came in (which were pre-pandemic), the number was actually a $4,900 gain. Kevin also pointed out that over 6 million people had moved out of poverty, the biggest drop since the War on Poverty had begun under LBJ. Kevin also pointed out that he had predicted that income inequality would fall as a result of the 2017 tax cut and that it had fallen.

Aside for non-economists: Why would reductions in income tax rates on corporations and on high-income individuals even be expected, at a theoretical level, to increase real wages? By increasing the incentive to invest in capital. The greater the capital to labor ratio, the higher are real wages.

29:10: Kevin catches Austan’s characterization of the proposed Biden tax hike as an increase in taxes on billionaires. Kevin points out that it would apply to people making over $400K annually. He then expresses optimism that Biden will hold off on raising marginal tax rates, due to the state of the economy.

31:00: Here is where Austan gives numbers on increases in real median family income that differ dramatically from Kevin’s data.

Aside:  As a viewer, I was able to type a question on line and I did. We learned near the end from Goda that a number of viewers had asked a similar question and it was this: “You two are disagreeing on actual facts; show us your sources.” I asked Mark Duggan, the SIEPR director, for the source and he sent me the link to the Census data that Kevin had cited. Kevin turned out to be right about the large growth in median family income of families, including black and Hispanic families. I’m still scratching my head about what data Austan had in mind.

32:00: Kevin says that growth in median real family income in the first 3 years of Trump vastly exceeded any 3-year period under Obama.

32:10: Goda lays out the deficit issue nicely and asks about the two candidates’ plans.

In Part 2, I’ll cover the rest of the discussion.

 

 

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CHART OF THE WEEKMission Impossible? Can Fragile States Increase Tax Revenues?

By Bernardin Akitoby , Jiro Honda, and Keyra Primus The COVID-19 shocks are proving to be especially challenging for fragile states. Pre-COVID, fiscal revenues were low in such countries and governments were struggling to raise them. Now, COVID-19 is hitting them hard and fiscal revenues are falling. Once the pandemic abates, restoring and further enhancing […]

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The Biden tax plan

With Joe Biden now favored in the election betting markets (albeit far from a sure thing), it’s time to take a look at his tax plan. Here are some of his proposals to change the personal income tax:

Imposes a 12.4 percent Old-Age, Survivors, and Disability Insurance (Social Security) payroll tax on income earned above $400,000, evenly split between employers and employees. This would create a “donut hole” in the current Social Security payroll tax, where wages between $137,700, the current wage cap, and $400,000 are not taxed.[1]

Reverts the top individual income tax rate for taxable incomes above $400,000 from 37 percent under current law to the pre-Tax Cuts and Jobs Act level of 39.6 percent.

Taxes long-term capital gains and qualified dividends at the ordinary income tax rate of 39.6 percent on income above $1 million and eliminates step-up in basis for capital gains taxation.[2]

Caps the tax benefit of itemized deductions to 28 percent of value, which means that taxpayers in the brackets with tax rates higher than 28 percent will face limited itemized deductions.

The first item is something I’ve long favored—higher wage taxes on the rich.  In the long run, a progressive wage tax is identical to a progressive consumption tax, although due to tax avoidance they might not be identical in practice.   This tax will raise a great deal of revenue, and more revenue will certainly be needed due to the recklessly large budget deficits in recent years.

The second item is a mistake, in two ways.  First, it’s simply not true that the top rate on federal personal income taxes is currently 37%; it’s over 40%.  The US has two personal income tax systems (itself a really foolish idea) and we should count both systems when computing the top rate of federal income taxes.  It’s also a mistake in the sense that raising the top rate also raises taxes on capital income—a bad idea.

The third item is really stupid idea.  And I don’t mean “stupid” in the sense of “I strongly disagree”. I mean stupid in the sense that it implies a lack of understanding of basic public finance concepts.  Capital income has already been taxed once as wage income, and is thus being double taxed by capital income taxes.  In addition, we tax nominal capital income.  Even if I am wrong and there is some “second best” argument for taxing capital income, you certainly don’t want to tax it at exactly the same rate as labor income. Setting both rates at precisely 39.6% (actually even higher), would like saying that since apples and oranges are both fruit, there should be a law requiring stores to sell apples and oranges at exactly the same price.  Even in the unlikely event that there is an argument for price controls on fruit, it’s almost inconceivable that the optimal price ceiling is identical for all types of fruit.

We need to transition from an income tax to a consumption tax.  One way of doing so is by removing all limits on 401k plans.  Allow unlimited contributions and allow withdrawals at any time, which would effectively eliminate taxes on capital income.  This approach may not be the most efficient, but it at least makes it obvious to voters that this money has been taxed once, and doesn’t need to be double taxed. Once you do that, you can make the overall system more progressive than today, without killing off capital formation.

It’s a good idea to cap the deductions at 28%, but an even better idea would be to cap them at zero percent.  In other words, move toward a system with only a standard deduction.  The tax reform of 2017 moved us a good distance toward eliminating deductions, but many in Congress want to bring them back.  To his credit, Biden doesn’t propose doing so, but I fear he’ll be pressured by Congress to undo the tax simplification of 2017, which caused the vast majority of people to shift to the (simpler) standard deduction.

Increases the corporate income tax rate from 21 percent to 28 percent.

This is a bad idea, but it does tend to confirm a point I’ve been making for years.  Back in 2017, I claimed that Hillary Clinton would have reduced the corporate rate to 28%, and this seems to confirm that 28% is the preferred rate of the Democratic Party.

There are lots of other minor suggestions, of which this seems to be the best:

Expands the Earned Income Tax Credit (EITC) for childless workers aged 65+

There are also lots of missed opportunities, such as a carbon tax.  Overall, I’m not a fan of Biden’s plan, and hope the Senate can block the more counterproductive changes.  But I fear the opposite—the worst aspects of the plan might be adopted, without the better suggestions.  Pray for gridlock.

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