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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