Taxes All the Day Long

February 22nd, 2013 at 8:21 pm

I began the day speaking at a great Tax Notes forum and throughout the day, I’ve stumbled on numerous interesting articles on tax policy, both from high and low analytic altitudes.

The forum was to mark (I’d say “celebrate” but not everyone would agree) the 100 year anniversary of the federal income tax (they even had a cake!).  I’ll find a link to it at some point—the other panelists were really interesting.

Here’s a summary of my points, with some of those articles sprinkled in:

What’s Right and What’s Wrong with Our Tax System—and Our Debate About It

Let me begin by just ticking off the things I think are healthy and less healthy about our system of taxation.  I’ll largely focus on federal taxation but will mention state/local in passing, since they’re important too.

As you just heard [from Joe Thorndike], we have a very enduring system of revenue collection.  I’m not saying everyone loves it, but its infrastructure is firmly in place, widely accepted, and highly functional.  Though of course you can find people who will disagree, the system is broadly viewed as legitimate.

I will, in a few minutes, introduce ways in which I fear that legitimacy is becoming more fragile and what we should consider doing about that.

What else is healthy about our tax system?  It’s elastic to growth.  Revenues are cyclical which helps avoid structural deficits, and provides people with more after-tax income in recession.  In fact, as I’ve often stressed on my blog, while Clinton-era tax increases certainly helped achieve the surpluses of the latter 1990s, economists widely attribute economic growth as the key determinant (and, of course, one must note here that tax increases did not preclude such growth).

Also, there has been, throughout history, though much less so today and this is a big problem, a linkage between paying taxes and building and protecting a better nation.  Pay your taxes to beat the axis; to build the infrastructure we need to fix today; to stand up our national system of public education (and here, state and local taxes also come into play).

With that, let’s turn to ways in which our system of taxation isn’t as healthy as it needs to be.

Most fundamentally, we are at serious risk of losing the connection between what the majority wants from government in terms of investments, public goods, safety nets, social insurance, national defense—and what they’re willing to pay for it.

In part, this harks back to the Laffer curve and what I think of as extreme supply side economics—we can raise more tax revenue by cutting taxes, especially on the wealthy—versus a view that says “you won’t lose of much as you think.”

It also relates to irresponsible politicians/policymakers and all sides of the aisle who are comfortable promising lots of goodies but very uncomfortable paying for them.  Let me give bipartisan examples.

During his presidential bid, Mitt Romney attacked Obama for a) not being willing to tackle unsustainable entitlement costs, and b) cutting Medicare.  And of course he constantly fell back on “dynamic scoring” to make the case that his supply-side tax cuts would add up.

The President, both in his inaugural address and especially in his SOTU presented a robust, and I thought enlightened agenda, but said not a peep about paying for them.

President Obama has also consistently contributed to the illusion that we can achieve meet the challenges and demands we’ll face going forward on tax increases only on HHs above $250,000, or now, post-fiscal cliff deal (which made 80% of the Bush-era tax cuts permanent, $450,000.  I cannot overemphasize the extent to which this position has cramped the tax debate.

[HERE ARE TWO EXCELLENT PIECES IN TODAY’S PAPERS ON THIS VERY TOPIC.]

On the other hand, the President also deserves high praise for having the courage to place a tax increase, even on a narrow slice of the electorate, at the heart of his campaign.  Even though the vast majority of the electorate wouldn’t be affected by it, in today’s climate, that’s still a step in the right (left?) direction.

Other problems:

–the tax system doesn’t raise enough revenue.  And that’s not just the recession; it’s also tax policy and anti-tax pledges.

What is enough revenue?  I don’t know, but historical averages (e.g., 18% of GDP) don’t really provide guidance…aging boomers, health care cost pressures, obligations to veterans (many of whom will need more help than earlier cohorts), aging infrastructure, future debt service, education, inequality, regulatory demands (climate change!)—all of these pressures mean the past is poor precedence in terms of adequate revenue levels.

–the system has become less progressive, with the largest declines in effective tax rates at the top of the income scale.  Look, I’ve been worrying about the growth of income inequality for decades now, but let me be clear: the growth is largely a pretax problem and I don’t expect the tax code to fix it.  But I sure don’t expect it to make it worse!!

Here’s also where the legitimacy of the tax code—a critical issue in a democracy—comes into play.  If average folks feel like the economically privileged can get a much better deal out of the tax system than they can, that system will lose legitimacy and that is, of course, a real risk today, one that was highlighted in the recent election.

To tie this to a concrete policy, when we privilege a particular unearned income and debt financing over paychecks, we’re chipping away at legitimacy.  Now, there could be good reasons for accepting such a tradeoff, e.g., if such favorable treatment led to faster growth and more investment.  But it doesn’t.  And this is a real problem we could and should fix.

–Corporate taxation in the US is a mess: high statutory rates, low effective rates, and historically low collections…massive tax avoidance, often through transfer pricing.  This also hurts legitimacy.

What to do?  At this point in the forum, economists invariably call for switching to a consumption tax, but I won’t do so.  I just don’t see it in the cards and there are, of course, regressivity complications.

I’d instead be guided by these principles:

–there should be no distinguishing between spending through revenue collection or deficits (borrowing), and tax expenditures.  The latter is simply spending through the tax code.  If politicians truly believe we have a spending problem, then they also believe we have a tax expenditure problem.

–we’ve got the worst of all worlds in corporate taxation; White House proposal has lots of fine ideas—takes the rate down to 28% and closes loopholes—but a) heavy lift (my loophole is your treasured investment incentive), and b) as per all the above, I don’t think revenue neutrality is the right goal.

–to the extent possible, I’d suggest we try something new in this space—or, if not new, something that hasn’t been around for a while; tying tax increases to what they’re intended to pay for.  To health coverage, infrastructure, education (as Gov Brown recently did in CA), preserving retirement security.  Dedicated taxation might be one way to help reconnect this very damaging gap between what we say we want and what we’re willing to pay for.

 

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22 comments in reply to "Taxes All the Day Long"

  1. Jim says:

    We do have dedicated tax revenue for Social Security and Medicare.


    • Jared Bernstein says:

      And they enjoy deep support.


      • Jill SH says:

        Not from everybody, but then maybe they are unclear on the concept. In today’s NYT David Brooks said this:
        “Sequestration carefully spares programs like Medicare and Social Security that actually contribute to the debt problem.” I heard him repeat that on NPR this afternoon.

        You’d think someone like him would know better.

        Why do I (we?) have to keep yelling at the top of my lungs that Social Security in NOT contributing to the debt, it’s FINANCING it!!


  2. save_the_rustbelt says:

    widely accepted, and highly functional

    Only because of the coercive power of the federal government and fear of the IRS.

    (I prepared and reviewed many thousands of returns over 30 years and sat through hundreds of tax planning conferences, FWIW. And a few stints as a tax prof.)


  3. save_the_rustbelt says:

    Yesterday’s newspaper…

    Facebook: huge profit, tax REFUND !


  4. readerOfTeaLeaves says:

    Observation:

    …massive tax avoidance, often through transfer pricing…

    I learned about ‘transfer pricing’ reading Nicholas Shaxson’s superb “Treasure Islands: Tax Havens and the Men Who Stole The World”, but I’m reasonably sure that few American’s understand this concept.

    After all, few of us are accountants or economists, and for many of us terms like ‘transfer pricing’ are about as boring as the inner workings of our carburetors. Nevertheless, ‘transfer pricing’ is a key concept in this tax debate, in an era of globalization.

    Could Dr. Bernstein please either link to a definition, or else put up a blogpost explaining why this concept is really quite important for more of us in the public to get our heads around?

    (Shaxson gives an example of a banana grown in South America, consumed in Britain, that is easy to follow. But without examples, a lot of us are lost.)


  5. Smith says:

    http://ctj.org/corporatetaxdodgers/
    http://www.ctj.org/corporatetaxdodgers/CorporateTaxDodgersReport.pdf

    In regard to the statement in the above blog post:
    “–the system has become less progressive, with the largest declines in effective tax rates at the top of the income scale. Look, I’ve been worrying about the growth of income inequality for decades now, but let me be clear: the growth is largely a pretax problem and I don’t expect the tax code to fix it. But I sure don’t expect it to make it worse!!”

    I think this statement vastly underrates the potential impact of the tax code to affect inequality. If all income and every type of income earned over $150,000 was taxed at a 50% marginal rate which progressively rose to 90% at $1 million, that would substantially affect the incentive to reward people with excessive monetary compensation. Ironically, Republicans agree with me, claiming people will refuse to work for higher taxed income. I disagree this would adversely affect the economy. Tremendous side effects like a balanced budget, restoring free education, infrastructure, R&D, would ensue. Yacht sales would decline. Any true liberals agree?


  6. Mark Jamison says:

    What are your feelings about a gross receipts tax instead of or at least as part of corporate tax reform?
    Where would a financial transactions tax fit into the picture? That would seem to have a salutary effect on making markets less speculative while raising some revenue.
    Thanks for your work.


    • Jared Bernstein says:

      Less excited about a GRT–these days, there are lots of firms with high profits, low receipts, so you’d get large differentials across industries.

      An FTT makes a lot of sense, as I’ve written in various places. When I was at the WH, the argument against it was that we couldn’t go there unless Europe did…well, Europe looks like it’s going there.


      • Mark Jamison says:

        A couple of additional questions on GRT. Where do the firms you mention fall in the spectrum in terms of size? Do firms with low volume but high profit tend to cluster in certain industries or at certain level of corporate size or are they spread somewhat evenly across the corporate world? If there’s clustering in one form or another then it might be reasonable to apply a different regimen to those clusters.

        GRT appears to offer something of an answer to the problem of transfer pricing. Are the firms that use this tool a good target for some form of GRT or do they fit the concern you expressed earlier?

        I know that AMT has a horrible reputation today but it was a useful solution when introduced and had it been fully indexed might not have become such a headache. I wonder if GRT or something similar couldn’t become a corporate AMT to ensure some minimal participation.


  7. Joe says:

    I would argue that the federal taxation of income has NOT become less progressive over the past 30 years. We have come to a point where the bottom 50% of households (in terms of AGI) pay, on average, less than 2% tax rate. That rate has been dropping consistently since the Tax Reform Act of 1986. The top 5% has also seen their tax rate drop but by a much smaller amount.

    In terms of AGI share to tax share, the ratio for the top 5% under Clinton was .6 or, 31% of AGI and 52% of tax shares). For the bottom 50% that ratio was 3.2 (14% of AGI and 4.3% of tax share). Under Bush, the top 5% ratio dropped to .59% and for the bottom 50% the ratio of income to tax share rose to 4.1%!! Increasingly progressive!!!

    Most recent data shows the top 10% have 43% of the AGI and pay 70% of income taxes while the bottom 50% has 13.5% of AGI and pay 2.3% of taxes!

    You can argue that the AGI needs to be improved for the bottom 50% but it is difficult to say the tax system has become less progressive.

    I absolutely agree (and we exchanged e-mail on this) that dedicated payroll taxes should be used for critical “investments” like infrastructure though I would want it funded by correspondingly reducing the lowest marginal income tax rate.


  8. Fred Donaldson says:

    While the very rich gain from low capital gains and dividend tax rates, the seniors with 401ks and IRAs must pay regular rates on withdrawals, because a certain percentage of withdrawals is mandated each year after age 70.5. This shows up as ordinary income, is taxed as such, and accounts for some of the income levels reported for seniors.

    Why would you use a statistic for income that includes forced savings withdrawals for one class of folks and not use it for voluntary withdrawals by a younger group? The answer is the statistic helps the argument that the elderly have a bunch of income, when in many cases they are just withdrawing savings until nothing is left – if they live long enough.

    Oddly, depending on investments and personal tax rates it can be more profitable to invest in stocks outside an IRA or 401K over a long period of time – given the 20% capital gains tax rate vs. nearly double highest personal rate.


  9. PeonInChief says:

    The problem with “dedicated taxation” is that there are lots of important things people don’t want to pay for–affordable housing for the poorest 50% being at the top of the list, but also subsidized childcare (which Jerry Brown cut in the last budget), welfare for single mothers with children (which Bill Clinton cut), disability (particularly mental illness) etc. People don’t want to pay for any programs that are perceived as benefiting “those” people.


  10. masaccio says:

    People are willing to pay taxes. What they aren’t willing to do is to watch the feral rich evade taxation while demanding and getting more and more from the government.


  11. Pinkybum says:

    I would go with dedicated taxation if I thought the money would be separated from the general fund (Al Gore’s “lock box”). But, as we have seen with Social Security the government writes itself an IOU, spends the money now and future expenditures have to paid for by future taxes anyway. And what has the government spent the money on? Two unfunded wars, tax cuts for the rich and Medicare part D. Now the right wing and the media are consistently beating the drum that so-called “entitlements” are not funded well enough for the future and we will have to accept cuts in benefits. This is a complete con-game and we are the suckers.


  12. David C says:

    I think a critical tool in raising the revenues we need to fund public investments has to be some kind of a carbon tax. The costs of climate change are already high (see: Sandy) and going to get much higher. Everything we can do to hasten the transition to non-carbon fuels is hugely important to the future our kids and grandkids will have.


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