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Defining Rich IV: Corporate vs Personal Tax collection patterns 1934 to present

When I left this series in September, I had introduced the idea of looking at past tax tables as a means of understanding how We the People define rich. One specific note from history was a surcharge on top of themarginal tax rates to pay for the Great One (WWII). Obviously, that aspect of our moral character has gone right out the window.

Also for a brief period (1936 to 1943,on 6 occasions) business paid more of the income tax revenue collected than did people. I also noted that 1983 and 2009 the corporate share of income tax revenue was just over 6% of the totalrevenues (FICA included). Its lowest points. Reagan/Bush II. However, interestingly enough, Bush II did manage to get thecorporate tax collections as a percentage of personal collections(excluding FICA) up to 33.9%! Clinton only managed 26.6% in 1995. The last time we saw a ratio where corporate collections were in the30% range was 1979. In 1959 it was 47.1%. 1980 heralded the new standard of the mid to low 20% range. Of course Reagan wins thispersonal verses corporate relationship with a corporate total that is only 12.8% of the personal in 1983.

One other very interesting aspect ofour tax history using the same table is that from 1934 to 1983 when tax revenue from personal collections became less than the year prior, this was only for one year with the exception of 1945/46. Corporate revenue follows the same pattern except for 3 periods where there was a decline for 2 years running: 1946/47, 1958/59 and1961/62. From 1983 until 2001 the personal revenue is more every year than the year prior. It’s like a switch was thrown after 1983. The corporate revenue declines twice for 1 year each in this 1983 –2001 span; 1990 and 1999. Starting in 2001, the decline in revenuecollections for both personal and corporate last for 3 years running;2001 to 2003 and 2008 to 2010. Someone threw a double pole switchhere. We’ll have to wait to see for 2011.

Obviously, from this bit of history we can see a few trends at least. We have been reducing the burden on corporations as paying their share for the use of the commons. From1984 to 2000 the personal collections never declined yet thecorporate did twice. Prior to 2001, our tax tables and all their loop holes produced a fairly stable ever rising stream of revenue. However, after 2001, the stability is less in that any time there isa reduction in revenue collections, it lasts 3 times longer. Finally, except for 2005 to year ending 2007, since 1980 we think that corporations should only pay between 20 to 26% of what We thePeople pay in to our government.
I mention all the above because it isevident that more than just the marginal rates are changing and, as far as my assessment of these changes go, they are leading us to anever less stable adjusted gross income base for then calculating the tax due. That is, the base has been adjusted such that it is moresensitive to down turns in the economy. Prior to the Reagan taxrevolution, both the personal and corporate base were fairly evenlysensitive with the corporate being maybe a little more sensitive.
For 50 years (1934 to 1983) there wereonly 3 periods in which the corporate collections were less for 2years in a row and none of them were the back to back Reaganrecessions. After 1983, the base for personal taxation has changedsuch that it is not effected by any recession. However, thecorporations got relief twice. Considering that from 1934 to 1982there are only 2 recessions listed by NBER as lasting more than a year (1973/75and 1981/82, 16 months each) 1 year of less revenue does not seembad. However, for the last 2 recessions, the revenue collectionshave been less each year for 3 consecutive years for both thepersonal and the corporate collections even though the latestrecession is listed as lasting 18 months.
Withinthis 3 year pattern, we also see that the declines are greater. Fromthe high to the low for 2000 to 2003, by 2003 personal collectionsare 79% of the high and corporations are 63% of their high. For thepresent recession personal became 78.4% of the high and corporationswas 62.9% of their high. Even in 1983, when Reagan wins thepersonal/corporation differential the declines were only 97% personaland 75.2% corporations. For another perspective, that 2 year declineof personal revenue collections for 1945/46 the personal declinedonly to 81.7% of the high. During this period the corporations onlydeclined for 1 year (1947) to 72.5% of the high. In 1947, corporaterevenue collections were 48% of the personal collections. In 2000,the peak corporations revenue was 20.6% and in 2008 it was 26.6% ofthe personal revenue collections.
Obviously we made more than marginalrate changes after 1980. We changed the way the base is calculatedsuch that corporations paid significantly less as a share of thetotal income taxes and was more tied to a change in the economy suchthat corporate taxes due were less during a recession where as thepeople had no reprieve. How’s that for fairness? Then came Bush II. The base changed even more… so such that now the decline inrevenue collected lasted longer than the recession and the declineswere greater.
We do not just need to raise the rates,we need to return to a broader base. That is, when all thedeductions are done, the adjusted gross income needs to be higher. On the other hand, what we are seeing here could be the results ofthe massive shift of income up the line combined with the decreasedrates. Considering this history, the cry to lower rates and get ridof loop holes just will not work. This is a cry for flattening theincome tax, which is what we have been doing since the 60’s which wasaccelerated since Reagan. It will create a tax base that is moreunstable and thus runs even greater deficits during times of economicdecline not to mention the overall decline in total revenue collectedduring good times. And, it totally ignores the issues of equality ofpower along with the concept of the commons. You know, that We thePeople premise.

But before you get to excited aboutthis suggesting or, that I am saying that the poor need to pay moretaxes and the rich are over taxed consider the tax table from 1936,its lowest income tax bracket is 4%. This is on an income up to$4000. Let’s bring that forward to 2010 using my favorite money converter. CPI states that $4000 is now $60,400. Today’s rate for $16,750 to $68,000 is 15% instead of 4%. Of course,I like the unskilled labor and nominal GDP/capita numbers of $145,000and $275,000 respectfully.

Alright, I’ll be fair. The lowest rate in1967 is 14% for up to $1000. That figures to 2010 of $6540 CPI,$6670 unskilled and $11200 nominal GDP/capita. Though, the $4000 in1936 is $9640 in 1967 which puts one in the 22% bracket ofthat year. Using the $12000 for the top of that 1967 bracket brings us to$78,300 CPI adjusted gross income for 2010. $78,300 puts one in the25% bracket for 2010. Obviously another issue we have here when itcomes to setting up marginal rates based on historical records is howmuch the base (adjusted gross income) is effected by how the CPI iscalculated. Any way you figure it, we have been pushing the marginalrate higher and deeper into the lower end of the income pool.

Ok, onto the fondly remembered tax yearof 1936. Next post.

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Beale debates Cato’s Edwards on the right’s "flat tax"–New Hampshire Public Radio

by Linda Beale

Beale debates Cato’s Edwards on the right’s “flat tax”–New Hampshire Public Radio

Last Wednesday (Oct. 26, 2011), I debated the Cato Institute’s tax policy guru Chris Edwards about the right’s various “flat tax” (FairTax, 9-9-9, USA Tax, consumption tax) proposals, on New Hampshire’s public radio station’s hour long program “The Exchange”, hosted by Laura Knoy. You can catch the program on the NHPR site, at “The Flat Tax is Back” (Oct. 26, 2011). (The live format is an initial discussion in response to the host’s directed questions, followed by call-ins from the public.)

I argued, as you might expect from my previous postings on this matter, that the various proposals for some form of VAT/consumption/wage-based/flat tax do not make sense at a time of inordinate income and wealth inequality in the United States. Consumption taxes are regressive, and most proposals from the right–including Herman Cain’s three step progress, with 9-9-9 as the midpoint, towards a national retail sales tax, and Rick Perry’s proposal for an ‘option’ of a 20% national sales tax–simply will make the rich richer and the poor poorer. They are terrible ideas at any time as a substitute for both the somewhat progressive income tax and the somewhat equalizing estate tax. They are especially terrible ideas in a period when inequality has returned roughly to the same level as it was in the Gilded Age and when plutarchy threatens to devour our democracy.

Edwards made some rather inconsistent statements–including acknowledging that all of these proposals call for elimination of tax on all income from capital and from all estates, and then a later statement that the flat tax would be fair because it would tax people alike on their total income! He also relied on straw man arguments–another favorite of the Cato Institute representatives that I have seen before, used to divert attention from the fact that they cannot really answer the real question at issues. Chris relied on the laughable Laffer-curve based argument of which Cato is inordinately fond and which has been adopted and repeated ad nauseum by the right, that tax cuts result in greater revenues to the rich that result in enhanced job growth. I reminded him and listeners that our greatest growth was from WWII to 1981 when we had very high tax rates, demonstrating clearly that high tax rates do not cause weak growth. (Of course, 1981 is the critical time, because the Reagan cuts ushered in the right’s reaganomics dominance with tax cuts, deregulation, militarization and privatization that led us to the current Great Recession–aided in part by the weak-kneed Democrats who went along rather than standing up for worker rights.) Chris’s response to the empirical evidence that tax cuts do not lead to broad-based growth or job creation was “we can’t ever go back to the high rates of the 1970s again.” Of course, that was a straw man argument. Nobody is arguing for 90% rates. I am arguing, however, that the flat tax–with its zero percent rate on most of the income of the uberrich and its very low rates on the rest of their income–will hurt the poor because it is distributionally unfair, and hurt the economy generally because it will lead to revenue shortfalls that will force spending cuts to programs that matter to the wellbeing of society.

Anyway, listen to the program. Your thoughts welcome in comments to the blog. (And sorry for miffing my chance at the “last word” at the end of the program. It was an instance of getting tangled up in what I wanted to say and ultimately failing to make the point with any power at all. What I was aiming for was something along the lines of the following:

Reagan passed the 1981 tax cuts, and then Congress realized what a problem the resulting deficits would be so was energized to pass increases in taxes. Problem was, most of the cuts favored the rich (were cuts in income taxes and in depreciation expenses providing cuts in income taxes, etc. ) and most of the increases disfavored the poor (i.e., were regressive payroll taxes). IN 1986, however, there was a broad process of Congressional review, resulting in the 1986 tax reform act that eliminated (for a very short time, as it turned out) the category distinction between capital gains and labor income. That was a major, good innovation that grew out of a sustained, measured, thoughtful though imperfect process. There is no indication that election of more hard right candidates will lead to any such similar reform process today. If elected, the hard right candidates are likely to push for, and may get, tax changes that continue to enrich the rich, like the flat tax or 9-9-9 tax plans being put forward by Perry and Cain.

originally published at ataxingmatter

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Perry’s Flat Tax and other "bold reform" ideas in context of the richer 1%

by Linda Beale

Perry’s Flat Tax and other “bold reform” ideas in context of the richer 1%

The hard right candidates of the GOP are competing to set forth plans that demonstrate their utter and complete loyalty to the right’s  “make the rich richer and make businesses less accountable” economic program.
This program involves the tired and failed policies of Reaganomics, just magnified:

  • more tax cuts for the wealthy (zero direct taxation of their primary source of income–making money off money, and –to the extent that the incidence of corporate taxes says that corporate taxation should be attributed to shareholders–reducing those taxes as well);
  • elimination of earned benefits for the rest of us (assuring huge revenue shortfalls to the federal government and no dedicated funding of programs, along with dedicated axing of benefits through the ‘deficit/debt’ scare tactic);
  • deregulation of everything to do with business or capital (gutting EPA, Dodd-Frank, Sarbanes-Oxley, and every other regulatory agency no matter the impact on the economy or on ordinary Americans, thus encouraging a return to  speculative frenzy that allows socialization of losses/privatization of gains);
  • privatization wherever possible (Perry’s plan for privatization of whatever Social Security remains after the afore-mentioned gutting; privatization of schools, firefighters, bridges, highways, etc.); and
  • continued militarization.

Michael Kingsley noted that the “economic growth” rationalization of the various flat tax plans that shift the tax burden to the middle class while granting enormous tax cuts to the wealthy is merely “hope masquerading as theory.”   See Kingsley et al,Flat Tax Proposals are Perpetual Fount of False Promises: View, Bloomberg.com (Oct. 24, 2011) (“This hope masquerading as a theory has dominated conservative economic thinking for three decades, despite all evidence to the contrary”).
Perry’s flat tax proposal is right on track with the right’s apparent goal of enriching the rich and shrinking Social Security and Medicare and other federal government’s programs for the well-being of its citizens.   He offers the so-called “Flat Tax” as an option, part of his “cut, balance, and grow” economic ‘plan’.   He says it’s a “bold reform.” Opel, Perry Calls His Flat Tax Proposal ‘Bold Reform’, New York Times (Oct. 25, 2011).
Perry’s plan involves devastating federal program cuts including cuts to Social Security and Medicare for current and future recipients, as well as a ‘cart before the horse’ constitutional amendment –a ‘balanced budget amendment’ that would, for example, prevent us from borrowing cheaply even if it were to pay for a temporary surge in costs for Veterans’ medical care due to the cohort of soldiers returned from Iraq and Afghanistan.  The proposal entails an unfounded assumption that reducing federal spending from about 24% of GDP today to around 18% of GDP within a decade would be reasonable, given the lingering costs of the Iraq and Afghanistan wars,  expenditures to make up for the drain on our military, the ongoing costs of the financial crisis sparked by deregulation and the ‘too big to fail’ phenomenon, etc.   Perry has argued against “arbitrary cuts” to defense spending while at the same time calling for enormous tax cuts for the wealthy.
Perry says his system is “fair, simple, and flat”.  In fact, it is none of the above.

So perhaps it is time to discuss two questions about Perry’s tax plan: (1) just what is this “Flat Tax”? and (2) what would be the distributional, administrative, government and other impacts of this new system of taxation (option to choose between the current income tax and the ‘Flat Tax)?
Regarding the nature of the Flat Tax, it is probably helpful to point out what it is not, since most Americans do not understand how it would work.

  • The “Flat Tax” is not flat, since it has two rates: it will have an exemption amount of some sort for the poorest taxpayers, just as our income tax provides a standard deduction and personal exemptions (and other provisions, like the Earned Income Tax Credit) to ensure that the poorest Americans do not have to pay the income tax. 
  • The “Flat Tax” does not eliminate all deductions: it will leave deductions for charitable contributions (highly favorable to the rich who are the ones that make the most such contributions) and mortgage interest (also favorable to the rich, who have the most expensive homes and get the full amount of the interest deduction even with a flat tax), and some health and child care expenditures. 
  • The Flat Tax is not just a “single rate” income tax since it is not tax on all types of income:  it will be a tax on wages that are not saved (so for the majority of Americans, a payroll tax or a tax on consumption).  The primary source of income for the rich –money earned by money–would not be counted. 
  • The Flat Tax is not a ‘postcard filing’ tax, Perry’s assertions aside (that “taxes will be cut on all income groups in America” and that taxes can be filed on a post-card size form).  The rich will pay much less, some in the middle class may pay less but only after fiddling with both forms, and the rest will not likely pay less.  The form still will require figuring out what counts as income and when it counts and what type of income it is for anybody in the middle class that might be in either one (lots of filler pages behind that “flat rate” times “taxable income” calculation).

Regarding the feasibility of the “Taxpayer Choice” system of income taxation and Flat Tax:

  • The system would lower taxes for the rich (and some others), with no benefit for the poor and lower middle class, so neither simple nor distributionally fair.
    • About 50% of American families pay no federal income tax anyway or pay less than the 20% rate of the “Flat Tax”.  Those families would have no benefit from the Flat Tax so for half of Americans, no benefit from the option.  But Perry –who says he is “dismayed at the injustice” of Americans who don’t pay any income tax (but do pay payroll and excise taxes) won’t achieve his goal of changing the fact that poorer Americans don’t pay the income tax.  They don’t under our current system because we have designed the stnadard deduction, personal exemptions and earned income tax credit to provide a minimal standard of living.  They won’t under Perry’s system because they can still file under the current system.
    • The wealthy would pay substantially less under the Flat Tax, since their main source of income–income from capital–won’t be taxed at all.  They’ll choose the Flat Tax for a substantial tax cut.
    • Assuming that the system provides an annual choice for taxpayers, it creates a nightmare.  There will be some in the upper middle class  who will have to calculate their taxes both ways and choose the most beneficial.  For some, there may be some tax benefit to the Flat Tax, but their taxes will be that much more complicated and their benefit will be minimal compared to the tax cut received by the wealthy.
    • If it doesn’t permit an annual choice, taxpayers may inadvertently find themselves locked into the clearly wrong system for them–leading to distrust of government, and a sense of lack of fairness in a system that provides a trap for the unaware.
    • The differential treatment of income  depending on its character under the Flat Tax option (zero taxed income from capital and fully taxed income from wages) will be yet a further impetus to tax evasion  and unfair taxation of workers compared to owners–i.e., it is both untenable and unfair.  (This was the reason that the 1986 TRA under Reagan eliminated the category distinction.)
    • Len Burman describes it as “political pandering at its worst.”  Perry Offers Tax-Cut Choice, BusinessWeek (Oct. 26, 2011).
  • The system will result in huge decreases in revenues.
    • The upper middle class and wealthy will choose the most beneficial tax (zero taxation of capital income, still get the mortgage interest and charitable deductions which are the biggest tax subsidies against their taxable income)
    • This will result in substantial decrease in tax revenues, leaving the government wither with huge deficits funded by further borrowing, or the necessity of making huge cuts in long-respected government programs like consumer protection, mine safety, worker safety, food safety, environmental protection and basic research funding for the humanities and sciences
    • The revenue shortfalls will inevitably call for shrinking the parts of government that the right that passes the bill doesn’t like–i.e., New Deal social welfare programs, EPA, etc.  It will make it well nigh impossible for the government to uphold its promise to pay for earned benefit programs like Social Security and Medicare.
    • That impact is an intended result of the revenue shrinkage built into the Flat Tax plans.
  • The choice of tax systems will require duplicate tax administration as well (adding costs).
    • Advocates of Flat Taxes/ VATS/ FAIR Taxes (national sales taxes) claim that their plans will all be “simpler” because of the single rate.  They disregard the facts
    • All of the complexities of the income tax remain for both the income tax and the Flat Tax–what is income, what character is the income, when is it income, is an item deductible or not (charitable contributions can really be quid pro quos, etc.).
    • Having an option means generating an entirely new set of forms, guidance, regulations that underpin the statute, audits, administrative determinations–essentially a new division of the IRS to cover the new option
    • Couple that with the right’s antagonism to the IRS generally and one can expect an underfunded IRS that has trouble enforcing either the income tax or the Flat Tax.
    • Underfunding of enforcement (exaggerated by the right’s demonization of government generally and the IRS specifically) will incentivize tax avoidance behavior–sophisticated, wealthy taxpayers will game the flat tax system in particular by recharacterizing ordinary expenditures as deductible savings or taxable compensation as excludible capital income.
    • Federal revenues will likely decrease even further because of the enforcement problems.
  • The compensatory benefit–the claim that the Flat Tax (and accompanying deregulation of financial institutions and major corporations through the repeal of Dodd-Frank and Sarbanes-Oxley) will unleash pent up investment and create a burst of economic growth that creates jobs is simply unfounded in fact.
    • We’ve tried this philosophy for four decades (since Reagan) and it hasn’t worked–it is not the wealthy elite who create jobs; it is the consumers, whose demand creates the potential for business expansion, that create jobs.  See, e.g., James Livingston, It’s Consumer Spending, Stupid, New York Times (Oct. 26, 2011); Steven Strauss, Actually Tax Cuts Don’t Seem to Have Much Impact on Economic Growth, Huffington Post (Oct. 25, 2011) (noting that “ideology is a poor substitute for pragmatic approaches to complicated problems. In fact the evidence that tax rates influence economic growth in any way is equivocal at best. A myriad of other factors are involved. Simply reducing tax rates, and primarily for the wealthy, may hinder — rather than enhance our economic recovery”).
    • And most of the countries held up as models for how wonderful the “flat tax” is in boosting their economy do not actually provide solid evidence for that.  Many flat taxes are in fact flat INCOME taxes, not just wage or consumption taxes.  Countries like Hong Kong, which had a flat tax and managed quite well for a while, benefited from the extraordinary circumstance of acting as the intermediary between communist China and the capitalist world–so that any tax would have raised sufficient revenues on the kinds of deals going through the city-state.  (And, as my colleague Mike McIntyre just reminded me, Hong Kong also benefited from an early real estate bubble like the one that gave this country a spurt of growth that looked like it was connected to the Clinton and Bush tax cuts but was actually connected to rampant speculation with easy money.)
    • There is no investment need in businesses that can’t be met currently by the vast resources of unspent cash held domestically (as well as offshore).  Corporations are not cash strapped–they are hoarding cash because they don’t have customers for their products.
    • The “Econ 101” Chicago School theory on which the idea of an economic boom from putting more money in the hands of the monied rests is incomplete and just plain wrong. It is based on unrealistic assumptions about human decisionmaking, “efficiency” and “welfare”.  Under that theory of efficiency, the marginal utility of the dollar is essentially disregarded.  Under that theory of welfare, if the rich gain all the benefits of the economy as they have for the last decade, that’s an aggregate increase in welfare so all is fine.  Again, this type of economic analysis is just “hope [for booming economic growth] masquerading as theory.”
    • The facts are different.  Empirical studies show decisively that increasing inequality is extraordinarily harmful to economic growth.  When the top 1% are better off and the 99% are suffering, the society suffers.  See The Spirit Level, Wilkinson & Pickett, or the work of Saenz & Piketty on inequality.  See also Benjamin Friedman’s book on the importance of broad-based economic growth to a sustainable economy.
    • In fact, the shortfalls in government revenues will lead to cuts to social welfare programs and to government spending on everything from infrastructure to disease control and food safety.  As to Social Security, Medicare and Medicaid, Perry himself suggests raising the retirement age, changing age eligibility for Medicaid, and introducing an income factor in determinating eligibility for these earned benefits.  These kinds of changes and governmental program cuts will have a ricocheting bad effect on the entire economy that is likely to throw the economy back into recession.  Indirect impacts including firing of government workers will add to the detrimental impact on the vast majority of Americans in the middle and lower classes.

Perry’s system also gets rid of the Estate tax.  All told, the right’s slogan here might as well be:  Make the Rich Richer! (no matter who else is hurt).
Note that this is all happening in a context where the rich are getting much richer, and everybody else is barely hanging on.  See, e.g., Pear, Top Earners Doubled Share of Nation’s Income, Study Finds, New York Times (Oct. 26, 2011).  The article reports on the CBO’s Oct. 25 report that the top 1 percent more than doubled their share of the nation’s income over the last three decades of the ascendancy of hard right economic ideas.  Their income increased an astounding 275% between 1979 and 2007.  Meanwhile, the bottom 20% had only an 18% gain in all those years–and in fact their share of the national income dropped from 7% to a measly 5%.  This is because government policies that can counter the upwards redistribution of income from everybody to the rich have been weaker since Reagan–“the equalizing effect of federal taxes was smaller” as the progressive income tax has become less progressive in nature and more federal revenues have been raised by the regressive payroll tax.  See also One Percenters’ Income Nearly Tripled in Last Three Decades: CBO, Huffington Post (Oct. 26, 2011) (noting that the US ranks alongside Uganda and Rwanda in terms of the gap between rich and poor, and adding that inequality at that level is “likely holding back the economic recovery”). The Perry and Cain plans would exacerbate this trend.  If we are almost at plutocracy (rule of the wealthy) now, we will surely be there if any of the hard right tax plans are put into effect.
Perry’s system dramatically changes the corporate income tax to favor multinationals–20% rate, removal of various deductions, almost tax-free repatriation of foreign earnings, and a territorial tax system.  Incredible breaks for the multinationals who are moving jobs offshore as fast as they can.  The right’s slogan here might as well be:  Give It Away to the Multinationals! (so they can move everything offshore).
Makes one think that Charles Pierce is correct when he says that these Flat Tax (Perry), FairTax (Cain) and VAT (Cain) plans are just an “unwieldy parade of hackneyed talking points (Kill the Estate Tax and Save the Family Farm!) and tired applause lines (The Job Creators Are Uncertain!).”  See Ken Houghton’s link on Angry Bear, here.  I only wish I were as certain about the chances of the right’s not being successful at enacting some form of flat/”fair”/VAT tax as Pierce is.
http://ataxingmatter.blogs.com/tax/

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Linda Beale on NH Public Radio…flat tax is back

The Flat Tax is Back

Moderated by  Laura Knoy on Wednesday, October 26, 2011
(follow link)

Quote:
“In past presidential cycles, the idea of fixing the tax code by charging everyone the same rate has caught on like wildfire, only to die out later. This Presidential election season, candidates Herman Cain Rick Perry, and Newt Gingrich are promoting flat tax plans. We’ll look at this concept…why it remains popular…and why it hasn’t yet become law.”

Guests


Linda Beale – associate professor at Wayne State University Law School. She contributes to the economics and finance blog, Angry Bear.


Chris Edwards – director of tax policy studies at the Cato Institute and editor of the website, downsizinggovernment.org
                                                                                                       

                                                                                                      (loonyhiker< /a>via Flickr/Creative Commons)

Of course Linda’s thoughts on the matter appear in more detail at Angry Bear and ataxingmatter

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Perry’s Flat Tax Proposal

by Linda Beal

Perry’s Flat Tax Proposal

The Atlantic has a good summary article contrasting Perry’s Flat Tax proposal (an alternative choice to the income tax, that is modeled after Steve Forbe’s flat tax, which will result in much lower taxes for the wealthy because of the deductions it retains along with the zero taxation of capital income) and Cain’s 9-9-9 intermediary proposal as well as Cain’s ultimate goal of the so-called “FAIR tax” –a national sales tax at a tax-inclusive rate of 23%–both of which will result in much lower taes for the wealthy because of zero taxation of capital income.  Of course, along the way to his purported “FairTax”, Cain will put us through his wacky 9-9-9 plan that includes a VAT (but one that has solely a wage base), an individual Flat Tax (but one whose provisions to benefit the poor are uncertain–some kind of poverty exemption and impoverished district exemption, without much information about how it works or how much it helps), and a FairTax (without any relief from the lumpiness of the tax that causes it to be particularly unfair to the poorest of the poor).  See Derek Thompson, Perry Tax, Flat Tax, Fair Tax, VAT (Tax): What’s the Difference?, The Atlantic (Oct. 25, 2011).

None of these proposals are revenue neutral (they will raise less revenues than raised under the current tax system).  Either the rates would have to be increased or the government would be forced to operate in deficits (as it was pushed into doing with the Bush tax cuts where the $1.2 trillion cost over ten years of the 2001 bill moved the nation from surplus to deficit in one fell swoop).

None of them are distributionally fair–they shift the tax burden (to whatever extent the federal government is allowed to exist) down to the middle class and maybe the poor, while giving the rich extraordinary tax reductions through complete exemption of their main type of income.

None of these proposals are “simple” in any meaningful way They all require similar tax administrative apparatus to the current system (or, in Perry’s case, duplicative administration to take care of the choice of Flat or Income tax), involve the same calculations about timing, amount and character of income necessary under the income tax (but now fraught with more potential for abuse through mischaracterization, since one type is entirely tax free), and require the same procedural due process and penalty mechanisms, as well as forms, instructions, guidance and audits that are required under teh current system.  The only sense in which the Flat or FAir tax or VAT is simpler is when you mean by simpler that the wealthy pay less in taxes.

So if we are to judge the proposals by their results, it would seem that these two right-wing contenders for the GOP presidential nod think that two things are immensely important:

1) reducing taxes on the uberrich, and

2) reducing revenues available to the government to fund important programs.

That fits, since the right wants to “drown” government (and get rid of the New Deal earned benefit programs of Social Security and Medicare that aren’t needed by the elite who fund the right) and wants to cut taxes on the rich/big corporations as close to zero as it can get away with.

Let me repeat.  The arguments used to support all of these consumption-type taxes are fundamentally flawed.  They are not simple–they will involve the same hair-splitting on categorization of income as the current income tax, the same forms, timing issues, accounting issues, tax procedures for due process, and tax administration as the income tax.  They are not fair–they push the tax burden off on the middle class (and the poor, especially under some of the variants) and give the wealthy inordinate tax breaks by not taxing at all their most common type of income from capital.  They will not bolster growth and result in superb “trickle down” effects for the poor–tax cutting measures simply cannot do this because the theory that says they can is based on flawed assumptions about real life and flawed judgments about what matters.  They will hurt government programs that are vitally important to quality of life.  They will exacerbate the inordinate inequality already hurting the US society by making the wealthy even wealthier, and push us even further towards outright plutarchy (plutocracy and oligarchy at the same time, where a wealthy and prestigious elite holds all the reins of power). They will result in the dismantling of the New Deal from Social Security to Medicare, accompanied by gleeful sounds of delight from the radical right that supports the corporatist state and moans of pain from the vulnerable, the poor, and the elderly who are thrust back into neofeudal serfdom under the corporate masters of the universe.

Michael Kingsley and Francis Wilkerson agree with me on the latter issues.  I just found their Bloomberg opinion piece on flat taxes:  Flat Tax Proposals are Perpetual Font of False Promises, Bloomberg.com (Oct. 24, 2011).

originally published at ataxingmatter

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Rick Perry’s 20-20 Vision

Charles Pierce sums up the true issue:

It is on days like this that I don’t envy political economists. They’re the ones that are going to have to take this Message from Goobertown seriously. They’re going to have to score it. They’re going to have to do the math, such as it is, and try to find a coherent formation in this unwieldy parade of hackneyed talking points (Kill the Estate Tax and Save the Family Farm!) and tired applause lines (The Job Creators Are Uncertain!). They’re the ones who are going to have to find a way to square the utter abandonment of the progressive income tax, a balanced-budget amendment to the Constitution, a return to explosively inflationary health-care costs, an unchained and undoubtedly newly amok financial-services industry, and the partial privatization of Social Security, all of which Goodhair has managed to wedge into “Cap, Balance, and Grow (!).”

(By now, I figure the political economists are going to be hopelessly drunk and firing rubber bands at each other.)

They’re the ones who are going to have to tell the family of the sad-eyed young intern in the corner that their son, a Wharton grad with a brilliant future, studied this plan for a couple of hours and then screamed, “But it doesn’t make sense!” prior to trying to feed himself into the fax machine in a vain attempt to get as far as possible from any place where this nonsense is taken seriously.

Personally speaking, I’m not bothering. When you’ve already lost Pete Davis, you can pretty much give up on anyone believing your economics will work:

Governor Rick Perry (R-TX) proposed his tax reform plan today and wrote this Wall Street Journal op-ed. Unfortunately, it’s just a slapdash of slogans. If this plan were enacted as proposed, it would lose a lot of revenue, reward the rich, and complicate filing for most taxpayers.

Giving taxpayers the option would also mean that only those who pay less would opt in, guaranteeing significant revenue loss. [OPENING QUOTE ADDED, sans original links; go read the whole thing]

And Andrew Samwick piles on with the politics:

And now we have another version of the flat tax, as if the crushing irrelevance of Steve Forbes to the primaries in 1996 and 2000 were not an indication of how unproductive the discussion will ultimately be. What are the prospects that a Republican President would actually be able to implement such a change if elected? They are equal to the chance that Republicans will both retain control of the House and secure a filibuster-proof majority in the Senate in 2012. In other words, absolutely zero.

Personally speaking, I don’t think the odds on that election scenario are “absolutely zero” (but I count people like Ben Nelson, who fellated George W Bush from the beginning, referring to him in interviews as “the King,” as part of that “filibuster-proof majority”). But the rest of the analysis is spot-on.

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Perry Proposes (no surprise) a flat tax…

by Linda Beale

Perry Proposes (no surprise) a flat tax….

Rick Perry, one night after what has been termed an ‘invigorated’ debate performance, has climbed on the flat-tax bandwagon (presumably meaning a flat-rate consumption tax a la the national retail sales tax idea).  See Tumulty, Rick Perry to Announce Flat Tax as Part of Economic Plan, Washington Post (Oct. 19, 2011).

See prior posting on ataxingmatter regarding Cain’s 9-9-9 plan and generally about the flat tax, here and here and here and here and here and here and here and here and here and here…..

Put briefly, having as the sole source of revenue for the federal government’s environmental protection, disease control, anti-trust, bank regulation, securities regulation, tax enforcement, consumer protection, military and defense functions a regressive national sales tax that would stifle the consumerism that accounts for about 70% of our economy would likely be quite harmful to the U.S. economy and to the overwhelming majority of Americans who earn less than $100,000 a year.

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Herman Cain, funded by Koch Bros, Says "Let the Little Guys Pay Taxes

by Linda Beale

Herman Cain, funded by Koch Bros, Says “Let the Little Guys Pay Taxes (not the uber-rich)

The New York Times’ “Room for Debate” ran a ‘mini-op-ed’ segment on Herman Cain’s 9-9-9 tax plan, called “What’s So Bad About a Flat Tax?” New York Times (Oct. 14, 2011) (with the subtitle: Isn’t Herman Cain’s ‘9-9-9’ plan essentially what fiscal conservatives and good government advocates have always wanted?). Yours Truly was one of those invited to participate: others include Kotlikoff, Ulbrich, and Gale.

I wrote, in A Plan for the Uber-Rich, that “there’s a lot wrong with flat taxes” (a term used to cover both the flat rate income tax and the flat-rate national sales tax ideas).

Either type of flat tax is regressive, in that it places a high tax burden on the most vulnerable at the lower income scales, for the simple reason that most lower income people use all of their income to pay for food, clothing, shelter and other consumption whereas members of the upper class have lots of cash to spare that they are unlikely ever to consume in their lifetimes. There are additional significant flaws in those tax schemes, like unrealistic economic assumptions, difficult transition paths, rosy revenue scenarios, misleading propaganda about rates and the probability that a national sales tax that cuts deeply into lower income finances will repress consumption that fuels small businesses.

Cain’s plan is even worse, since it:

  • exempts capital income from taxation
  • eliminates the estate tax
  • imposes a flat rate on wage income with no deductions (and apparently only some exemption for the poorest of the poor in certain ‘zones’ defined by the national government, so that if you are poor and live with lots of other poor people, you may not have to pay as much in taxes, but if you are poor and live where there aren’t enough poor people, tough luck)
  • shifts the burden from rich to poor since the rich will only pay on their compensation income and some small additional portion due to consumption taxes, while the poor will pay on all of their income and all of their income again in consumption
  • and continues the regressivity with some type of value-added tax that will also fall mostly on wage earners.

Added since the original positing is Dan Mitchell–conservative spokesperson for the Cato institute, who lauds the flat tax in “The Beauty of the Flat Tax” as “desirable” for its “simplicity, fairness, and transparency.”

  • Actually, the national sales tax version of the ‘flat tax’ supported by Mitchell is anything but simple. It results in the government taxing itself and counting the revenues as a gain. It calculates the tax rate in a way intended to be deceptive and likely to be far too low to raise the claimed amounts of revenues. Since it is a sales tax, we normally discuss that as a tax on top of the price, so a price of $100 and a tax at 23% means a final price including tax of $123. But the way the national sales tax has been discussed is different: they say a tax of 23%, but they calculate that rate by taking the ratio of the tax to the price plus tax–so the rate looks lower than it would look calculated as a ratio of tax to price! In fact, most objective analyses of a national sales tax have suggested that the rate (as a tax to price ratio) would be at least 40% and possibly 50% or even higher, meaning that something purchased foa $100 sales price would have an added national sales tax (not taking into account local and state sales taxes) of betwen $40 and $50 or more. And, worst of all, it will inevitably require an exemption for the poorest of the poor (if not as broad an exemption as currently permitted), thus requiring poor people to pay up front, retain all of their receipts and file a very complex return that will be a request for a refund of the tax. It will, though, be quite simple for the uberrich–they will not have to file income taxes and then would consume only a small amount of their income (and probably even there find all kinds of ways to get around paying their fair share of that limited tax burden). Further, part of the “simplicity” assumption about the tax is that you can get rid of any federal tax collection bureaucracy and that tax enforcement will be minimal. Both of those assumptions are either naive or intentionally misleading: the tax collection responsibilities will fall to the states (imposing significant costs, especially with state systems that still rely on income taxation) and the federal government will nonetheless have to retain a national enforcement system. Most experts say the opportunities for crookedness will be as big in the sales tax system as in any other tax system.
  • What about fairness? Well, fairness is one thing that the flat tax cannot offer. The rich get off super cheap, and the poor pay through the nose. Everybody pays only on what they consume (that is actually collected at the point of consumption), but the rich can choose whereas the poor consume all of their income. Accordingly the national sales tax is highly regressive, compared to our somewhat progressive system today. And with the elimination of the income tax and the estate tax, the role that the tax system plays in pushing against gross inequalities will be eliminated.
  • Transparency is missing as well. The points about simplicity should answer that question head on. It is not a transparent system at all, for much the same reasons that it is not a simple system.
    • Mitchell praises the “repeal of most forms of double taxation” in Cain’s 9-9-9 plan. What he is calling “double taxation” is the fact that people currently pay some tax (though too low) on income earned by capital as well as income earned by labor. Cain repeals all taxes on income earned by capital (and taxes income earned by wages particularly hard–at about 27%, with the “income” tax on wages only, the VAT-type business tax which deducts investments but not wages, and the sales tax (on consumption, which for most wageearners is on all or most of their wage income). But the tax on capital is NOT “more than one bite of the apple” as Mitchell asserts. If you invest 20 and that 20 earns 5 in interest, then the 5 in interest is new money that should be subject to tax, just as 5 earned in payment for labor is new money. The idea that any tax on income from capital is a double tax is just “free market” doubletalk to justify the elimination of taxes on the wealthy. Although economists like to say that “only people pay taxes” and use that to justify allocating all corporate income to shareholders and then asserting that shareholders pay the corporate taxes paid on that corporate income, that is an a priori decision that ignores the reality of perpetual life, managerial renttaking, and “personhood” of corporate quasi-sovereign entities in today’s “free market” globalized economy.
    • Mitchell then asserts that getting rid of deductions and “other distortions in the tax code” will mean that “people will make decisions on the basis of good economics rather than clever tax planning.” Wrong on two counts. First, most businesspeople still do not make most decisions based on tax planning. They want to make money in their business, and if a plan will make money, they will do that plan (even if it also means paying some taxes. Second, some deductions are merely common sense–for example, not allowing businesses a deduction for wages will encourage layoffs in favor of capital investments/robotics, which will accelerate job reduction in the US, not create jobs.

Today’s Associated Press revelations about Cain’s longtime ties to controversial Koch brothers’ group key to his surging presidential bid, AP (Oct. 16, 2011) show a harmonious fit between Cain’s 9-9-9 plan, Cain’s various comments scorning the non rich and his links to wealthy plutocratic anti-populists like David and Charles Koch, billionaires who “bankroll right-leaning causes through their group Americans for Prosperity” Id. (The Koch-funded group would be more aptly named America Run for the Super-Rich, since it lobbies for the right’s agenda of New Deal elimination and targeting of earned benefits of ordinary Americans through a campaign for zero taxation on capital, deregulation, militarization, and privatization .)

AFP tapped Cain as the public face of its “Prosperity Expansion Project,” and he traveled the country in 2005 and 2006 speaking to activists who were starting state-based AFP chapters from Wisconsin to Virginia. Through his AFP work he met Mark Block, a longtime Wisconsin Republican operative hired to lead that state’s AFP chapter in 2005 . . ..

The article notes the many people in Cain’s organization now or earlier with links to AFP, including Rich Lowrie, the accountant/investment manager who serves Cain as chief economic adviser.

And the Koch brothers have a quite clear record of wanting to abolish Social Security, all kinds of federal welfare, minimum wage laws, and similar programs intended to redress the economic imbalance that has grown in our economy since the advent of winner-take-all economics in the Reagan era.

originally published at

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Tax Rates and Economic Growth Over Ten Year Time Horizons, plus Why a Flat Tax Would Result in Much Slower Economic Growth

by Mike Kimel

Tax Rates and Economic Growth Over Ten Year Time Horizons, plus Why a Flat Tax Would Result in Much Slower Economic Growth

Last week I had a post looking at the the real GDP growth maximizing income tax rate using both top marginal income tax rates and and “average marginal” “all-in” tax rates for all taxpayers (including those who paid nothing) computed by Barro & Sahasakul. The post noted that the optimal top marginal rate was in the neighborhood of 64%, a finding that corresponds with many other posts I’ve written on the topic. The post also noted that the Barro-Sahasakul rates were not as useful at explaining economic growth as the top marginal income tax rates.

David Altig of the Atlanta Fed commented on the piece here, but he essentially had one very gently delivered criticism and one follow-up comment. The criticism is that my post did not consider long run effects – for each year, it looked at how the tax rate that year would affect growth in real GDP from that year to the next. The comment was that the post’s results did not correspond with results of a paper he published in the AER with Auerbach, Kotlikoff, Smetters and Walliser. (Ungated version here. The paper

uses a new large-scale dynamic simulation model to compare the equity, efficiency, and macroeconomic effects of five alternative to the current U.S. federal income tax. These reforms are a proportional income tax, a proportional consumption tax, a flat tax, a flat tax with transition relief, and a progressive variant of the flat tax called the ‘X tax.’

In his post, Altig provides this graph:

Figure 1.

The graph shows that according to the Altig et. al simulation model, after about ten years, the growth maximizing tax (among the types they simulated) is a flat tax. I read the paper this afternoon, and while I have a few small quibbles (some of them raised by the authors themselves, to their credit), having done a bit of simulation work myself, I think there is one thing that is worth mentioning and which I can cover in this forum: results of a simulation must fit known facts.

Now… I think there is a quick and dirty way regression that can account for both a long range analysis and to test the notion of whether the cause of rapid economic growth is best served by a progressive tax system or a flat tax. Here’s what I have in mind:

equation 1: annualized growth in real GDP, t to t+10 = f(top marginal income tax rate, top marginal income tax rate squared, bottom marginal income tax rate, bottom marginal income tax rate squared)

The quadratic terms allow us to find the growth maximizing tax rates, as I’ve done in so many posts before. And by including both top and bottom marginal rates, we can compute the optimal growth maximizing top marginal rate and the growth maximizing bottom marginal rate. And… if a flat tax is the best tax, the optimal bottom rate should be more or less equal to the optimal top rate.

As in the previous post, data ran back to 1929, the first year for which real GDP was computed by the BEA. Top marginal and bottom marginal rates came from the IRS Statistics of Income Table 23.

So here are the results, as spit out by Excel.

Figure 2.

What this tells us is that each of the components of equation 1 are significant. For top marginal rates, we have the expected shape, and if you work it out (either with calculus or by plugging the numbers into a spreadsheet) you’ll find that the model claims the optimal rate is about 67%, and that getting tax rates there from the current 35% would add about 1.4% a year to real GDP growth.

For the bottom marginal income tax rate, things are a bit more complicated… it turns out that the expected quadratic shape isn’t there. In fact, the model indicates that tax rates should be as low as possible. In the range from 0 to 100, 0 is best. The model also provides support for the Milton’s Friedman negative income tax rate, though I’d say results are bit shakier there as rates were never at or below zero during the sample for which we have data. If I were to do it again, I think I’d specify the bottom marginal rate differently – no quadratic shape – but right now I gotta go. I would note – I’d also add a few other variables, both to account for the small degree of patterns that appear in the residuals and frankly, just to make the model more realistic. But its fairly clear – especially since I keep getting results that more or less the same no matter how I approach the problem, that better specification wouldn’t change the results all that much. They might push estimates of the top marginal rate down a bit, but its fairly clear that top marginal rates well above where they are now will lead to much faster economic growth.

And of course, the other thing we learn… because the effect of top and bottom rates are so very different, and relative to where they are now, pull economic growth in different directions, it makes no sense for the top rate and the bottom rate to be in close vicinity. Put another way – a flat tax is a very bad idea, at least when it comes to generating economic growth.

As always, if you want my spreadsheet, drop me a line via e-mail with the name of this post. My e-mail address is my first name (mike), my last name (kimel – with one m only), and I’m at gmail.com.

(Rdan…post was modified at 10 am to include the link to Altig’s post)

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Guest post: Want a Flat Tax? I Got a Flat Tax for You

Guest post by Steve Roth

Want a Flat Tax? I Got a Flat Tax for You
crossposted with Asymptosis

One percent of financial assets. Personal and corporate. Annually.

With somewhere north of $55 trillion in U.S. financial assets out there (2009, down from $63 trillion in 2007), a Financial Assets Tax would generate more than $550 billion in annual revenue.

What could we do with that revenue? Here are some options:

• Eradicate taxes on corporate profits, dividends, and capital gains, and cut income taxes by between 22% and 51%. (Depends on which tax year you’re looking at; this for 2007-09. NIPA Table 3.2.)

• Pay off some of our national debt, invest in productive infrastructure to build true national wealth, greatly expand the EITC (and index it to unemployment) to turbocharge the real economy, or…

• Some equitable and economically efficient combination of the above

Why should we do this?

Simple: greater prosperity and greater equality. Both.

This idea seems to have far greater upsides than downsides. But I’ve undoubtedly missed some things, which I hope my gentle readers will fill in.

Here are some of the issues involved:

Innovation and growth. Naysayers (mostly — surprise! — large holders of financial assets) will scream that THIS PROPOSAL TAXES SAVINGS!!!, which for not-very-well-hidden and supposedly moralistic reasons is seen as BAD!!! (As my friend Gabriel in England said to me once, “Yes, well, we shipped all our Puritans over to you, now didn’t we?”)

Their post-hoc rationalization for that faux moralizing: savings are (more accurately: can be) used for investment, by which they mean (in this instance) fixed investment in productive assets — structures, equipment, software, etc. We want to encourage fixed investment, right? It drives growth (and long term, employment), and builds national wealth and prosperity, right? The answer to those questions is “Yes.”

But when they start objecting to the tax because it “will hurt poor people,” raise at least one eyebrow. First — as usual — they’re confusing flows with stocks. Savings is a flow. Money from savings goes into the stock of financial assets — cash in mattresses, bank account balances, CDs, stocks, bonds, collateralized debt obligations, etc.

But that misconception aside, talk about being wrong by 180 degrees. This proposal does indeed discourage saving — in favor of real investment.

Remember: there are only five things a person or company can do with a dollar of income:

1. Spend it on consumption (buy food or office supplies, pay wages for ongoing operations, etc.)

2. Invest it (to create or purchase — hence spur creation of — real assets)

3. Save it (“invest”/store it in financial assets — effectively or actually lending it out)

4. Pay off loans (basically saving, but on the other side of the balance sheet)

5. Pay taxes

If a dollar is “saved,” it is by definition not invested. (Though it or an identical, fungible equivalent might flow back out of the pool of financial assets to be spent on real investment –or on consumption, loan payoffs, or taxes.)

If people and companies sock away their income in financial “investments” (save it) and just enjoy the returns, one percent of those returns will be skimmed off every year. (Not terribly onerous, given that hedge-fund “investors” pay large multiples of that and still make piles of money for doing nothing.)

If, on the other hand, people and companies use that money to build houses, apartment buildings, malls, office buildings, amusement parks, and factories, invest in new equipment and software, or spend it on those deucedly hard-to-measure but massive contributors to our national asset base — education, training, research, and development — the assets they create won’t be hit by this tax.

And the ongoing income generated by those real assets will be taxed at a far lower rate.

Alternatively, the income that isn’t saved might be spent on consumption — increasing monetary velocity and aggregate demand, and making the whole swirling pie that is the economy, bigger.

If you think collateralized debt obligations are valuable national assets, you should hate this tax. If you think — correctly — that as Kuznets and many others have pointed out, real assets constitute true national wealth (though many of the most important real assets, like ideas, knowledge, skills, and “organizational capital,” are intangible and unmeasurable), you should love this tax.

What do we mean by financial assets? There are some gray areas that would need to be sorted out (insurance, pensions, etc.), but most financial assets quack like ducks. For a quick list, take a look at the column headings in Table 2A the of the Fed’s analysis of the Census’s 2009 Panel Survey of Consumer Finances (XLS):

Transaction accounts
Certificates of deposit
Savings bonds Bonds
Stocks
Pooled
investment funds
Retirement accounts
Cash value life insurance
Other managed assets Other

We might even want to include cash (actual dollar or euro bills). Why should we encourage cash in mattresses? TBD.

My friend Steve tentatively suggested “anything that’s traded on an exchange,” which seems like a good idea except it would encourage Wall Streeters to move towards assets that are traded off-exchange, over the counter. We’ve seen the effects of that.

What about incentives and economic distortions? How much would this tax distort economic decisions? Think: Nobody, ever, says “I’m not going to get wealthy because I’d have to pay taxes.” Why? Ask any of Jane Austen’s heroines: because there’s no substitute for wealth.

Earned income? Quite otherwise, because there’s a very good substitute for working to earn money: leisure. Spending time with the kids, playing golf, writing overly long and abstruse economic blog posts, watching NASCAR, assembling intricate miniatures of Civil War battle scenes.

In economic terms, the demand for employment is quite elastic because there’s an attractive substitute. The demand for wealth is quite inelastic, because there just ain’t no substitute for being rich.

The Financial Assets Tax would provide a very slightly lower incentive to earn money every year (anyone care to do the arithmetic?), but nothing like the disincentive that results (in theory, to some greater or lesser degree) from high marginal income tax rates, corporate profit and dividend taxes, etc.

The biggest incentive — arguably an economic “distortion,” but every tax except maybe land value taxes is distortionary — would be to spend on real investment (and consumption) instead of saving.

But that incentive would actually compensate for an inherent distortion resulting from the nature of financial assets, which are at root an artificial creation: Financial assets don’t decay and depreciate like real assets do. After ten years (or whatever), you still have the initial capital, plus the returns, which is not true with fixed investments. So fixed investments have a big disadvantage when they’re competing for “investment” dollars. A Financial Assets Tax would to some degree correct for that inherent market distortion/inefficiency.

Too big to fail. I’ve pointed out that the financial economy — the trade in financial assets — is many time larger (40x, 50x?) than the real economy — trade in goods and services. And it’s arguably many times larger than is necessary to lubricate and intermediate the real economy. And innumerable wise voices have pointed out the negative externalities of this excessive size: systemic risk of financial-market meltdowns that trash the real economy, gross misallocation of financial and human resources, etc.

There have been some salutary if rather timid proposals to address this via taxes on financial transactions — the flows — to compensate for those externalities and shrink the sector. But this proposal for taxing the stock of financial assets could be a superior alternative. I’ll leave it to others, for now, to analyze the pros and cons of those two alternatives.

What about private residences? This is both a large segment of fixed investment, and kind of a special case — different from business investments because the value derived isn’t in the ability to produce more, saleable goods and services, but having a roof over your head.

Here’s the functional scenario: you’ve got half a million dollars in financial assets, and you want to build a half-million-dollar house. Here are the two ends of the spectrum — you can land anywhere in between:

1. Sell all your financial assets and spend the money to build the house.

2. Sell $50,000 of financial assets for the 10% down payment on a loan, and borrow the rest.

Your taxes on the house asset are the same either way. But in scenario 2, under the Financial Asset Tax proposal you also pay tax every year on the $450,000 in financial assets you’re still holding. So it’s less attractive. It effectively increases the interest rate on your loan by 1%.

Putting aside for the moment all the other factors you personally consider (liquidity, risk, return, peace of mind, etc.): which of these scenarios — if repeated by millions of people over decades — contributes more to national wealth and prosperity? Which should the tax system encourage? (Because every tax system encourages something.)

The first scenario reduces the value of financial assets by reducing demand for them; the second increases it. As Dirk Bezemer has explained, borrowing-driven booms in financial asset values drain resources from the real economy, and so are associated with slower real-sector growth. The second scenario also effectively prints $450,000 in new money, causing more inflation pressure, which puts pressure on the Fed to raise interest rates, which discourages real-sector investment.

Which one should we encourage — borrowing or real investment? You decide. (And yes: we should also eradicate the insanely economically inefficient — and regressive — mortgage interest deduction, which makes the second scenario so much more attractive.)

What about volatility? The value of U.S. financial assets (nominal — not inflation-adjusted) fell by 13% from 2007 to 2009 (assets held by U.S. households, nonprofits, and nonfarm, nonfinancial businesses — Fed Flow of Funds TFAABSNNCB + TFAABSHNO). Under this proposal, that would result in a huge hole in the Federal budget.

Personal income went up by 2% (nominal) over that period (NIPA Table 2.1). This tells you: the revenues from a Financial Assets Tax would be much more volatile than from income taxes, because asset values are far more volatile than incomes.

But let’s step back: Every reasonable person (this excludes large portions of the Republican and Tea Parties) agrees that it’s smart for government to spend more in the bad times (causing a government deficit), and less in the good times (causing a surplus). It’s intuitively obvious (thanks to Keynes), we’ve seen it work (1939 passim), and all sorts of old and new economic theory, notably Modern Monetary Theory, supports it in spades.

The problem, of course, is politicians. When bad times hit and government revenues are down, they panic like scared children. They don’t remember (or look forward to) the good times, like when the federal debt was plummeting during the Clinton boom/tax-increase/surplus years. So they do exactly the opposite of what common sense and prudent wisdom prescribe: they cut spending. The volatility of the Financial Asset Tax could contribute greatly to this panic-driven policymaking.

My only reply: it is to be hoped that the economic efficiency of the Financial Assets Tax — the growth and prosperity it engenders, especially in the real sector of the economy — would over the long term overwhelm the negative effects of political mismanagement. Other suggestions to overcome this difficulty, much appreciated.

What about evasion and offshoring? Stocks of financial assets are easier to track and harder to hide than flows of income. They have to be stored somewhere. Since they’re not ongoing flows, they can’t be laundered and hidden as easily through multiple international pipelines and entities. People will still use secret accounts in the Bahamas to hide their money (as long as we allow the Bahamas bankers to get away with it; the Swiss can’t anymore…). And yes, people and businesses will figure out new schemes to evade this tax. People will always figure out ways to commit fraud. A simple tax on an easier-to-track item will make it harder for them to do so.

Since we’ll tax domestic entities’ financial assets no matter what country those assets happen to be stored in (just as we tax worldwide income now — at least of natural humans) — people and businesses will have less incentive to keep piling up their treasure in financial (and real) assets overseas. They can bring it home at no cost (they’re paying taxes on it in either place) hopefully investing it in real assets here.

Why not a consumption tax or VAT instead? I don’t actually know much about these, so take this for what you will.

Those taxes are good because they don’t penalize or kill incentives for work, innovation, and real earnings (personal earned income and real — nonfinancial — corporate profits). But both of them, as I understand the proposals and real-world examples I know of, tax investment spending at the same rate as consumption spending. So they’re not really just consumption taxes. They’re also investment taxes. That’s not good. I assume there are carve-outs to correct for that, but the more carve-outs you put in place for various and sundry reasons, the more messed up, gamed, and inefficient tax regimes become. The Financial Assets Tax makes things much more clear and simple. That’s one value of a flat tax.

Also: to make consumption taxes reasonably progressive, the top marginal rates have to be high, maybe even greater than 100%. Imagine a million-dollar consumer paying two million dollars in taxes on that consumption. You think that’s gonna happen?

How do you phase it in? This would be a big change in the rules of the game. It’s both fair and efficient to give people time to adapt. I would do it based on: 1. person versus company, 2. age, and 3. quantity of financial assets.

For people: Give a few year’s warning, then in the first year, people 30 and under with more than $5 million in financial assets would be subject to the tax. (I am rather unconcerned with these people’s well-being, or with their ability to adapt to the new regime over the course of their lives.) Increase the age and reduce the cutoff — perhaps ending at around four to six times median income — over ten or fifteen years. Other personal tax rates should decline in concert. For companies: Give two or three years warning, then replace the tax on C-corp profits with the Financial Assets Tax. They’ll adapt just fine — mainly by shifting from financial investment to real investment, but also probably by increasing dividends, putting the money back out there where it can be intelligently allocated by the wisdom of the crowds rather than by CEOs’ purported omniscience. Maybe this will also encourage corporations to hire CEOs who are real business managers, rather than practitioners of financial prestidigitation.

Oh yeah: equity! Don’t change the channel, America. It matters. It especially matters to those who don’t have it. (Few of whom are reading this.) But excessive inequity hurts the rich too, in the long run, because it kills long-term national prosperity. Economically efficient policies that deliver greater equity also deliver greater long-term prosperity. Even the rich get richer under progressive policies (except maybe the very, very rich). The poor and the middle class get far richer.

What do we mean by equity and inequity? Are we talking about income inequality? Feh.

Our world in pictures (regular readers will recognize some of these, but some are all new):

DESCRIPTIONSource: Piketty, T. and Saez, E. 2007. Income and Wage Inequality in the United States 1913-2002. In Atkinson, A. B. and Piketty, T. Top Incomes Over the Twentieth Century: A Contrast Between Continental European and English-Speaking Countries, Oxford University Press, Chapter 5; series updated by the same authors. Hat tip Catherine Rampell.

Source (pdf). The tax info here is just an added bonus feature, showing that above about $60K or 80K in income, our tax system (local, state, federal combined) isn’t progressive at all. The people making $160K pay the same share of their income pool as the people making $160 million. DESCRIPTIONSources (PDF): Sylvia A. Allegretto, Economic Policy Institute; Edward Wolff, unpublished 2010 analysis of the U.S. Federal Reserve Board, Survey of Consumer Finances and Federal Reserve Flow of Funds, prepared for the Economic Policy Institute. Another hat tip to Catherine Rampell.

Figure 2. The actual United States wealth distribution plotted against the estimated and ideal distributions across all respondents. Ariely and Norton, 2010 (PDF).

The bottom 80% gets about 40% of the income.

The bottom 80% owns about 15% of the wealth.

You want freedom? Look to your bank balance. You want opportunity? Look to your bank balance. You want time and space enough to innovate and be an entrepreneur, without the disincentive (not to mention embarrassment and inconvenience) of potential financial catastrophe? You want to buy birthday presents for your kids, get their teeth fixed, or put them through good colleges, maybe take a family vacation every year or two? You know where to look.

But if you’re not in the top 20%, you’re not looking at shit. So who pays the tax? You can see the ownership breakout for financial assets sliced various ways in the aforementioned Fed/Census Bureau table (XLS). Here’s the breakout for personal holdings, by levels of income:

This would be a very progressive tax, because the the distribution of wealth is very regressive. It would compensate quite effectively for all our country’s regressive taxes, like payroll taxes, sales taxes, property taxes, and cut-rate taxes on financial investments.

I don’t have the wherewithal to calculate the total resulting progressivity. Perhaps it would be excessive, to the point of economic inefficiency (though I doubt it).
If we thought that was the case, we could reduce the rate from 1% to .75% or .5%, and continue income and other taxes at higher rates. Subject to discussion.

Bottom line: If we want widespread freedom, opportunity, innovation, entrepreneurship, and healthy, happy living, all feeding on itself in a virtuous, self-perpetuating cycle, then broadly based wealth distribution is at least one necessary condition. A tax on financial assets would be an (economically) efficient and effective means to move towards that goal.

Oh, and not that this matters, but in the short and medium term, while pies are growing and boats are rising, tens of millions of people get to suffer less. But maybe it does matter, because in the long run, you know…

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