Opus 1: A Discussion on taxation

My hunt for Obama’s econ advisor lead me to a paper that incorporates a review of a book: Does Atlas Shrug? The Economic Consequences of Taxing the Rich. It caught my attention because the paper is written by a tax lawyer.: Reuven S. Avi-Yonah, the Irwin I. Cohn Professor of Law and director of the International Tax LL.M. Program… He also served as consultant to the U.S. Treasury on tax competition and OECD on tax competition, and is a member of the Steering Group of the OECD’s International Network for Tax Research and chair of the American Bar Association’s Tax Section Committee on Consumption Taxes.

I never really thought about it, but laws are the means by which we create taxation. They do reflect our reasoning. So, maybe we need to consider law arguments as we discuss taxes?

This will be presented in multiple parts in order to not hog the blog space here (or bore those not interested). My intent in presenting this review is to move the question of taxation beyond the simple rhetoric. We are at a time that is being implied will be a mark on our historical time line of national personality; the coming presidential election. For the best of our personality to come through, we need more than focus group tested conversation about money. We need to do the work to not only understand the physics of money but, also the philosophies of money. We have experienced 3 distinct approaches: pre-income tax, New Deal and Reaganomics. Time we start being responsible for the decisions made and look at what we decided, how we justified them and what those decisions gave us. Now is the time to ask: Just what the hell was I thinking here?

The paper is actually a discussion by Mr. Avi-Yonah that uses a review of Does Atlas Shurg for his lead in to his title: Why Tax the Rich? Efficiency, Equity, and Progressive Taxation. We here at AB have tossed around the short answer “because the richer you are the more benefit you get”. Mr. Avi-Yonah sets up his paper’s question:

“Thus, the question of whether high marginal tax rates come with an unaffordably high cost to the U.S. economy remains unsettled. Does Atlas Shrug?,…attempts to answer this question.

Part I begins with an excellent historical survey by W. Elliot Brownlee of the rates facing the rich from the beginning of the U.S. income tax in 1913 to the present. He indicates that effective rates during the high marginal rate years of World War I reached 15.8%, and that during the high marginal rate years of World War II they reached an astonishing 58.6% in 1944. After the war, while the top marginal rate remained extremely high at 91%, the effective rate for the rich declined to 32.2% in 1952, then 24.6% in 1963, rising to 28.9% when Ronald Reagan took office and declining to 22.1% following the 1986 tax reductions. The conclusion drawn by Brownlee is that the rich can be taxed at very high effective rates during times of national emergency, but that at other times their political clout ensures that effective rates are much lower than marginal rates.”

Well, guess we don’t need to worry about the nominal rates, they mean squat. But the question; do high rates cost us? The summary answer:

“In general, they provide a mixed answer… While there is some evidence of behavioral responses, it is quite limited and seems to depend crucially on the authors’ chosen methodology. Importantly, most of the findings of behavioral response relate to the use of various tax avoidance techniques—and even there the evidence is mixed, with some obvious techniques being used less than they should be in a world in which tax minimization is very important to the rich. Real behaviors, such as labor and saving, seem much less affected by taxation. This distinction is important because while both tax avoidance techniques and real behavioral changes cause deadweight losses, the former can be partially prevented by changing the law, while the latter are less amenable to legal change since one cannot force the rich to work or save more.”

As to the evidence, Mr. Avi-Yonah states that the 9 studies are reported in 3 groups. The first being limitations of past research such as noted by Goolsbee. The second group:

“…support the view that behavioral responses by the rich to taxation are quite limited. A study by Moffitt and Wilhelm investigates the labor supply decisions of the rich based on responses to the 1986 Tax Reform Act and finds essentially no responsiveness of the hours of work of high-income men to tax reductions…But the studies also suggest that high-income men are unlikely to decrease hours worked as tax rates go up…Other studies in this group suggest that even financial behaviors, which are less “ real,” and therefore more likely to be tax-motivated than labor or saving decisions, do not respond much to taxation.”

He specifically notes evidence that portfolio choices do not significantly change, there is not “judicious” sheltering of capital gains and that “inter vivos giving” are “much lower” than would be expected if “households were taking full advantage of this estate tax avoidance technique.”

So far, nominal rates mean squat and the rich don’t really play the tax rate game as has been implied by those offering tax rates as an excuse for our sorry condition. But, they do play:

“The third and final group is made up of studies that do find some behavioral responses to taxation. For example, Auten, Clotfelter, and Schmalbeck find that the current tax system does stimulate some charitable giving by the wealthy, compared with a system in which contributions are not deductible, but that the sensitivity of giving to tax changes is smaller than suggested by previous researchers. They also find that current law does encourage the wealthy to engage in elaborate estate tax arrangements associated with their charitable donations. Alm and Wallace examine a wide range of taxpayer reporting decisions by the rich in the wake of tax law changes and suggest that they show increased responsiveness due to their larger control over the form of their compensation. Finally, Carroll, Holtz-Eakin, Rider, and Rosen investigate the behavior of entrepreneurs in response to tax rate increases and conclude that individual income taxes do have a large negative effect (a five percent increase in marginal tax rates decreases mean capital expenditures by approximately ten percent).”

My theory on this last info, they like to make sure they settle their conscience in the end but only if they get a break and if they earned it with their own business they will sacrifice the business to keep up the income.

“I would also add that most of the evidence for behavioral responses in the book relates to tax avoidance strategies (e.g., charitable giving techniques, shifting income from corporations to individuals, and the timing of receipts), rather than to real activities (labor and saving decisions).”

Mr. Avi-Yonah closes this part of his argument noting that the book did not address the issue of illegal tax avoidance:

“Slemrod is not to be blamed for not focusing on this issue because no recent data exist, but it is high time for Congress to study the question of illegal tax evasion by Americans.”

So, if the nominal rates don’t matter as the tax code is currently set up and the rich don’t respond to higher rates by working less or lower rates by working more and they will cheat the game to the benefit of them self, then the question of “why” and “how much” tax needs a reasoned answer verses a mechanized answer. We have to justify our taxing with words and use the research to tell us if our reasoning is getting us to our goal. We have to accept that money is and does as we say it is and will do. It is the entity created in our own image. It is a medium of personal creative expression.

To be continued…

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