Relevant and even prescient commentary on news, politics and the economy.

The Tax Code Ain’t Nearly So Big as Often Claimed

by Linda Beale

The Tax Code Ain’t Nearly So Big as Often Claimed

I can’t resist pointing readers to tax professor Jim Maule’s excellent post chastising everybody–from those obviously slanted propaganda-tank tax gurus Chris Edwards (you all know him as the purported tax expert from the right-wing pseudo-libertarian Cato Institute, whose other associate, Dan Mitchell, makes similar ridiculous claims in touting the purported “Laffer Theory” about how tax cuts restore tax revenues–I should note that I debated Chris in the run-up to the 2012 elections on Herman Cain‘s ridiculous tax “plan”) and Steve Malanga (you all know him as the purported tax expert from the right-wing Manhattan Institute) to generally reasonable Taxpayer Advocate Nina Olson–about their ridiculous claims of a tax code that runs to the tens of thousands of pages. See James Maule, Code-Size Ignorance Knows No Bounds, MauledAgain (June 5, 2013).

Reagan as a Presidential candidate today

by Mike Kimel

A very interesting video from Think Progress juxtaposes a speech by Barack Obama with a speech by Reagan. In it, Reagan says:

We’re going to close the unproductive tax loopholes that allow some of the truly wealthy to avoid paying their fair share. In theory, some of those loopholes were understandable, but in practice they sometimes made it possible for millionaires to pay nothing, while a bus driver was paying ten percent of his salary, and that’s crazy. […] Do you think the millionaire ought to pay more in taxes than the bus driver or less?

Here’s the video.

Its been said that Reagan couldn’t win the Republican nomination for President today. Its probably true.

Define Rich, Part III. What the tax tables of yore say.

 By Daniel Becker

Randolph Duke: Money isn’t everything, Mortimer.
Mortimer Duke: Oh, grow up.
Randolph Duke: Mother always said you were greedy.
Mortimer Duke: She meant it as a compliment.
A while ago (an understatement) I posted on the question of what is rich. The first dealt with what issues to consider in defining rich. The second was looking at the issue of getting rich if that is even what one wants to do. The “rat race”. I don’t believe most people really want to be rich. I believe most people when thinking about being rich are thinking about what it would take to remove the fears of events that would make one’s life either very difficult in a world that requires money to remove risk or drastically different from what one’s life was. I’m thinking things like losing a job, debilitating injury or illness possibly resulting in physical disability or Louis Winthorpe III.
This all ties into “The American Dream”. The “Dream” is not just an ideology of governance and social philosophy. It is also a life style and thus requires a specific level of income. I have posted on this issue also and noted just how high in income we have driven this “Dream” such that two people with bachelor’s degrees just starting life together may not be able to have it.
Now that we have entered a period where taxes are on everyone’s minds such that there is serious consensus to raising taxes, maybe we need to see what we had in the past to know what we need now. I am sure most readers are aware of Mike’s work defining what rates appear to effect economic growth the best. If I recall correctly the number for the top 1% was around 65%. I have also suggested that there is a range as to how large a share of the income the top 1% should have. That number for the top 1% is not to be above 15% and not to much below 10%.
I should also mention my postings on taxation’s purpose. Specifically I looked at taxing from the perspective of the legal profession as oppose to the economic profession. The conclusion was that there was one main reason for taxing. It is to fulfill the directive of our constitution: equality of power. It is to assure the concept of one voice one vote. If there was ever a time in our history to raise taxes in order to assure this directive it is now in the age of the Citizens United ruling. President FDR referred to the issue and those with the one voice multiple votes do to their monied power as “economic royalty”. I like that phrase and I wonder why it is not used as are retort to those who use “class warfare” as a guilt trip.
Let’s get started.

I have constructed 4 sets of data using the tax rates of 1936/37, 1945/46, 1965/67 and 2010. I chose 1936 because it is a tax rate increase after the economy had turned north based on Mikes posting. I chose 1945/46 because it is another adjustment that happens right after after WWII. I chose 1965/67 because it is the decrease often spoken of fondly. Of course 2010 is because that is where we are at.

This posting would be hugely long if I post on all 4 periods at once, so I have broken it up. Let me first and I think most importantly note that we people today have no idea just how much we were willing to tax ourselves to have the society that we now refer to as “the good old days”. Not only did we have the tax tables of 1936, that table eventually had a 10% surcharge added to pay for the war. Yes, another reason to consider the generation that fought the 1st and 2nd world wars the greatest generation. There was a 7% surcharge for the Vietnam war, though that number became less as time passed. Still, we knew that if we wanted to do exceptional things, we had to tax ourselves exceptionally. Also, the early taxation made no distinction for single or married, never mind filing joint or separate. Everyone paid the same rate. Most interestingly, with the current table, the people who comparatively get screwed are those who are married and file separately. All the rates kick in at a lower income than even those who are single. The other thing we don’t seem to understand is that all the tax rhetoric we have been hearing since Reagan we’ve heard before virtually to the word.
Andrew Mellon, Treasury Secretary 1921 to 1932 :
Generally speaking, Mellon argued that tax burdens were too high. Steep rates, he insisted, served only to stifle incentive and foster tax evasion. “Any man of energy and initiative in this country can get what he wants out of life,” he wrote. “But when initiative is crippled by legislation or by a tax system which denies him the right to receive a reasonable share of his earnings, then he will no longer exert himself and the country will be deprived of the energy on which its continued greatness depends.”
Worse yet, Mellon argued, high rates didn’t even raise money. By encouraging both legal tax avoidance and illegal tax evasion, they eroded the tax base and reduced overall revenue. Lower rates, he said, would actually raise money by spurring economic growth and reducing the incentive for tax avoidance. “It seems difficult for some to understand,” he complained, “that high rates of taxation do not necessarily mean large revenue to the government, and that more revenue may actually be obtained by lower rates.” In particular, Mellon insisted that high rates distorted investment decisions, boosting the popularity of tax-free state and local government bonds. Indeed, Mellon made these tax-free bonds a regular target of his reform attempts, but Congress resisted his plans to eliminate them.
Atlas Shrugged wasn’t even written then!  What we don’t hear much of are the original concerns and reasoning for progressive taxation. Teddy Roosevelt:
1906…We should discriminate in the sharpest way between fortunes well-won and fortunes ill-won; between those gained as an incident to performing great services to the community as a whole, and those gained in evil fashion by keeping just within the limits of mere law-honesty.
1907 regarding an income tax:…while in addition it is a difficult tax to administer in its practical working, and great care would have to be exercised to see that it was not evaded by the very men whom it was most desirable to have taxed, for if so evaded it would, of course, be worse than no tax at all; as the least desirable of all taxes is the tax which bears heavily upon the honest as compared with the dishonest man.
No advantage comes either to the country as a whole or to the individuals inheriting the money by permitting the transmission in their entirety of the enormous fortunes which would be affected by such a tax; and as an incident to its function of revenue raising, such a tax would help to preserve a measurable equality of opportunity for the people of the generations growing to manhood. We have not the slightest sympathy with that socialistic idea which would try to put laziness, thriftlessness and inefficiency on a par with industry, thrift and efficiency; which would strive to break up not merely private property, but what is far more important, the home, the chief prop upon which our whole civilization stands. Such a theory, if ever adopted, would mean the ruin of the entire country–a ruin  which would bear heaviest upon the weakest, upon those least able to shift for themselves.
At this moment, I want to mention corporate taxes. There are lessons to be learned from it’s history. I think it is a factor in understand more completely the issue Mike is focusing on: taxation and GDP growth. Wrap your minds around the fact that from 1936 to 1943 there were 6 years that corporate tax collections were greater than personal income tax collections. 1943 was the best year for this as personal income tax collections were 68.1% of the corporate tax collections. Just one year later it flips to corporate tax collections being 75.3% of personal income tax collections. In 1944 $34,543 million in total for the two taxes was collected vs 1943 $16,062 million in total.  In fact, personal income taxes remain in the mid to high 40 percent of total revenue collections from 1944 to present. The corporate share of total revenue peaks in 1943 at 39.8% and declines to hover around the 10% level with a few ventures into the single digits. Most notably 1983 the corporate share was 6.2% and 2009 it was 6.6%.
First up is our current tax table. I used the “married filling jointly” as that would be consistent with the other tables. One big rule of this series of postings: DO NOT concern yourself or me about the deductions that exist. They do not matter for this presentation and for all intent and purposes we can consider the income to have already gone through the deduction calculator and is now ready to have the tax table applied. This is because, these tables only apply to adjusted gross income.
You will notice that the table is calculated out to $,1,000,000 of income. I did this in order to keep all the tables going to the same income level. The 1936 table actually has rates for incomes up to $8 million. That is $8 million in 1936. (Using my favorite money converter that would be $301,000,000 in unskilled labor or $573,000,000 in GDP/capita.) Going to $1,000,000 in income also allows one to see what happens at the top when the rate no longer rises.
A very important concept to understand is that not every dollar is taxed at the single percentage rate as you go up the income ladder. Thus, there are two columns in my charts. The “Marginal Tax” is the additional money paid at the top of the bracket for the corresponding rate. The “Total tax” is the actual money paid up to that level. It is the “effective rate”. In simple terms, if you are at the 35% level, you 
are not paying 35% on all that you earn. Instead you are paying the amount based on your income being divided up into the number of brackets that exist. For 2010, there are 6 brackets, thus you have six different incomes so to speak.
This is what it looks like as a graph.
When the rate maxed out, I divided the range to $1 million into even parts so that the tax paid for each additional income level is the same. For the 1945/46 and 1965/67 data sets I converted the net income to 2010 dollars. I used the “unskilled labor” and GDP/cap as those are the 2 factors suggested as being the best for knowing what income equivalents are over time. The 1936 data set is converted to 1967 dollar because the numbers just get crazy. For example, a net income of $3840 is $145,000 in unskilled labor and $275,000 in GDP/cap. Though it is only $60,400 via the CPI. Which doesn’t say much for today’s median family income. It also gives us a clue as to just how much money is considered “rich”.
Next posting, I will start presenting the historical data sets. I’m still thinking about the best way to do it as what is important is the comparison among the data sets.  Maybe post just the data charts and later the graphs or maybe one data set and it’s graphs at a time. 

Tyler Cowen and ‘something amiss’

by Mike Kimel

Cross posted at the Presimetrics blog

I really don’t understand this post by Tyler Cowen. He begins by noting:

The median earnings of full-time Canadian workers increased by just $53 annually — that’s right, $53 annually — between 1980 and 2005.

He then links to two documents, one of which says this:

A more likely explanation is that the rich have used their clout to get governments in the United States, Britain and Canada to change the rules, redirecting economic benefits to themselves.

They convinced governments, for instance, to alter the rules governing executive stock options, making them much more lucrative. (Although only about one-third of Canada’s top corporations were using stock options early in the 1990s, they were all were using them by the end of the decade. The value of stock options for Canadian CEOs exceeded their salaries by 300 per cent.)

The rich also managed to use their control of corporate boards to push up executive compensation. Since corporate boards are largely made up of corporate executives, a decision to raise the salary of an individual CEO helps set a higher standard for executive pay generally, benefitting all board members.

“They have a conflict of interest, since they have a stake in high financial salaries,” notes Richard Posner, a critic of today’s executive compensation (and also, incidentally, the judge who recently turned down Conrad Black’s U.S. legal appeal).

The rich also greatly enriched themselves by convincing governments to lower their taxes. Whereas the top marginal tax rate — the rate paid on income above a certain level — averaged 80 per cent in Canada in the early postwar years; it is now just 46 per cent (39 per cent in Alberta).

It was argued that lower taxes would encourage better performances at the top, increasing overall economic growth.

But that didn’t happen. On the contrary, economic growth rates were higher in the early postwar years — roughly twice as high — as they’ve been since 1980.

This suggests that higher taxes on the rich — like those in the early postwar era — do not discourage economic growth.

In fact, the introduction of an inheritance tax in Canada (like ones that exist in almost all advanced nations) would enable Ottawa to collect enough revenue to create educational trust funds for all Canadian children, thereby significantly improving national productivity.

Yet anyone advocating higher taxes on the rich is quickly denounced by groups like the right-wing Fraser Institute. Mark Milke, a commentator with the institute, dismisses concerns about rising inequality in Canada as merely the product of envy, or what he calls the “green-eyed beast.”

The very next sentence Cowen writes:

This is one reason why I do not adhere to some of the progressive or “class struggle” explanations of relative stagnation in median income growth. Canada is not ruled by the so-called Republican Right.

I don’t know enough about Canada to say whether or not the article he linked to is correct, but it seems to be directly contradicting his thesis.

I note that his blog has a very, very healthy comment section, and it doesn’t seem like the folks leaving comments noticed anything amiss either. Very odd.

A Simple Explanation for a Strange Paradox: Why the US Economy Grew Faster When Tax Rates Were High, and Grew Slower When Tax Rates Were

by Mike Kimel

A Simple Explanation for a Strange Paradox: Why the US Economy Grew Faster When Tax Rates Were High, and Grew Slower When Tax Rates Were Low
Cross posted at the Presimetrics blog.

If you are familiar with my writing, you know that for years I have been covering the proverbial non-barking dog: the textbook relationship between taxes and economic growth, namely that higher marginal rates make the economy grow more slowly, is not borne out in real world US data.

Sure, there are a whole raft of academic studies that claim to show just that, but all of them, without fail, rely on rather heroic assumptions, and most of them throw in cherry picked data sets to boot. Leaving out those simple assumptions tends to produce empirical results that fail to abide by the most basic economic theory. This is true for data at the national level and at the state and local level.

Making matters more uncomfortable (and thus explaining all the heroic assumptions and cherry picking of data in the academic literature) is that the correlations between tax rates and economic growth are actually positive. That is to say, it isn’t only that we do not observe any relationship between tax rates and economic growth, in general it turns out that faster economic growth accompanies higher tax rates, not lower ones, and doesn’t take fancy footwork to show that. A few simple graphs and that’s that.

Now, obviously I sound like a lunatic writing this because it goes so far against the grain, but a) I’ve been happy to make my spreadsheets available to any and all comers, and b) others have gotten the same results on their own. Being right in ways that are easily checkable mitigates my being crazy (or a liar, for that matter), but it doesn’t change the uncomfortable fact that data requires a lot of torture before conforming to theory. And yet, that’s the road most economists seem to take, which explains why economics today is as useless as it is. It also speaks poorly of economists. The better approach is come up with theory that fits the facts rather than the other way around.

I’ve tried a few times to explain the relationship that I’ve pointed out so many times, but I never came up with anything that felt quite right. I think I have it now, and it’s very, very simple. Here goes.

1. Economic actors react to incentives more or less rationally. (Feel free to assume “rational expectations” if you have some attachment to the current state of affairs in macro, but it won’t change results much.)
2. There is a government that collects taxes on income. (Note – In a nod to the libertarian folks, we don’t even have to assume anything about what the government does with the taxes. Whether the government burns the money it collects in a bonfire, or uses it to fund road building and control epidemics more efficiently than the private sector can won’t change the basic conclusions of the model.)
3. People want to maximize their more or less smoothed lifetime consumption of stuff plus holdings of wealth. More or less smoothed lifetime consumption means that if given the choice between more lifetime consumption occurring, with the proviso that it happens all at once, or a bit less lifetime consumption that occurs a bit more smoothly over time, they will generally prefer the latter. Stuff means physical and intangible items. People also like holding wealth at any given time, even if they don’t plan to ever spend that wealth, because wealth provides safety, security, and prestige, and for some, the possibility of passing on some bequest.

(If the first two look familiar, they were among 8 assumptions I used last week in an attempt to get where I’m going this time around. Note that I added two words to the second assumption. More on last week’s post later.)

Due to assumptions 1 and 3, people will want to minimize their tax burden at any given time subject provided it doesn’t decrease their lifetime consumption of stuff plus holdings of wealth. Put another way – all else being equal, peoples’ incentive to avoid/evade taxes is higher when tax rates are higher, and that incentive decreases when tax rates go down. Additionally, most people’s behavior, frankly, is not affected by “normal” changes to tax rates; raise or lower the tax rates of someone getting a W-2 and they can’t exactly change the amount of work they do as a result. However, there are some people, most of whom have high actual or potential incomes and/or a relatively large amount of wealth, for whom things are different. For these people, some not insignificant amount of their income in any year comes from “investments” or from the sort of activities for which paychecks can be dialed up or down relatively easily. (I assume none of this is controversial.)

Now, consider the plight of a person who makes a not insignificant amount of their income in any year comes from “investments” or from the sort of activities for which paychecks can be dialed up or down relatively easily, and who wants to reduce their tax burden this year in a way that won’t reduce their total more or less smoothed lifetime consumption of stuff and holdings of wealth. How do they do that? Well, a good accountant can come up with a myriad of ways, but in the end, there’s really one method that reigns supreme, and that is reinvesting the proceeds of one’s income-generating activities back into those income-generating activities. (i.e., reinvest in the business.) But ceteris paribus, reinvesting in the business… generates more income in the future, which is to say, it leads to faster economic growth.

To restate, higher tax rates increase in the incentives to reduce one’s taxable income by investing more in future growth.

A couple acknowledgements if I may. First, I would like to thank the commenters on my last post at the Presimetrics and Angry Bear blogs, as well as Steve Roth for their insights as they really helped me frame this in my mind.

Also, I cannot believe it took me this long to realize this. My wife and I are certainly not subject to the highest tax rate, and yet this is a strategy we follow. At the moment, we are able to live comfortably on my income. As a result, proceeds from the business my wife runs get plowed back into the business. This reduces our tax burden, and not incidentally, increases our expected future income.

SILOs –more action needed?

Tax advantaged “sale-leasebacks” with strapped-for-cash municipalities (SILOs, in the ever-present tax acronym set) came back to light when the Washington Metro train crashed a week ago. The cars were ones that were involved in the metro authority’s SILO deals with various banks, and the authority didn’t have any spare cash left to fund replacements. See this A Taxing Matter posting on the Metro SILOs, Jun 25, 2009.

I won’t rehash the entire discussion of SILOs covered there. Just note that the transit SILO deals were contrived to permit banks to “buy” the federal income tax depreciation deductions on municipal equipment. The municipalites couldn’t use the deductions, since municipalities are tax-exempt entities. The buying corporations were subject to US tax (usually, a bank) and they were looking for every way possible to avoid paying tax–they would essentially pay a fee to the municipalities, sharing part of their tax savings, for serving as an accommodation party in these deals. They “purchased” the municipalities’ property with nonrecourse debt, and then had “lease income” that was offset by both interest deductions and depreciation deductions, generating artificial losses from the accelerated depreciation. Most of the purchase price was set aside to defease the seller’s obligation under the lease, with the excess the fee for accommodating the tax shelter.

Jim Lehrer covered transit agency SILOs in the March NewsHour, depicting many of the transit agencies as motivated by their desperate need for capital–and encouraged by the federal Dept. of Transportation to use these means to get some. So there is a vicious double circle of irony here, that as states and localities cut taxes during the GOP years, under the flawed assumption that lower taxes means higher revenues, the states and municipalities also cut back on the funding needed by these important public service agencies, and an arm of the federal government encouraged these transit agencies to enter these deals, and at least 30 of them did, serving as accommodation parties in tax shelter deals with banks, so that banks would pay even less taxes than they already did.

Future SILOs were generally undone by new section 470, one of the few revenue raising provisions in the 2004 tax act. (The 2004 Act otherwise amounted to a pile of tax breaks for US corporations, such as the rate cut on repatriating offshore profits. It was misleadingly labeled the “American Jobs Creation Act” to signal the purported justification for all the corporate tax breaks. It didn’t lead to the creation of many jobs.) The new section disallowed to U.S. taxpayers a “tax-exempt loss”, defined as the excess of deductions other than interest and interest deductions allocable to tax exempt use property over the aggregate income from the property. Exceptions allowed certain “true” leases–essentially, ones in which the obligation of the seller-renter had not been defeased by the payment from the buyer and where the buyer had actually put some equity into the deal (the provision requires only 20% of genuine, at-risk equity). There are fewer tax benefits to true leases, so even with the exception, the provision deters leasing deals.

One hitch–the act only applied prospectively, and the transit deals (just one of the varieties of SILOs that were being done at the time of the 2004 change) got special treatment, in that any deals in the pipeline were allowed to be grandfathered in as long as they were done by 2006!

The IRS pursued the old deals with pre-2004 Act tools and won SILO (and LILO–the earlier “lease in, lease out” deals) cases against Fifth Third Bank, BB&T, PNC and other banks. See, e.g., IRS Wins AWG SILO Tax Shelter Case, TaxProf Blog (May 28, 2008) (dealing with the Ohio court’s decision in 2008-1 USTC 50,370, in favor of the IRS in a SILO case involving two US national banks’ “purchase”, with nonrecourse loans from German banks whose proceeds were used by the “seller” to defease the lease obligation, of a German waste facility used to acquire beneficial tax deductions); Ohio Judge Rejects Tax Claims on $423 Million Alleged Purchase of German Facility Made by Cleveland & Pittsburgh-Based Banks, DOJ (May 30, 2008); DOJ, Ohio Jury Finds Cincinnati-based Bank not Entitled to $5.6 Million Tax Refund (LILO transctions); BB&T Corp, 2008-1 USTC 50,306 (4th Cir.) (striking down tax treatment of financial service company’s lease of Swedish wood-pulp manufacturing equipment as a LILO shelter); DOJ, Statement of Assistant Attorney General Nathan J. Hochman on Today’s Decision in BB&T Corporation v. United States (Apr. 29, 2008).

After the court victories, the IRS offered a SILO settlement for these deals that permitted them to keep 20% of their claimed tax losses and waived the penalties, if they terminated the transactions. IRS Commissioner’s Remarks Regarding LILO/SILO Settlement Initiative (Aug. 6, 2008); Donmoyer, IRS Offers to Settle 45 leasing Tax-Shelter Disputes, (Aug. 6, 2008); Service Launces LILO, SILO Settlement Initiative, J. Acct. (Oct. 13, 2008). It later announced that “hundreds of taxpayers settled similar cases involving tens of billions of dollars.” DOJ, Justice Department Highlights FY 2008 Tax Enforcement Results (Apr. 13, 2009). On leaving office, Korb statedthat “taxpayers representing over 80 percent of the dollars involved have elected to take advantage of the settlement initiative.” See Korb Interview. (Dec. 19, 2008).

The settlement offer required taxpayers to terminate the transactions by Dec. 31, 2008, else they would be deemed terminated by that date, with taxpayers still able to claim the partial loss benefit through the actual termination date if they terminated the transaction by Dec. 31, 2010. That’s a fairly strong incentive for termination, but the municipalities may be on the hook for hefty termination payments under their contracts. Even worse, the AIG situation provided a perfect trigger for causing a technical default to apply. AIG guaranteed these deals, so when its credit rating went down, the transit agencies are in technical default and liable for hefty penalty payments. (see NewsHour video, above).

There are real problems here, including the idea of one agency of the government supporting its “clients” (transit agents of municipalities) entering into deals like this that result in corporate tax cheats robbing the government of important revenues. Another problem is the idea of the banks that were instrumental in causing the fiscal crisis–by risky, speculative behavior that disregarded the systemic risks–using AIG’s collapse because of that fiscal mess as an excuse to get municipalities that are especially cash-strapped because of the fiscal crisis (and finding their ability to borrow or get tax revenues severely restricted) to pay over large penalty amounts under their shelter contracts. It seems like an unfair windfall for tax cheating Big Banks at the cost of the people.

And of course, just extending the 2004 provision to make grandfathered SILO/LILO transactions illegitimate and their tax deductions disallowed doesn’t solve this problem, since these are windfalls that the tax cheaters would get under their “lease” contracts.

Rep. Menendez of NJ has proposed a potential solution–the “Close the SILO/LILO Loophole Act” S. 1341, introduced in late June. His bill, he says, would “help protect WMATA and other transit agencies who are being threatened by banks seeking to gain a windfall from the current economic climate while potentially putting transit agencies at risk.” See press release, As Lease-Back Deals Are Raaised as an Issue in Metro Crash, Menendez Says legislation Can help Unwind Deals, (Jun 26, 2009); Davis, Bill Would Tax Banks that Sue Agencies , Star Ledger (Jun 24, 2009); Letter from Menendez to Hoyer (Jun 26, 2009) (noting a need to “protect transit agencies from banks who are seeking to exploit a technicality that would result in agencies having to pay banks millions of dollars that could otherwise be used to shore up equipment and ensure safe operations, even though they have not missed a single payment to the bank”). The bill imposes an excise tax equal to 100% of any “ineligible amount” collected by “any person other than a SILO/LILO lessee” as a party to a SILO/LILO transaction. Ineligible amounts are proceeds from terminations, rescissions, or remedial actions in excess of those under defeasance arrangements. The bill also would deny deductions for attorney fees and other costs attributable to seeking to recover ineligible amounts.

It’s messy, but it does end up with the right results, it seems. I note, though, that there are no additional co-sponsors at this time. Doesn’t look like Congress is hopping on the bandwagon.

Correlation is not Causation

I spent most of the evening reading Underbelly posts, so this link is probably due to Buce:

On Oct. 22, 1986, President Reagan signed into law the Tax Reform Act of 1986, one of the most far-reaching reforms of the United States tax system since the adoption of the income tax. The top tax rate on individual income was lowered from 50% to 28%, the lowest it had been since 1916.

About thirteen years from 1916 to 1929. About thirteen years (plus the Clinton Administration) from 1986 to 2008.

Annals of Republican Obstructionism

Last week, the Senate failed to invoke cloture on S.3335, a measure which among other things would extend the production tax credits for solar and wind energy, plug the Highway Trust Fund deficit, and keep the Alternative Minimum Tax at bay for elements of the lower-upper-middle-classes for another year. The vote was 51-43, with a few mostly endangered Republicans joining the Democrats, and Harry Reid voting Nay for procedural reasons — so the bill does have at least majority support.

In fact, since the elements of the package are broadly popular if not useful, this bizarrely enough seems to be an effort of the Republicans to be against a package of tax cuts before they’re for it. (More Republicans than Norm Coleman and Gordon Smith would be hard pressed to vote Nay in a final vote, methinks.) Whether this represents Pyrrhic support for the Bush administration’s idiotic plan to raid transit funds for the highways, or an effort to get the Democrats to accept oil drilling to get essential legislation passed, is unclear from the reporting I’ve seen.

I’d seen Tom Ridge on TV yesterday claiming that it’s the Republicans with a comprehensive energy plan, whereas Obama is supposedly opposed to the zero nuclear plants currently under construction. In fact, not only are the Republicans working to effectively throw a spanner in the works of the rapidly expanding renewables industry — providing generating capacity with no sensitivity to fossil fuel prices in multi-gigawatt quantities now. In fact, it may be down the page but McCain supports the tax credits his caucus is opposing.

It makes me wish I were rich enough to get on the air with an ad on this flip-flopping and obstructionism by the Grumpy Old Party.

Palley on Tax Preferences for Homeownership and the Bubble

Mark Thoma points to Thomas Palley playing lightning rod with “Tax Policy and the House Price Bubble.” With a title like that, you might expect a prima facie case for a causal link between tax preferences for homeownership and the bubble, but Palley’s lede is deeply buried and there turns out not to be a lot of there there. The central issue is that there’s no obvious variation in tax policy that is associated with the bubble. More after the jump.

Plenty of Sensible Economists have sniped at the mortgage interest deduction among other favorable tax treatments for homeownership. Reforming, though not eliminating, the mortgage interest deduction also was a recommendation of the Tax Reform Panel whose report was broadly ignored after its 2005 publication gave some of us in the econoblogiverse plenty of material (for anyone interested, my contemporary blogging on the subject is linked here). Palley recites the traditional indictment: the tax policies are expensive (*), pay the middle- to upper-middle classes to do something they’d do anyway (**), are unfair to low-income taxpayers who don’t itemize or otherwise get a smaller deduction (***), and by increasing house prices work somewhat at cross purposes to the notional intent of making housing more affordable. Fair enough.

Thing is, as far as the housing bubble is concerned, none of this is new. The deduction was distorting the housing market well into pre-bubble history. Indeed, the reductions in marginal tax rates affecting most middle- and upper-income taxpayers ought, in principle, to have reduced the distortion on the margin. Here, for instance, is the CPI-adjusted OFHEO house price index against the marginal tax rate applicable to a family with a constant-dollar income somewhat north of mine (****):

Marginal Tax Rates and House Prices

Correlation is not causality, of course, but the simple correlation here is negative (-0.55). Moreover, there isn’t any clear connection between the major changes in tax policy over the period and bubbly prices, unless someone can account for the rather variable lag structures. The 1986 tax reform eliminated the deductibility of non-mortgage interest, which in particular made home-equity credit relatively attractive; in 1997, the capital-gains treatment for owner-occupied housing changed. In both cases, at least using the CPI adjustment, prices had started recovering from their local troughs before enactment of the changes.

The ’97 change — which replaced a tax deferral for homeownership capital gains rolled into another residence with a flat exemption of $250,000 for an individual (twice that for joint filers) — is tricky. It does favor owner-occupied housing as an asset class by making something of a Roth IRA out of one’s house. However, the benefits relative to previous law only assert themselves upon exit of the owner-occupied housing market, and the complete tax deferral of rolled-over equity may have been worth more in the short run to movers up or down in areas with high nominal appreciation. Also, this was enacted against the backdrop of a right-of-center program to reduce taxation of capital income; I tend to the view that there’s not a lot of distortion between a zero capital gains tax rate and the low rates that currently prevail for other long-term gains.

So Palley is left with a rather tenuous assertion connecting the bubble and tax policy:

The tax system has helped create a cult of home ownership, and that cult appears to have been an ingredient in the recent house price bubble.

I don’t think the tax preferences exactly hurt the cult’s marketing, but let’s face facts: to explain the bubble, it’s necessary to find factors associated more-or-less with the bubble era, and from that perspective it should be amply clear that the irrational exuberance came roaring out of the financial world. The cult part was all the spinning of tales for why houses were just like stocks in the late-90s except for the crashing back to earth part, combined with the deployment of financial technologies which, while not necessarily dangerous per se (*****), certainly bore risks of unintended consequences that were broadly ignored. So now we have a socialized financial system (at least on the downside), woohoo!

Meanwhile, I’m skeptical to say the very least regarding claims that we’d be living in a paradise of economic dynamism if only we were all unencumbered by our illiquid and inconvenient owned housing. Long-term wage stagnation is a huge problem, but one that can’t fairly be placed at homeownership above other causes.

So Palley has some reasonably sensible reform plans that someone might phase in, but I’m not going to tell anyone that a bit of political capital ought to be spent on them that might otherwise be spent extracting us from George and Dick’s Excellent Adventure or breaking our addictions to oil and/or GHG emissions — both of which are far more difficult and urgent.

(*) $80 billion is a lot of money, but at ~3% of the federal budget, not the biggest boondoggle in annual expenditures.

(**) Distastefully inefficient to the extent it’s true.

(***) Also true in large part, though non-itemizers do have the standard deduction.

(****) This is based on a constant-dollar income putting a 2007 taxpayer in the 28-percent bracket, not adjusted for other tax-law changes. Historical tax rates via the Urban Institute/Brookings Tax Policy Center.

(*****) If you think there’s something magical about 20%-down financing, go read the Irvine Housing Blog’s archives, handy link in the sidebar!

Some Advice For Robert Stein and Other Conservatives Trying to Construct a New Tax Structure

Robert Stein has been kind enough to clarify a lot of points about his tax plan, so I’d like, if I may, to offer conservatives my thoughts on a tax plan. Not a tax plan, but things I feel they should keep in mind about taxes if their goal is to come up with a plan that will a) have the support of folks in the center and the center-left and b) be “pro-growth” in deed as well as in word.

1. Do not make assumptions about the percentage of people’s income that will go toward taxes based on figures from the IRS Statistics of Income. The IRS Statistics of Income gives us reported taxable income, which has a much greater tendency to overstate the percentage of income paid in taxes by high income earners than it does for low income income earners. A couple reasons come to mind quickly…

1a. It is not going to include tax free income, such as tax free municipal bonds. These are generally not a part of the income stream of the working class.

1b. Its usually awfully hard to, shall we say, push the envelope when all of your income comes from one employer and is reported on a W-2. On the other hand, if your income comes from multiple sources, and it depends in large part on how big your costs are, things are a little different. Robert Stein used to work at the Treasury. I had a stint at a then Big 6, now Big 4 Accounting firm. The reason high net worth individuals pay enormous fees to the Big X is not because their returns are complex – its to ensure their returns are complex. That way, when there’s a dispute, and the folks at the Big X are one side of the table, and the outgunned folks from the Treasury (whose goal is to one day be on the other side of the table, making more money – talk about Capture Theory!) meet, there’s no question what the outcome will be. Costs are inflated using every loophole, and revenues are deflated the same way. And the incentive of folks who make enough money to go through PWC or E&Y or Deloitte or KPMG is not going to go away just because tax rates fall, unless those rates fall close to zero. And its not going to go away if the tax code is simplified.

2. Here’s a table I made for another post a few months back based on data from IRS SOI Bulletin Historical Table 8. It shows the income taxes paid (as per the IRS SOI) as a percentage of the personal income (from the BEA’s NIPA tables), not as a percentage of the personal income declared to the IRS.

I don’t think its excessively cynical that the conclusion to be reached from this is that tax collections are less a function of marginal tax rates than they are of something else. Here’s why – tax rates dropped dramatically while LBJ was President, and yet tax collections as a share of income went up. Conversely, as Republicans will never forget, GHW Bush raised tax rates… and still reduced the percentage of people’s income collected in taxes.

For lack of a better term, let’s call that something other than marginal tax rates that affects tax collections “enforcement.” Its a simple matter – if the folks appointed to run the Treasury and the IRS are very much against the concept of taxation, tax collections as a percentage of income will diminish. Its no surprise or accident that the red bars are all one side of horizontal axis and the blue bars are all on the other.

3. I realize its fashionable to claim that one is “pro-growth” if one is in favor of lower taxes. I’m not sure if Robert Stein has used that term, but its certainly a term in vogue. The problem is this – another graph I used before…

I pulled some data from the BEA’s NIPA table 7.1. For each president, its calculated from the last year before the President took office to the last full year the President served. (Since JFK was killed and Nixon quit more than half-way through the year, I assumed JFK’s “last full year” was 1963 and Nixon’s was 1974.)

Its hard to construct a story that includes both this graph and the previous one and that still puts the “pro-growth” label on lower tax collections*. I am not saying that higher tax rates produce faster growth – I am saying that there is an optimal rate of taxation when it comes to growth. Think of it as a Laffer curve, but with real GDP per capita growth rather than tax collections on the y-axis. At the rates of actual tax collections we’ve observed since 1952, not theoretical marginal collections but actual ones, taxes are now well below the level we need to maintain growth. Taxes pay for infrastructure we need to maintain a smoothly running economy, things like roads and bridges.

* Any such story usually involves the Kennedy tax cuts. To cut that off at the pass, let me point out here and now, for the umpteenth time, the Kennedy tax cuts came in 1964. Kennedy was already dead. Its one thing to credit them with some of the growth during the LBJ years, another to credit them with growth during the Kennedy years.

Correction. Modified the sentence referring to GHW Bush and taxes. Originally it referred erroneously to GW, and was somewhat nonsensical. Apologies for the screw-up.