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

Infrastructure gamesmanship puts wealthy ahead of jobs, good bridges, and country

By Linda Beale

Infrastructure gamesmanship puts wealthy ahead of jobs, good bridges, and country

For those who are paying attention to the House and Senate these days, it seems like a frustrating exercise.  Mostly it is one of watching the “do-nothing” Republicans find excuses for never requiring millionaires and billionaires to pay their fair share of taxes while making up excuses for not doing anything of the varied real approaches to stimulating the economy in ways that will create jobs for ordinary Americans.

Take the vote on the infrastructure bills.  The Senate leadership asked the Senate to vote for funding $60 billion of much needed infrastructure projects (just a tip of the iceberg of everything that is needed to bring this country’s infrastructure into nonembarassment).  The GOP refused, because it was funded by a de minimis tax on millionaires.

There’s no end to things that can be said about this further evidence of the craven state of the GOP in the US today.  Political advantage for the wealthy class is to be given primary importance, no matter what happens to the vast majority of Americans and the country we all love.  Jim Maule has it right, in The Tax and Spending Stalemate: Can It Destroy the Nation?, MauledAgain (Nov. 7, 2011).

When partisan loyalties mean more than the nation’s well-being, when money means more to wealthy “world citizens” than does the long-term physical security of the nation, and when protection of millionaires who fund campaign treasure chests means more than the lives and safety of the rest of America, the literal physical survival of the nation is imperiled. …

[A]s long as this absurd tax and spending stalemate continues, where decisions are not made on the merits of the issue but on the partisan attachments of supposedly public servants, the nation and its infrastructure, the nation and the health of its citizens, the nation and its economy, will continue to stagnate, deteriorate, and crumble. The question now is how close we are to the point of no return.

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A Post: Tax Burdens, Presidents, and Subsequent Economic Growth – A Few Pictures, Part

by Mike Kimel

A Post: Tax Burdens, Presidents, and Subsequent Economic Growth – A Few Pictures, Part 1

Last week I had a post looking at the relationship between the change in the tax burden in the first two years of a Presidential administration and the growth of real GDP during the remaining years of the administration. I’ve done variations of this exercise before. It turns out that the more an administration reduced the tax burden in its first two years, the slower the growth the in real GDP over the remainder of its term in office administration. Assuming the result is more than an artifact of the data (and it does seem to correspond with other results I’ve reported here over the years), it requires an explanation. While (I am not happy to report) an increased tax burden might in and of itself stimulate faster economic growth, I suspect a bigger effect is that a) the easiest way to move the tax burden is by increasing or decreasing tax regulation and b) there is a correlation between an administration’s views on tax regulations and its views on other regulations that are intended to prevent externalities. This theory is supported by the fact that the relationship between lower tax burdens and slower growth is strengthened by not including the administrations that served only four rather than eight years makes the relationship stronger.

As I keep noting, one doesn’t have to like the results. I personally would much prefer a world in which lower tax burdens do lead to faster economic growth. But the data doesn’t seem to show that. Still, every time I put up a post like this, I get a lot of flack. One thing people keep telling me is that the results are, at best, a coincidence. In their honor, in today’s post I’m going to describe a few more coincidences that the data shows in my next few posts. Some of these coincidences I expected to see, and some, to be frank, I did not. Today I’m going to stick with a few coincidences I expected.

So… let’s go with coincidence number one. The graph below shows the change in the tax burden from Year 0 (i.e., the last full year of the prior administration) to Year 2 on one axis, and the growth rate in the last full year of each administration. (Only eight year administrations are included.) As an example, for Ronald Reagan, we see the change in the tax burden from 1980 to 1982 along one axis and the percentage change from the 1987 real GDP to the 1988 real GDP.

Figure 1

Notice that the relationship between the tax burden in the first two years of each administration and the growth rate in its last year is extremely strong. That’s consistent with what I wrote in my last post (and so many times before): most administrations do not change their tax policy very much, but tax policy (and other policies that correlate with tax policy) can take a while to have an effect on the economy.

Before I go on, a few ground rules for those who want to comment or send me e-mail:
1. If you really believe that the growth rate in the last year of an administration is “causing” the change in the tax burden in the beginning of the administration, I encourage you to seek psychiatric help. I can’t do anything for you.
2. US’ participation in World War 2 prior to 1940 is best described as peripheral. Growth in 1940, or 1939, or 1934 for that matter, is not due to World War 2.

(If you find my constant repetition of these ground rules funny, hazard a guess as to what creeps into my inbox.)

Now, another coincidence… the next figure shows the the change in the tax burden from Year 0 (i.e., the last full year of the prior administration) to Year 2 on one axis, and the growth rate in the fourth year of each administration.

Figure 2

Again… the picture looks an awful like Figure 1. The fit isn’t as good (consistent with the idea that it takes a while for policy to have a a very strong effect. Kind of odd for a coincidence.

Now… you may be wondering… what about other years. I’ll tell you flat out, the fits in years 1 and 2 are awful… consistent with the idea that it takes a while for policy to have a very strong effect. As to the rest, that will wait for the next post.

To close, nominal and real GDP come from the Bureau of Economic Analysis. GDP was first computed in 1929, so the first complete administration for which we have data is FDR I. Data on the Federal government’s tax receipts comes from the Bureau of Economic Analysis’ NIPA Table 3.2.

As always, if you want my spreadsheets, drop me a line at my first name (mike) period my last name (kimel – with one m only) at gmail period com. I should also point out, you can find a lot more of this sort of analysis in Presimetrics, the book I wrote with Michael Kanell.

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Mandatory submission to e-verify program…a few points more

Op ed by Nancy Ortiz

Scott Hochberg’s article Making E-Verify Mandatory: The Perfect Storm for Crippling the Social Security Administration and Jeopardizing the Social Safety Net discusses issues regarding the e-Verify system and a move in Congress to make it mandatory for everyone hired for a job in the US. He points out that eVerify is every bit as much a threat to SS and Medicare as any of the other benefit, COLA, or Medicare provider cuts now being discussed. I read Hochberg’s article with great interest and have a few additional points to add to his excellent analysis of this subject.

When the Immigration Reform Act took effect in 1987, I was the manager of the SS office in Northern Santa Barbara County in strawberry, broccoli, lettuce and wine grape country. Thousands of migrant workers pass through the area at the height of the picking season between January and May. Many stay with or without authorization so that about 60% of the population is Hispanic and/or non-English speaking/non-US national. You will find similar demographics up and down the California Central Coast in agricultural areas, so there’s nothing unusual about this.

I’ll spare you the war stories of actually implementing IRCA’s social security number provisions. This was the Bush I administration notable for its parsimony in budgeting for SSA operations. (How bad was it? How about no hiring, no overtime and no photocopy paper bad?) Farm workers in the area lined up with their new Immigration work visas in hand outside our office door at 6:00A and we interviewed Social Security Number applicants until 5:00P every day from 1987 til mid-1989. It was hard to get anything else done, but the normal operation got busier because of the recession that put maybe 15% of the workforce in our area out of work.

Alright, now it won’t take much imagination to imagine the same situation but worse, because now every worker would be subject to e-verify. Not just the “obvious illegals,” every single one who applied for a job. Hochberg’s article summarizes the projected workload from this but SSA’s workforce is now 20 or more years older
and really, really ready to retire. And, of course, Congress is talking about cutting the whole federal civil service workforce 10% across the board while maintaining an indefinite hiring freeze and whacking every agencies’ budget in its 2 Trillion to 4 Trillion dollar spending cuts. The President is ready to agree to at least 2 Trillion in cuts, but discussions are continuing.

Perhaps you can see now why making it illegal to work in the US without lawful admission was a bad, terrible, awful, rotten, really bad idea from the git-go. “All we would have to do to” avoid this debacle is revoke this provision and we could go back to doing business the way we did before 1987. The punitive notion of making
work without documents a “crime” has resulted in a flood of counterfeit and stolen documents. Field workers often buy many sets of documents (at high prices) before getting a set that will pass employers’ inspection. Every town in California and other border states has document mills. Sanctions against employers for hiring undocumented workers are virtually never imposed. Identity theft, impossible to prevent and prosecute effectively, is epidemic. And, on and on. All because of the notion that working in the US should be a crime.

If you remain unconvinced, let me remind you that the budget for SSA’s New New Computer Center was reduced about in this last round of spending cuts. This will make it impossible to meet an early construction deadline made necessary by the fragility of the existing computer system. This is estimated to result in causing SSA’s now aged and outdated computer processing and data storage systems to collapse
sometime between now and 2013. 2013 is supposedly the outside range of functionality assuming nothing catastrophic (such as a major power grid black out) happens between now and then. Otherwise, it can go at any time. Finally, I don’t need to remind you of the pending DIB appeals workload of approx. 700K cases still on hand.

But, in closing let me ask you–can you prove you are a US citizen or lawfully admitted alien with permission to work if I ask you right this minute? No, your drivers’ license isn’t enough. Your SS card isn’t ID. You may have a US Passport but it won’t resolve the matter unless it is current. Your current or former employer’s assurance isn’t enough either.

Prove to me who you are or you can’t work here any more. And, it says here on this little No Match notice that you aren’t who you say you are. So, what about it? Exactly who are you anyway, Mr. Working American?

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Unforced Error, or How Well Has That Worked Out for You, BarryO?

PGL, in the process of an optimistic piece, points us to Martin Feldstein ringing in 2011. Apparently, the reason is this:

The most substantial potential boost to spending comes from a temporary reduction of the payroll tax, lowering the rate paid by employees on income up to about $100,000 from 6.2 per cent to 4.2 per cent. But, while the decline in tax payments will be about 0.8 per cent of GDP, it is not clear how much of this will translate into additional consumer spending and how much into additional saving. Because this tax cut will take the form of lower withholding from weekly or monthly wages, it may seem more permanent than it really is, and therefore has a greater impact on spending than households’ very feeble response to the previous temporary tax changes.

Feldstein attempts a free-finesse with “it may seem more permanent than it really is.” This is like playing the seven to the Queen when you’re only other holding is 10-x and expecting it to work.

It’s six months later. The crowd jewel of BarryO’s deficit-saving agreement, per Feldstein, was a low-impact change that was mostly (if my paycheck is any indication) neutralized by other factors (such as increases in health insurance costs). So the payroll cut is going to UHC or Aetna, or BCBS, or some other place where the money multiplier will be significantly less than one.

Even more interesting is that, just three paragraphs before, Feldstein understood that workers are still engaged in balance-sheet repair, and the likely consequences of same:

Even for those taxpayers who had feared a tax increase in 2011 and 2012, it is not clear how much the lower tax payments will actually boost consumer spending. The previous temporary tax cuts in 2008 and 2009 appear to have gone largely into saving and debt reduction rather than increased spending.

It is surprising, therefore, that forecasters raised their GDP growth forecasts for 2011 significantly on the basis of the tax agreement.

But Feldstein did see some good in the greater tax deal—it would temper deficit fears:

Obama wanted to continue the 2010 tax rates permanently for all taxpayers except those with annual incomes over $250,000….By agreeing to limit the current tax rates for just two years, the tax package reduces the projected national debt at the end of the decade (relative to what it would have been with the Obama Budget) by some $2 trillion or nearly 10 per cent of GDP in 2020.

That reduction in potential deficits and debt can by itself give a boost to the economy in 2011 by calming fears that an exploding national debt would eventually force the Federal Reserve to raise interest rates — perhaps sharply if foreign buyers of US Treasuries suddenly became frightened by the deficit prospects.

There can be only one remaining question:

When will Martin Feldstein endorse Jon Hunstman for President?

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Why Tax Law Should be Required of All Law Students

by Linda Beale
crossposted from Ataxingmatter

Why Tax Law Should be Required of All Law Students

We tax profs have a tendency to tell our colleagues that tax law should be a mandatory topic for all law students because there’s nothing that you do that has economic consequences for which tax law isn’t relevant.  Whether you are marrying or divorcing, having a baby or buying a home, there are tax considerations that you should know about.  If you are starting a business, depositing the proceeds of a theft in a bank, embezzling or gambling, there are tax considerations that you should know about.  If you are filing a tort action, there are tax ramifications.  If you own property, there are tax consequences.  If you work and earn a salary, there are tax consequences.  If you find a diamond in the street and keep it, there are tax considerations.  If  you get an “extreme makeover” home, there are tax consequences.  If your home is rented by tourists in town to see the Master’s Golf tourney, the tax consequences will vary tremendously if the tenants are there for only 10 days versus if they are there for three weeks, even if you live in the house every other day of the year.  And on and on.

Ted Seto, a tax prof at Loyola Law School in Los Angeles, noted another interesting fact about tax law that relates to this claim.  He notes that many of the important laws in other fields that we tend to think of as just a part of the common law had their origins in–you guessed it–tax law.  The following is quoted with his permission:

The Rule in Shelley’s Case was an anti-tax-avoidance rule. So was the Doctrine of Worthier Title. So was quia emptores terrarum, the statute that, by accident, created modern Anglo-American property in the first place. And the Magna Carta, which created the beginnings of Anglo-American democracy, was a tax cap agreement (sort of like Prop 13). It’s all tax, all the way down.

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ABA Tax Section Report on the Economic Substance Doctrine

by Linda Beale

ABA Tax Section Report on the Economic Substance Doctrine
crossposted with Ataxingmatter

The ABA Tax Section put together a large working group to write a report on the newly codified economic substance provision–Download ABA Economic Substance. Comments on Notice 2010-62.

The working group was led by several people, including Michael Desmond, who just happened to be at Treasury during the Bush Administration.  (There are lots of people in private practice now, writing reports on government decisions, who were in government under Bush just a while ago.  Is that a good thing?  I suppose it has its pluses and minuses.  On the plus side, it ensures that there are always those in practice who understand how government works and where important decisions can get hung up or expedited.  ON the minus side, the very decisions that were put in place during a person’s tenure in government may be susceptible to persuasive lobbying (using that insider perspective) from those who worked on the provision in government and now comment on it on the outside.)

The practitioner community is generally concerned that the codification of the economic substance doctrine will mean that it will “chill” regular business transactions because of the uncertainty regarding its exact application.  So the report asks for clarification–just what are the transactions that are susceptible to the application of economic substance, what is a substantial purpose, what does it mean to have a potential for profit, how do we know when state tax provisions are related to federal tax provisions, and what, in fact, does “economic substance doctrine” mean.

While the desire for absolute clarity is understandable, I am not sure that it is a desire that the Treasury should attempt to satisfy.  One of the benefits of judicial doctrines, compared to very specific statutory anti-abuse provisions, is their flexibility.  Courts, in the context of particular cases, review the circumstances of a transaction and conclude that it lacks economic substance.  The doctrine has developed as part of the federal common law of tax, and it has gone through periods of being particularly useful in curbing super-aggressive tax avoidance shelters.

For people like me who were worried that codification of the doctrine could lead to its demise by narrowing its scope and defining away its power to adapt to unforeseen abusive pattersn (and to create enough uncertainty among tax practitioners to discourage the most aggressive tax return gambits), the ABA’s demand for “clarification” is therefore worrisome.  If we take Congress at its word, it expected the courts to continue applying the doctrine in the circumstances in which they applied the doctrine before codification.  Codification solves the problem of different tests for economic substance applied in different jurisdictions by settling on one test, but it leaves it to the courts’ careful case-by-case analysis to add more meat to the bones of the test.  This is as it should be.

Practitioners would nonetheless like an “angel” list of transactions to which the economic substance doctrine can’t apply.  Treasury has wisely refused, since the power of the doctrine is in looking beyond form to substance and recognizing that abusive transactions (shelters) are highly innovational within the confines of existing statutory provisions.  The creation of an angel list would be an invitation for creative tax genuises to manipulate code sections to create an abusive transaction out of the angel one.

Let’s be honest.  Many practitioners would also like to see the significant test for business purpose narrowed in scope.  Here too I disagree.  it is important for transactions that are honored in their form for tax purposes to have a significant purpose that is germane to the business and not conjured up solely to achieve favorable tax results.

While some guidance would be helpful, Treasury should be careful not to put the pliable economic substance doctrine into a straitjacket that limits its ability to police aggressive transactions.

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How Tax Rates Affect Investment and Consumption – A Look at the Data

by Mike Kimel

How Tax Rates Affect Investment and Consumption – A Look at the Data
Cross posted at the Presimetrics blog

This post looks at how changes in the top marginal tax rates affect peoples’ decisions on how much to consume and invest. Ask a libertarian or conservative economist and the answer is obvious – raising tax rates on high income individuals dissuades them from doing productive things – that is to say, it causes them to cut back on working and investing. In the interest of avoiding strawmen at all costs, many libertarians and conservatives might assume that a hike in the tax rates on such individuals can also cause them to cut back on consumption. After all, if tax rates are raised high enough, perhaps people won’t have enough left over to consume as much as they otherwise would. However, the reduction in voluntary activities that take effort (i.e., work, investment) should easily swamp the reduction in consumption, some amount of which is needed for simple survival. Put another way, as tax rates rise the ratio of investment to consumption should fall.

That right there is what’s known as a testable implication, and there’s data aplenty for that purpose. But before we move on to testing this, let me note that the first paragraph actually provides a second, far more familiar testable implication, namely that higher tax rates will generally lead to slower economic growth. While that particular narrative seems to be widely believed even by non-economists, it certainly isn’t borne out by US data from the last eight decades or so:

Figure 1

(Figure 1 first appeared in this post.)

The graph shows that, at least until top marginal tax rates get somewhere above 50% (a bit more precision available here), increasing those rates does not correlate with slower economic growth, but rather with faster increases in real GDP. In fact, raising top marginal tax rates doesn’t have many of the effects many people seem to expect (And incidentally, its worth noting that state level data also produces results the Chicago school and most libertarians don’t expect.)

Now, the reason I mention the data’s irresponsible failure to abide by conservative and/or libertarian philosophies when it comes to tax rates and growth is because I think the relationship between tax rates and economic growth can be at least partly explained by the relationship between tax rates and investment. As I stated here, in my opinion, higher tax rates can lead to more investment. After all, one way a person who owns a business (large or small) can reduce the taxes they pay on profits is to reinvest the profits, which in turn leads to faster economic expansion. Furthermore, the incentive to avoid taxes and reinvest increases as tax rates increase. Of course, at some point, tax rates get high enough to encourage individuals to reinvest even though the “benefits” from more reinvestment, at the margin, are negative. Where that happens, I don’t know, but based on Figure 1, my guess is that it takes a top marginal tax rate above 50%.

So… here’s what libertarians and conservatives should expect to see: as the top marginal tax rises, the ratio of investment to consumption falls.

Here’s what I expect to see: the relationship between the top marginal tax rate and the ratio of investment to consumption is somewhat curved. For top marginal tax rates between 0 and some point X (where X > 50%), an increase in the top marginal rate leads to an increase in investment/consumption. After that, as the top marginal rate rises, we should investment/consumption level off, and for even higher marginal rates, investment/consumption should fall.

So… using top marginal rates from the IRS’ Statistics of Income historical table 23, and national investment and consumption figures from the Commerce Department’s Bureau of Economic Analysis’ National Income and Product Accounts table 1.1.5, we can construct this little graph:

Figure 2

It’s not a perfect quadratic curve, but it sure looks a lot more like what I had in mind than what any conservative or libertarian would expect. FYI, the correlation between the top marginal tax rate the ratio of investment to consumption for top marginal tax rates below 50% is 55%. That is to say, an increase in tax rates increases the ratio of investment to consumption when tax rates are below 50%. On the other hand, the correlation is a negative 11% when tax rates are above 50%. That is to say, increasing tax rates when they are above 50% has a (not particularly strong) negative effect on people’s “invest v. consume” decision.

Put another way – conservatives and libertarians have a very, very flawed theory of the world. At the very least it does not conform at all with historical US data. At all. Which of course has serious consequences; because that theory is somewhat dominant in the political sphere, and has been since the late 60s. The end result – slower economic growth for all of us since the late 60s. That has real consequences for real people – 310 million of us. That should have repercussions for the consciences of economists who peddle this garbage, though apparently it doesn’t.

But that’s for another post. Today, I want to remain clinical. So… what does Figure 2 mean, with respect to Figure 1? It means that, yes, at least until a certain point (somewhere above 50%), raising the top marginal rate both increases the ratio of investment to consumption and the real economic growth rate. Its not outlandish to assume that increasing investment is one of the factors that can increase real economic growth. (Worth exploring more in a post sometime in the future.) Other things matter, of course, but I think investment is up there among factors that matter.

It also means that since we’re keeping tax rates at the level they’ve been for the past decade or so, we shouldn’t expect sustained rapid investment or economic growth any time soon. Don’t expect the 60s or even the 70s again any time soon – we’re in end of the 80s and 00s level taxation, and over the long haul, we’re in for that sort of growth too.

A few closing remarks:

1. 1. This post was partly inspired by an interview I had with George Kenney of Electric Politics. It was a really useful and interesting conversation for me, in part because he pressed me a bit past my comfort level. I understand he’ll have that interview up in a few weeks.

2. 2. I’ve noticed that a number of the graphs I’ve been putting up are not so much quadratic as a bit bimodal. I have been thinking about that for the past few days, and I think that will be my next post on this “kimel curve” approach to world I’ve been following lately.

3. 3. Please, please, please, please, if you object to something in this post and are planning to bring up Romer and Romer, read this first to save me from being embarrassed on your behalf.

4. 4. As always, my spreadsheets are available to anyone who wants them.

5. 5. Between the time I finished my spreadsheet and the time I wrote this post, I read this blurb from Tyler Cowen’s next book. It might be uncharitable of me, but my first thought was to wonder about the odds a libertarian professor would add two and two together, and whether he could remain libertarian if he inadvertently did.

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CBO data on taxes and income

CoRev asks if anyone wants to discuss the justifications of the beneficiaries of the different parties policies. So I though this gives me an opportunity to present some recently published
CBO data on income and tax that could give people something to tie the discussion to.

Republican policy has been to favor the more affluent in our society and justifies it with the claim that increasing the wealth and/or income of the “investor class” will make everyone better off — a rising tide lifts all boats. If this worked I would strongly support such policies.

But look at what this data shows has happened between 1979 and 2007. This is a good set of dates for comparisons because it is essentially a peak to peak comparison from just prior to the 1980-1982 double recession and the current recession. Moreover, it is an era dominated by the Republican policy of tax cutting and the investment boom of the 1990.

First, as everyone knows this has been an era of a great surge of income inequality driven both by natural economic forces — the winner take all economy — and tax policy.

The net product of this 30 year era was a shift of about ten percentage points of the economic pie from the bottom four quintiles to the top quintile.

This shift in the share of income share by the top quintile has also generated a significant
increase in the share of taxes paid by the top quintile.

But the shift in the distribution of the tax burden is due entirely to the growth in income
rather than a shift in tax policy as the average effective tax rate paid by each quintile has fallen. Actually, on a proportional basis the lowest quintile had the largest drop in its tax burden.

The federal tax burden is quite progressive as the last chart shows. But in general state and local taxes such as sales taxes and property taxes are much more regressive, so the total tax burden is much less progressive than this chart implies.

If this shift in income to the top quintile had generated the increase in savings and investment and generated widely shared prosperity it would be a good thing, and the
greater income inequality would be a fair trade-off for greater growth.

But the actual results since the early 1980s has been a significant slowing of economic growth and a drop in private savings– just the opposite of what republicans and economic theory says would happen. Rather the results has been that since the early 1980s the US has increasingly lived beyond it means and ran up a major foreign debt to finance this consumption binge. The two major drives behind this shift in the US has been the Reagan and Bush tax cuts.

So I’ll take on CoRev and argue that the reason I oppose Republican policies is that they have been a complete and utter failure to deliver the results they promise. They have just ran up a massive foreign debt to finance our living beyond our means and now blame Obama because he has failed to reverse the adverse impact of the failed republican policies.

Supporting the republican “starve the beast” strategy reminds me of the comment I use to make back in the early 1970s that if Arthur Burns — the Fed Chairman — was a friend of business, business did not need any enemies.

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Taxes and Private Sector Investment – Evidence from the Real World

by Mike Kimel
Cross-posted on the Presimetrics blog.

Taxes and Private Sector Investment – Evidence from the Real World
Last week I had a post (which appeared both here and at Angry Bear). The post included the following graph:

Figure 1

The graph looks at every eight year period since 1929 (the first year for which National Accounts data is available from the Bureau of Economic Analysis) that can be thought of as a complete “administration.” It notes that there is a very strong negative correlation between the tax burden in the first two years of an administration and the economic growth that follows in the remaining six years of the administration. In plain English – the more the tax burden was reduced during the first two years of an administration, the slower the economic growth in the following six years. Conversely, the more the tax burden was raised during the first two years of each administration, the faster economic growth was during the following six years.

At this point I note… this is not my opinion, it is what the data shows. And there is no cherry picking – I went back as far as there was data and included every eight year stretch for which a single President occupied the Oval Office or in which a VP took over from a President in the middle of a term. And these real world results contradict just about everything that standard economic theory (Classical, Austrian, you name it) tells you.

So I tried providing an explanation:

Michael Kanell and I advanced several theories in Presimetrics but the one I think makes the most sense is that changes in the tax burden are a sign of the degree to which an administration enforces laws and regulations.

The logic is simple – (1) collectively, Americans cheat on their taxes and (2) whether the tax burden, the percentage of GDP that the government collects in taxes, rises or falls seems to have nothing whatsoever to do with whether marginal income tax rates rise or fall. Thus, one way for tax burdens to go up is increased enforcement, and one way for tax burdens to fall is decreased enforcement.

Now, to me that’s self-evident. But I’m starting to realize not everyone sees it this way, so let’s run a simple test. If a regime tolerates corruption or encourages companies to game the system rather than to be productive, we should expect growth in the private sector to be minimal at best. All else being equal, we should expect faster growth in the private sector the less rot there is in the system. I assume this is not remotely controversial. And it implies that if tax collections are indeed an indicator of an administration’s intolerance for shenanigans, then growing tax burdens should be followed by rapidly increasing private sector activity and falling tax burdens should be followed by relatively slow growth in private sector activity.

Crazy, right? Lower taxes leading to less private sector activity! Insanity! It defies economic theory. And common sense. But how does it fit with what happened in the real world? Extremely well, actually.

The graph below shows the change in the tax burden in the first two years of each 8 year administration on the horizontal axis, and the annualized change in real private investment per capita in the remaining six years along the vertical axis.

Figure 2.

Notice… administrations that cut the tax burden early saw mediocre increases in private investment later. On the other hand, administrations that started out by increasing the tax burden enjoyed big increases in private investment in the remainder of their term. This is yet another instance where real world results contradict just about everything that standard economic theory teaches, particularly the Chicago School, Austrian, and Libertarian variety. And sadly, that theory has so permeated our collective thought processes that it has come to be referred to as “common sense.” Just as it was common sense at one point that the earth was flat, and the center of the universe.

It’s worth pointing out, by the way, that the relationship between the tax burden and real private consumption is similar; administrations that raised the tax burden saw greater increases in real private consumption per capita than administrations that reduced the tax burden. The relationship, albeit a strong one, is slightly weaker than the relationship between tax burdens and investment. By contrast, the relationship between changes in the tax burden in years 1 and 2 and changes in real Federal Government spending per capita are much, much weaker.

So let me revisit once more the explanation that Michael Kanell and I put forward in Presimetrics and which is consistent with the data presented in both graphs above. Administrations that cut the tax burden tended to do so mostly by reducing enforcement of tax laws and regulations. But people who don’t believe in enforcing tax laws are also not particularly fond of most other forms of rules and regulations, preferring a laissez faire “pro-business” government in all walks of life. Sure, there may well be many private sector winners when the government allows a free-for-all. However, as the costs of exploiting loopholes, breaking laws and creating externalities falls relative to the costs of doing productive things, fewer truly useful productive activities take place, and that kills growth.

If you have a better explanation, let me know.

Data sources and comments.

The definition of the tax burden used in this post is Federal government current receipts from line 1 of NIPA Table 3.2divided by GDP from NIPA Table 1.1.5, line 1. Real economic growth was measured as the change in real GDP per capita, which was obtained from NIPA Table 7.1, line 10. Population came from the last row in the same table.

Real private investment came from line 7 of NIPA Table 1.1.6.

As always, the change in any series over the length of an administration is measured from the year before the administration took office (the “baseline” from which it starts) to its last year in office.

I intend to look at the relationships described in this post in a bit more detail going forward. However, expect the next post to cover another issue which seems to come up a lot – whether the results I’ve been posting are statistically valid or not.

Note also… if it’s not obvious, this post deals with the tax burden, the share of GDP going to the Federal government, and not marginal tax rates. Please do not insist on commenting on a topic unrelated to this post.

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Told Him So

Robert Waldmann

told Paul Krugman so

About 21 months ago Paul Krugman had a question

lower and middle-income Americans would be substantially better off under the Obama plan. But where is the money for health care reform?

I proposed an answer

there are two puzzles in Obama’s proposals
1) How does he plan to pay for both health care reform and his middle class tax cut ?
2) Why is he raising the social security tax even though it is probably not needed to pay old age and disability pensions ?

I think the two questions answer each other. I think that Obama is planning to pay for health care reform with the donut FICA increase (taxing individual labor income over $250,000).

Now we know. Yes most of the money for health care reform came from planning to have the CMS squeeze hospitals and nursing homes, then much from eliminating the Medicare advantage boondoggle (not eliminating the program just paying private insurance companies the same per policy holder as the CMS spends), then from the tax on expensive health plans.

However, when cutting that unpopular tax, expanding subsidies, making the special deal for Nebraska universal and making the special deal for collectively bargained health insurance benefits universal, Obama was short a few hundred billion. So in the Obama compromise proposal (the first proposal from the Obama administration) the donut tax returned.

The bill imposes new taxes on wealthier people. Individuals making more than $200,000, and families making more than $250,000, will have to give up more of their paycheck to the Hospital Insurance payroll tax. Instead of paying 1.45 percent like most workers, they’ll pay 2.35 percent. And a new 3.8 percent tax will be added to income from interest, dividends, annuities, royalties, and rents.

OK so it’s described as an increase in the Medicare plan A tax not the social security old age and disability pension tax. It starts at income of 200,000 or family income of 250,000. It applies to capital income too. The rate is lower than I guessed way back then (I just assumed it was 6.25%). Still I now type “I told you so.”

It was always there in his mind in case it was needed.

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