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Friday, August 2, 2013

What Real Liberal Tax Reform Would Look Like

      They say it's lonely at the top. I wouldn't know about this though I'd be happy to give it a shot and get back to you-sort of what the economists call a natural experiment. 

      They NY Times makes the point that there are other lonely things besides the top-like being an advocate of tax reform:

       "Debbie Schaeffer, the owner of Mrs. G TV and Appliances, probably did not give the answer the two chairmen of Congress’s powerful tax-writing committees were looking for when they pressed her this week for ideas on a fairer, simpler tax code: “Get rid of the deductions that don’t affect me,” she said.

      "As talk of tax reform caught Washington’s attention on Tuesday, the comment by Ms. Schaeffer illustrated the central challenge of those eager to overhaul the tax code: Even those who favor eliminating tax breaks want to hang on to the breaks that benefit them."
     "It is one of the main problems confronting Senator Max Baucus, chairman of the Senate Finance Committee, and RepresentativeDave Camp, chairman of the House Ways and Means Committee, who have been struggling almost unnoticed for months to build some momentum behind their bipartisan push to overhaul the federal tax code. Party leaders looked on skeptically, and the American public shrugged and defended its self-interestsay it's lonely at the top. I don't know if that's true or not-how could I? Let me try the top first then I'll let you know... However, the NY Times makes the point that tax reform is another thing that brings loneliness."


     http://www.nytimes.com/2013/07/31/us/politics/lonely-bipartisan-push-to-overhaul-tax-code-finally-gets-noticed.html?_r=1&

      There's a lot of truth in that. On Tuesday, President Obama brought tax reform back to the forefront a little by making an overture to GOPers. This offer, which was very generous, brought nothing but the usual GOP demand of 'My way or the highway.' No, dropping the  corporate tax rate 20% from 35% down to 28% isn't enough for them if it means the money that ostensibly will be raised-by closing corporate loopholes-is used for a little stimulus for the American people. As usual this is where the GOP chooses to draw its line.

      Still, it got me to thinking what should liberal tax reform look like? As the NY Times piece illustrates well, Tax Reform is always a vehicle to achieve more of the kind tax code you'd want. In the 60s and 70s the Dems used it to  to prevent the rich form using loopholes to avoid paying taxes altogether  Then Tax Reform because a conservative vehicle to cut taxes particularly for the rich.

      The Dems with Harry Reid at the helm have finally rediscovered using Tax Reform to achieve liberal ends.

      http://diaryofarepublicanhater.blogspot.com/2013/07/what-does-tax-reform-mean-to-you.html

      They are requesting that any Tax Reform bill not only can't be revenue neutral-heeding the advice of people like Jared Bernstein

      http://diaryofarepublicanhater.blogspot.com/2013/07/tax-reform-1986-and-better-mousetrap.html

      but that it 'can't be close to revenue neutral.' You go, Harry Reid!

      Good job Democrats. However, what would comprehensive liberal tax reform look like? First of all, let's admit something. Reid, Bernstein, and the rest of the Dems are taking license by calling a tax increase 'tax reform.'

      I have no trouble admitting this. It's not really in the spirit of what 'true tax reform' is supposed to be about. Ideally, tax reform is supposed to be revenue neutral. The idea that not just the amount of tax the government collects from the economy but the mode in which it collects it makes a big difference. The idea of tax reform stems from the notion of two concepts that mainstream economists believe in: the income effect and the substittuion effect.

      http://diaryofarepublicanhater.blogspot.com/2013/07/wanniski-bartlett-starve-beast-and-tax.html

      Now the income effect says that an increase to someone's average tax rate will lead them to work harder to make up the lost income as there is a certain X amount of income a worker strives for and if their income drops they'll make it up by working harder. 

      On the other hand there's the substitution effect. If you raise someone's marginal tax rate-the tax on the last dollar they earn they won't make up this lost income but will instead bone up on more leisure. It's not entirely clear-at all-to me why any of this should be so. Logically, I don't know why you should be so bummed if your top marginal rate goes up provided your average rate doesn't or goes up much less, but this is the theory tax reform is predicated on. 

     This is basically a Supply Side concept yet interestingly, Jude Wanniski-who largely wrote the Bible of Supply Side economics-argued that the goal should not be increased work effort anyway, but more productivity and more leisure at the same time. 

     In any case this is what tax reform is predicated on. Again, I'm a skeptic. For instance one virtue tax reformers are always preaching is 'simplicity' and 'reducing the cost of compliance.' Why is this such a virtue? It's possible to conceive of a very simply tax code that's yet exceedingly unfair-the flat tax. Though I digress, the flat tax is actually only simply in theory. If we can just say we all pay 17% and that's it as Steve Forbes ran on in 1996 it's very conceptually.  Still as we saw with Herman Cain's9-9-9 plan in the GOP primary this year, once you start getting into the logistics of how it would really work, a flat tax usually gets very complex very quickly. Cain's plan was also very unfair as he got rid of all tax credits and the tax exemption for the poor. 

    http://diaryofarepublicanhater.blogspot.com/2013/07/jude-wanniski-and-battle-for-reagans_20.html

    I remain skeptical about the idea that the tax code magically improves markedly by changing the way it's gathered. Most of the ideas that are held to make it simpler-the flat tax, the value-added tax-are deeply regressive.

    So what should liberal tax reform be about? Liberals-at least American liberals-believe the tax code should be progressive. This commitment is ethical-it's about fairness though it's also about efficiency. The rich have more money to tax and we need the poor to spend to increase consumption-the rich have a much higher propensity to save-you see my Keynesianism here; Supply Siders of course think we want to cut consumption in favor of saving-which they believe is all necessarily delayed spending-ie, investing. 

   I think liberals want two things from the tax code. That it be fair-ie, progressive-and it raises an adequate amount of revenue to properly fund the social safety net and whatever other government  aid or redistribution the government needs to do. 

   Note that this differs from European progressives who have long chosen a regressive tax code in exchange for a much bigger welfare state with a government that provides much more generous goods and services. 

   If we liberals want the rich to 'pay their fair share' it seems clear to me that what our tax reform must be about is ending tax preferences of any kind for the rich. What I mean is no more preferential rates for capital gains or anything else-including saving. I see no reason that we have to encourage savings. Supply Siders never demonstrate that this drought of capital exists anywhere but in their models. 

   Still, what tax reform must do for us is make us keep an eye on the whole board and not lose site of the forest for the trees. Remember that there are-at least-four tax rates to watch when talking about what the tax rate on the rich should be. 

   1. The individual tax rate

   2. The corporate tax rate

   3. The capital gains tax rate

   4. The dividends rate

   I say 'at least four' as you also have to keep an eye on retained earnings and income moved out of the country. The goal is to select a tax rate-say for arguments sake 40%-and apply it uniformly to all tax rates. There should be no meaningful difference between any of these rates. If there is, it just means that the rich are going to divert their income to the the preferential rate.

   Historically we had the 50s when the rich paid the 90% tax rate. This seems very steep and it's hard not to even as a liberal feel a little sorry for them-after all, imagine $.91 cents out of very $1 you make going to the government. At that level you might be able to believe that might reduce work incentive. 

   Yet, of course no one ever paid that rate. First of all 91% was only the top marginal rate. What also must be borne in mind is that the top capital gains rate back then was only 25%. Indeed, arguably Supply Siders should have preferred that tax code as capital gains had a huge preference-shouldn't this have encouraged huge levels of capital investment?

    Even though I liked the President's fiscal cliff deal, it's important to remember that while the individual income rate went back to 39.6%-this was only the top rate, so the rich still have a considerably lower rate than prior to the Bush cuts in 2001-the capital gains rate went up from 15% but only to 20%-Sumner always makes a big deal about the tax surcharge in Obamacare of 3.8% but roughly the same amount will be raised on income tax rate as well thanks to Obamacare. No matter how you look at it, the capital gains rate will still be roughly half the income rate. 

   So you're still going to see rich people reporting as much income as 'capital gains' as they can. . The dividends rate on the other hand also rose from 15% to 39.6%-so we should also see a diversion from dividends to capital gains-companies will perhaps be paying out considerably less in dividends going forward. 

  Indeed, at 39.6% the dividends rate is now higher than the U.S. corporate rate of 34.7%-so you might now see dividends go back to corporate income. So if we could get all these rates in line with each other this would achieve a considerable objective of tax reform-taking away distortions in the allocation of resources due to tax considerations. 

   I think 40% isn't a bad rate, but what I have in mind is an effective rate of 40%. We can put the tax rate at any amount we like on the books but what counts is the effective rate. We always hear that the 35% rate is the highest in the world but that's only true nominally. Effectively the corporate rate is much lower. We've seen very wealthy, successful businesses like Chevron achieve record profits while paying not tax-let's call this the Mitt Romney Problem. 

   The way to achieve an effective 40% rate rather than just a nominal 40% rate while the real rate is 19.3% is to get rid of loopholes. Indeed, done this way, we might be able to lower rates somewhat. It would be predicated on the conservatives accepting no tax preference for either capital gains, corporate taxes, nor any class of income-nor should there be any preference for saving. 

   Here we could take out distortions that lead to all the costs of loophole seeking accountants, while raising adequate revenue, having the rich pay their fair share, and having enough left over to fund some programs for the poor and middle class-how about a Minsky style move to workfare-ie, the Jobs Guarantee, etc?

   UPDATE: On the President's weekly radio address he vows that tax reform can only happen with spending to increase jobs, calling it a 'Grand bargain for the middle class.'

    http://talkingpointsmemo.com/news/obama-no-tax-reform-without-spending-to-spur-jobs.php?ref=fpb
     

1 comment:

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