James Pethokoukis

Politics and policy from inside Washington

Hillary’s revealing tax gaffe

Jun 2, 2010 19:56 UTC

Who really cares what Hillary Clinton thinks about taxes, right? She’s Secretary of State in the Obama administration, not Treasury. It’s not as if Timothy Geithner said the following, as Clinton did last week:

Brazil has the highest tax-to-G.D.P. rate in the Western hemisphere. And guess what? It’s growing like crazy. The rich are getting richer, but they are pulling people out of poverty. There is a certain formula there that used to work for us until we abandoned it — to our regret, in my opinion. My view is that you have to get many countries to increase their public revenues.

The actual cross-country comparison doesn’t interest me much. Brazil has a very different tax structure and an economy that’s one-seventh the size of America’s. And I am not even sure, really, what Clinton is talking about. Brazil’s aggregate tax burden, as Dan Mitchell of Cato notes, of about 24 percent of GDP “is slightly below the aggregate tax burden in the United States.” And its top marginal income tax rate is a third lower than America’s.

But here is what I am interested in: Clinton’s tax analysis is perfectly reflective of the counter-reformation against the global tax revolution launched in the 1980s. According to this economic cosmology, tax burden is really a secondary or tertiary economic factor. Bill Clinton raised income taxes in the early 1990s, after all, and the U.S economy roared. (Here is a different economic narrative of that decade.) Of course, liberal Democrats are talking about increasing taxes far beyond what Clinton did– such as imposing a value-added tax — to deal with the exploding budget deficit. At the very least, as Clinton’s comments indicate, Democrats believe America’s wealthy still aren’t paying their fair share. But that is just wrong-headed for several reasons:

1) Top tax rates are already at dangerous levels where ever-higher rates bring in less money. Take a look at “The Elasticity of Taxable Income with Respect to Marginal Tax Rates” by Emmanuel Saez, Joel Slemrod and Seth Giertz:

Following the supply-side debates of the early 1980s, much attention has been focused on the revenue-maximizing tax rate. A top tax rate above [X] is inefficient because decreasing the tax rate would both increase the utility of the affected taxpayers with income above [Y] and increase government revenue, which can in principle be used to benefit other taxpayers. Using our previous example … the revenue maximizing tax rate would be 55.6%, not much higher than the combined maximum federal, state, Medicare, and typical sales tax rate in the United States of 2008.

2) Taxing the wealthy to solve the budget deficit would require confiscatory rates. As the Tax Policy Center found:

Washington would have to raise taxes by almost 40 percent to reduce — not eliminate, just reduce — the deficit to 3 percent of our GDP, the 2015 goal the Obama administration set in its 2011 budget. That tax boost would mean the lowest income tax rate would jump from 10 to nearly 14 percent, and the top rate from 35 to 48 percent.

What if we raised taxes only on families with couples making more than $250,000 a year and on individuals making more than $200,000? The top two income tax rates would have to more than double, with the top rate hitting almost 77 percent, to get the deficit down to 3 percent of GDP. Such dramatic tax increases are politically untenable and still wouldn’t come close to eliminating the deficit.

3) The rich already have a high tax burden. Here at the latest numbers from the Tax Foundation:

In 2007, the top 1 percent of tax returns paid 40.4 percent of all federal individual income taxes and earned 22.8 percent of adjusted gross income. Both of those figures—share of income and share of taxes paid—are significantly higher than they were in 2004 when the top 1 percent earned 19 percent of adjusted gross income (AGI) and paid 36.9 percent of federal individual income taxes. The 2007 numbers show that the top 1 percent’s income and tax shares reached all-time highs for the third year in a row. That is likely to reverse direction when data from recessionary 2008 is published a year from now.

Dramatic tax increases on the wealthy — much less the broad middle class  – are  neither the ticket to higher economic growth nor a path to fiscal solvency.


Here’s the deal Mr. Pethokoukis; We are going to raise the taxes on the wealthy…Hopefully,aggresivly on extreme wealth. We are going to set up some rules to improve our markets and reward true productivity rather then monopoly and casino finance. The economy will improve. The deficit will improve. Income inequality will lessen. The middle class will be stronger and the rich will still be very rich…. and you will be wrong again. THAT’S GOING TO HAPPEN.

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The coming fiscal war between the old and the young

Jun 2, 2010 18:13 UTC

In the London Times, Anatole Kaletsky outlines a soon-to-escalate generational conflict between seniors and younger voters :

The politics of the next decade will be dominated by a battle over public spending and taxes between the generations. Young people will realise that different categories of public spending are in direct conflict — if they want more spending on schools, universities and environmental improvements they must vote for cuts in health and pensions.

Schools and universities are more important for a society’s future than pensions. Yet every democracy around the world has made the opposite judgment. While many politicians claim to be obsessed with education — recall Tony Blair’s three priorities were “education, education and education” — in reality they support health and pensions to the point of national bankruptcy, while squeezing universities. The same applies to the many fiscal benefits heaped on pensioners over the years. Is it, for example, better for society to offer free bus travel to wealthy 80-year olds rather than students or impoverished youngsters looking for their first job?

He half-seriously tosses out this interesting solution:

Here is a modest proposal to avert this awful outcome. Since children under 18 are not allowed to vote, perhaps pensioners could be deprived of the right to vote after 75 or 80. An equally effective alternative would be to give mothers an extra vote for every child under voting age.

Me: I dunno. Every entitlement reform plan I have seen basically excludes cuts on seniors currently getting benefits. And healthcare reform was passed despite projected cuts in Medicare. So it can happen. And changes can linked to income so they don’t bite middle-class folks. Here is a bit of insight from Andrew Biggs of AEI:

Social Security reform involves raising taxes or cutting benefits in ways that people can easily understand, and dislike. But a sensible Social Security program is easy to imagine: solid protections for the truly old and the truly poor, coupled with universal retirement savings accounts for everyone else. There’s no free lunch, but neither is it an impossible task.

Cocky CEOs have more innovative companies

Jun 2, 2010 17:27 UTC

That is the conclusion of this paper, “CEO Overconfidence and Innovation,”out of the University of Toronto:

In this paper we study the relationship between CEO overconfidence and innovation. We use a simple career concern model to show that CEO overconfidence can increase innovation. The model also predicts that the impact of overconfidence will be stronger when product market competition is more intense. We find strong empirical support for these predictions.

In particular, overconfident CEOs obtain more cite-weighted patents, and this effect increases with product market competition. These findings suggest that overconfident CEOs are more likely to initiate a significant change in their firm’s innovation strategy. … Our findings are complementary to those in Aghion,Van Reenen and Zingales (2009). While they show that institutional ownership encourages innovation by reducing the likelihood that a CEO is dismissed after a decline in profits, our results show that overconfidence encourage innovation by reducing the CEOs internal beliefs about the likelihood of failure.

Does the BP oil spill mean the West should get poorer?

Jun 2, 2010 16:56 UTC

Economist Kenneth Rogoff sees a comparison between the Gulf oil spill and the financial meltdown:

The accelerating speed of innovation seems to be outstripping government regulators’ capacity to deal with risks, much less anticipate them. The parallels between the oil spill and the recent financial crisis are all too painful: the promise of innovation, unfathomable complexity, and lack of transparency (scientists estimate that we know only a very small fraction of what goes on at the oceans’ depths.) Wealthy and politically powerful lobbies put enormous pressure on even the most robust governance structures. … The oil technology story, like the one for exotic financial instruments, was very compelling and seductive. Oil executives bragged that they could drill a couple of kilometers down, then a kilometer across, and hit their target within a few meters. Suddenly, instead of a world of “peak oil” with ever-depleting resources, technology offered the promise of extending supplies for another generation.

That is fine as far as it goes, but then he adds this:

If ever there were a wake-up call for Western society to rethink its dependence on ever-accelerating technological innovation for ever-expanding fuel consumption, surely the BP oil spill should be it. … The advanced countries, which can best afford to restrain long-term growth, must lead by example. The balance of technology, complexity, and regulation is without doubt one of the greatest challenges that the world must face in twenty-first century. We can ill afford to keep getting it wrong.

Me: All the more reason, then, to look beyond oil for next-generation power sources. But the oil spill is no reason to go wobbly on pursuing technology — nanotechnology, genetic engineering — that would help allow living standards in America, and the rest of the world, to continue to rise. This sounds like Rogoff, a fine economist, is veering dangerously close to advocating the neo-Luddite Precautionary Principle. As Rogoff well knows, the world faces a huge debt problem and will need snappy growth to get out of the trap. Technological innovation will need to be a big part of that.