James Pethokoukis

It worries me when I hear folks, mostly liberals, speak fondly of the 1950s economy and its 90 percent marginal tax rates. In this piece, James Surowiecki advocates soaking the super-rich:

A better tax system would have more brackets, so that the super-rich pay higher rates. (The most obvious bracket to add would be a higher rate at a million dollars a year, but there’s no reason to stop there.) This would make the system fairer, since it would reflect the real stratification among high-income earners. A few extra brackets at the top could also bring in tens of billions of dollars in additional revenue.

There would be political advantages, too: the reform could actually make tax hikes on top earners more popular. Critics like to describe tax hikes as hurting small business, because small-business owners make up a sizable percentage of people in the top two brackets and because small-business owners, unlike Wall Street traders, are popular on Main Street. It would be harder to mount a defense of millionaires, which may be why this year a Quinnipiac poll found overwhelming support, even among Republicans, for a millionaire tax.

And the economic reason would be what, again? You’re not going  to balance the budget that way, and you only feed the mistaken view that taxing “somebody else” will bring fiscal solvency.

From the Great One, Larry Kudlow:

Then there’s the confidence-threatening war between business and the White House, which is also related to the liberal tax revolt. It’s still a battle royale between the nation’s business leaders and the administration over taxes, spending, regulation, and trade.

Treasury man Geithner made lite of this war at a Christian Science Monitor breakfast this week. A Daily Caller headline read: “Geithner Bored by Complaints from Business about Obama Policies.” White House chief of staff Rahm Emanuel also doesn’t seem that concerned. In a Wall Street Journal interview with Jerry Seib, Emanuel was a bit more conciliatory about reexamining regulatory issues, but he was still inconclusive.

There are two big things that businesses want right now: One is an across-the-board corporate tax cut, including cash expensing for investment. This is the single most powerful job-creator of all. The other is a senior business executive in one of the key economic policy slots in the White House. Neither of these requests seems to be on the table. But to conclude that the White House is burying the hatchet with business you’d have to see these conditions met.

So far it ain’t happening.

Ben Bernanke, the Federal Reserve chairman, doesn’t want tax rates to reset higher at the end of this year, even for the rich. The White House and the Treasury think differently. Here’s how an off-the-record Bernanke might try to talk Tim Geithner, the Treasury secretary, around to his point of view.

From:      Ben Bernanke <HelicopterBen@xxxxx.com>

To:          Tim Geithner <ObamaFan2008@xxxxxxx.com>

Subject:   Bush tax cuts

Date:       July 25, 2010

T-Dawg: First, major congrats on getting the financial reform bill passed. Trust me, I don’t want to have to make another late-night trip to Capitol Hill to beg Congress to bail out the banks. (Still worried about TBTF, though.) Man, can that Pelosi give a guy the evil eye! Hope the bill doesn’t cost you that future CEO gig at Goldman! (Totally joking!)

Second, those Bush-era tax cuts that are set to expire. Look, I told Congress  that extending them might help support the fragile economy, while you said they should expire, at least for the rich. And Congress seems on both sides of the issue — of course!

I know you guys are worried about the $1.5 trillion budget deficit. So am I. And I know the president campaigned against extending the tax cuts. But as I told Congress, the economic outlook was “unusually uncertain.” I’d prefer that the few monetary policy bullets I have left stay in the barrel.

So maybe you guys could help with fiscal policy. While letting all the Bush tax cuts expire would help lower the budget deficit by $341 billion over the next two years, it would also be the equivalent of about 3 percent of GDP in fiscal tightening over that period.

Letting rates rise on just the wealthy would be less contractionary, but could still bite. Here’s the thing: Your Treasury economists have found that capital gains taxes, mostly paid by the rich, have a big economic impact. Cutting them could generate enough growth to recoup 50 percent of the lost revenue. And I just ran across a Berkeley study hinting that the tax burden on higher earners may be at the point of diminishing returns. And if you look at history, cutting capital gains taxes is followed by more initial public offerings and more venture capital. That’s all good stuff.  Plus, letting income taxes on the “rich” expire would raise taxes on two-thirds of small business profits.  Just to be on the safe side, maybe we should leave rates alone for the next year or so.

As for the deficit, you probably saw that POTUS’s commission may agree to match every $3 in spending cuts with $1 in tax increases. Getting that sorted out correctly is more important than short-term tax revenue.

Anyhoo, I am wheezing on longer than my Humphrey-Hawkins testimony. Take care and say hi to Summers for me. (Hope he’s not still cranky about my second term!)

Cheers,

BB

To reiterate, higher taxes are not the answer to deficit problem (via the Tax Foundation):

So for fun, we’ve been putting pencil to back of envelope to see how else lawmakers could raise revenues to erase the deficit using tax increases alone. The results (and these are very much back of the envelope) are truly frightening.

To erase this year’s estimated $1.5 trillion deficit, we would need either to:

• Enact a 25% VAT (Greece is still a mess with a 19% VAT);

or,

• Take 130% of the taxable profits earned by U.S. companies this year (that’s what you call net operating losses);

or,

• Raise the top three tax brackets (28%, 33%, and 35%) to 100%. Actually, this would still not raise enough money to erase the deficit – of course, assuming all the wealthy taxpayers didn’t flee to Switzerland.

or,

• Take 100% of the business income earned by individual taxpayers in 2008.

In other words, new taxes are not the solution to Washington’s deficit problem. That is, unless we want to wreck our economy for decades to come.

Larry Kudlow thinks it’s time for Team Obama to consider a different path:

Fred Smith, the CEO of FedEx, does not have a Nobel Prize in economics. But he founded from scratch a gigantic global transportation and delivery company that has employed tens and tens of thousands of workers, something the Nobelists have never done. And Smith argues that the best job-creating measure would be a significant reduction in the corporate tax rate and a move to full expensing for business-investment tax write-offs. He’s exactly right.

Japan intends to cut its corporate tax rate. So does Great Britain. But the U.S. corporate tax rate of 35 percent, or 40 percent when states are included, is not even remotely competitive anymore. So why aren’t people talking about the economic benefits of unleashing business power? The rapidly growing Asian economies treat capital and business better than they’re treated in the United States. Same for Europe. What are we waiting for?

Me:  Even Krugman-ite Democrats — folks more worried about jobs than deficits — should support this. Lowering taxes is the one form of  ”stimulus” that might get GOP support.  Might this mean a bigger deficit in the short run? Perhaps, but I see little evidence that markets are too concerned right now about red ink.

The US has the second highest corporate tax rate among advanced economies. But maybe not for long. Tell the people the bad news, Reuters:

Japan’s ruling Democratic Party will seek a reduction in corporate tax to encourage economic growth as part of its platform in upcoming upper house elections, Japanese business daily Nikkei reported on Saturday. Without citing any sources, the daily said the Democrats want to cut corporate tax in order to increase the global competitiveness of Japanese companies. Rates charged to Japanese firms are high compared with other countries, Nikkei reported. Japan’s corporate tax is around 40 percent, about 10 to 15 percentage points higher than taxes in EU nations and countries like neighbouring South Korea, it said.

Scott Hodge of the Tax Foundation finds this peculiar:

On the same day that Japan’s Nikkei business daily is reporting that the Japanese “government is aiming to cut tax on company earnings by five percentage points next fiscal year,” the Wall Street Journal is reporting that “Democrats are trying to boost their political fortunes ahead of this year’s midterm elections by attacking corporate tax rules they say encourage U.S. multinationals to send jobs overseas.”

Me: What the US should be doing is putting a long-range deficit reduction plan into place and then boosting growth through cuts in corporate and capital tax rates.

Tax-cut guru Arthur Laffer worries about next year. He attributes the economic rebound this year to workers and business pulling forward economic activity into 2010 to avoid more taxes and regulation in 2011. As he puts it in the WSJ today:

In my view, this shift of income and demand is a major reason that the economy in 2010 has appeared as strong as it has. When we pass the tax boundary of Jan. 1, 2011, my best guess is that the train goes off the tracks and we get our worst nightmare of a severe “double dip” recession.

In 1981, Ronald Reagan—with bipartisan support—began the first phase in a series of tax cuts passed under the Economic Recovery Tax Act (ERTA), whereby the bulk of the tax cuts didn’t take effect until Jan. 1, 1983. Reagan’s delayed tax cuts were the mirror image of President Barack Obama’s delayed tax rate increases. For 1981 and 1982 people deferred so much economic activity that real GDP was basically flat (i.e., no growth), and the unemployment rate rose to well over 10%.

But at the tax boundary of Jan. 1, 1983 the economy took off like a rocket, with average real growth reaching 7.5% in 1983 and 5.5% in 1984. It has always amazed me how tax cuts don’t work until they take effect. Mr. Obama’s experience with deferred tax rate increases will be the reverse. The economy will collapse in 2011.

Me: That is the supply-side version of things. But even Keynesians should worry. Goldman Sachs ran a study awhile back looking at what would happen if all the 2001 and 2003 tax cuts were repealed. As I have written:

Using the respected Washington University Macro Model, Goldman reset the tax code to its pre-Bush status, assumed all tax cuts expired, and watched how the economy reacted as 2011 began. What did the firm see? Well, in the first quarter of 2011 the economy dropped 3 percentage points below what it would have been otherwise. “Absent a tailwind to growth from some other source,” the analysis concludes, “this would almost surely mark the onset of a recession.”

It’s almost as dodgy a notion as nuking BP’s gusher. The U.S. Federal Trade Commission is mulling ways to subsidize the flailing news industry. Paying for it could involve head-scratchers like taxing iPad sales. What the media industry needs is innovation not intervention.

America’s struggling newspapers might like a $35 billion-a-year cash infusion. They have historically drawn 80 percent of revenue from advertising. But Internet competition — from Google to Craigslist — has halved that since 2000. Classified ad revenue alone has plunged to $6 billion from $20 billion.

But the FTC’s “possible policy recommendations” draft paper seems out of sync with a nation wary of more government bailouts and spending. Among the various subsidies: a program to pay young people to work at small-town papers. Federal funding for public radio and television might get a boost from $400 million a year to $7.5 billion, matching the per-capita spending level of Canada. Newspapers could get a tax credit for every journalist they hire. Taxpayers could also elect to donate $200 of their federal income taxes to industry non-profit organizations. (Wisely, no dollar estimate for that is given.)

In this age of austerity, all that spending would at least be paid for. Radio and TV broadcasters would be taxed up to $6 billion a year. A 2 percent sales tax on TV advertising would bring in as much as $6 billion. A 3 percent tax on monthly mobile phone service would be good for another $6 billion.

Then there’s a 5 percent tax on consumer electronics – the iPad levy – which could generate $4 billion. As if all this money weren’t enough, changes to copyright law would make it harder for search engines to make use of newspaper content.

The trouble with all this, is that government support for Old Media at the expense of New Media seems inconsistent with also advocating cutting support of Old Energy (oil) in favor of New Energy (wind and solar.) Instead of addicting newspapers to government handouts — which would also raise issues of journalistic independence from the state – it would be better to keep the playing field level.

New business models will continue to emerge and evolve, especially as the economy and ad climate improves. Journalism has a future even if traditional newspapers may not.

Superblogger Barry Ritholtz of The Big Picture takes issue with my claim that America’s wealthy have a high tax burden since they pay such a huge share of U.S. taxes. A bit from his email to me (in his own inimitable style):

All you have proven is that the Rich pay most of the taxes. Duh. But you have failed to demonstrate the rich have a “high tax burden” — indeed, you actually say ABSOLUTELY NOTHING ABOUT THEIR TAX BURDEN. Paying a lot of taxes — even most of the taxes — is not the same as a high tax burden.
You have mentioned that 2010 taxes are higher than 2004 taxes. You stated 1% pay alot of taxes. Again, probably true, but fails to demonstrate your claim.

When you discuss “A high tax burden” you are making a qualitative statement. The tax burden is onerous, difficult, challenging. Its painful, disruptive, counter-productive.

OK, I am intrigued by your claim. So prove it to me.
I think you have raised a very fascinating and fundamental issue — but have not created a convincing case for it.
(It’s easy to sway innumerate nitwits, but I assure that is not what my driver’s license states). My question ultimate boils down to this: Is the tax burden on the rich that high?

Me: The post referenced earlier states a few things: 1) there is research that shows combined taxes on the rich are at the point when higher rates will bring in lower tax revenues; 2) to balance the budget, tax rates on the rich would have to skyrocket; and 3) the top 1 percent of tax returns pay 40 percent of all income taxes (as of 2007.)

Certainly I think if you put all that together it makes the case that forcing the rich pay higher taxes is a self defeating way to restore fiscal solvency. Indeed, there is also research that shows cutting spending is a better way to balance the  budget than raising taxes. (It is less harmful to economic growth.) Moreover, the track record of countries cutting debt though austerity is not good.

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.