April 01, 2003

Alan Murray Reports on Dynamic Scoring

Alan Murray reports on the Congressional Budget Office's analysis of the effect of the Bush budget proposals on economic growth and on tax collections:

WSJ.com - Political Capital: ...The results: Some provisions of the president's plan would speed up the economy; others would slow it down. Using some models, the plan would reduce the budget deficit from what it otherwise would have been; using others, it would widen the deficit.

But in every case, the effects are relatively small. And in no case does Mr. Bush's tax cut come close to paying for itself over the next 10 years.

For the handful of people who read the report in its entirety, there is another surprise. Of the nine different economic models used to analyze the president's plan, only two showed a large improvement in the deficit over the next decade as a result of "supply side" effects. Both those models got their results by assuming that after 2013, taxes would be raised to eliminate the remaining deficit. The theory is that people will work harder between 2004 and 2013 because they know that their taxes will be going up, and will want to earn more money before those tax increases take effect.

Using those same models, if the assumption is changed so that government spending falls after 2013 to close the deficit -- the outcome preferred by most supply-siders -- the economic benefits disappear. The president's plan would cause the deficit to become slightly wider over the next 10 years than it would have been otherwise.

What Alan Murray doesn't say--but should--is that the further out you look, the worse the effects of the proposals are.

Posted by DeLong at April 1, 2003 09:38 AM | TrackBack

Comments

> The theory is that people will work harder
> between 2004 and 2013 because they know that
> their taxes will be going up, and will want
> earn more money before those tax increases
> take effect.


Our old friend, intertemporal substitution of labor, makes an appearance. Barro has been using the same logic to argue that the back-loaded Bush tax cuts are contractionary, and therefore need to be speeded up.

It used to be we'd get an appropriate Larry Summers witticism demolishing this logic, but he's too busy with other things now.

Posted by: P O'Neill on April 1, 2003 10:17 AM

Why is it that I find no rationale in either tax for spurring economic growth, rather I find a desire to force a contraction of the what conservatives take to be a welfare state. The idea is to add to the deficit as an excuse for cutting social benefit programs from Social Security to Medicare to free school lunches. That there will be continual widening of the income and wealth gaps between the richest and the middle class, seems all to the good for our newly empowered compassionate conservatives.

Supply side economics is hokkum, but compassionate conservatives are bent on using the rationale radically change the American economic mix.

Posted by: jd on April 1, 2003 10:36 AM

Why is it that I find no rationale in either tax cut for spurring economic growth - add tax "CUT"

Posted by: jd on April 1, 2003 11:08 AM

http://www.nytimes.com/2003/04/01/business/01INSU.html

April 1, 2003

Insurance Loophole Helps Rich
By DAVID CAY JOHNSTON - NYTImes

Fifty years ago Congress, trying to help farmers and others having a hard time getting insurance, allowed the creation of tiny, tax-exempt insurance companies. Now, some of those taking advantage of the program do not make their living off the soil.

One is Peter R. Kellogg, a billionaire Wall Street investor who has used the insurance exemption to escape more than $100 million in taxes on investments in four years. Eighty-five hospitals in New York State have avoided $27.5 million in taxes over five years. Alfa Mutual Fire Insurance in Montgomery, Ala., saved $58 million on federal corporate income taxes over three years.

They are doing it with the blessing of, and sometimes even at the suggestion of, accounting firms, which are paid for advice on how to use the exemption and then collect fees for preparing reports to the Internal Revenue Service. Some tax shelter promoters are also showing companies and wealthy individuals how they can make taxes vanish through a tax-exempt insurance company....

Posted by: dahl on April 1, 2003 11:11 AM

Since the rich already have so many absurd tax advantages, what is the point of the Administation providing them more advantages such as tax free stock dividends? Is there even the slightest concern among these "compassionate" conservatives for middle class, working class, Americans. Oh. Of course not.

Posted by: dahl on April 1, 2003 11:18 AM

http://www.nytimes.com/2003/03/21/opinion/21KRUG.html?ex=1049346000&en=8c7967721ccdcb0b&ei=5070

By Paul Krugman -

The latest official projections acknowledge (if you read them carefully) that the long-term finances of the U.S. government are in much worse shape than the administration admitted a year ago. But many commentators are reluctant to blame George W. Bush for that grim outlook, preferring instead to say something like this: "Sure, you can criticize those tax cuts, but the real problem is the long-run deficits of Social Security and Medicare, and the unwillingness of either party to reform those programs."

Why is this line appealing? It seems more reasonable to blame longstanding problems for our fiscal troubles than to attribute them to just two years of bad policy decisions. Also, many pundits like to sound "balanced," pronouncing a plague on both parties' houses. To accuse the current administration of wrecking the federal budget sounds, well, shrill and we don't want to sound shrill, do we?

There's only one problem with this reasonable, balanced, non-shrill position: it's completely wrong. The Bush tax cuts, not the retirement programs, are the main reason why our fiscal future suddenly looks so bleak....

Posted by: lise on April 1, 2003 11:49 AM

Krugman is right, on his own terms. The "balanced" crowd are right, on their terms. "Our fiscal future suddenly looks so bleak" because of Bush era policies, it's true. That's because of the "suddenly". The only thing that came upon us suddenly is Bush era tax and spending changes. The big entitlement programs are a major part of future demands on revenues, but demographics and program requirements have not changed -- they aren't sudden.

The problem with both approaches is that their proponents almost certainly are aware of their own trickiness with language. Back home, that makes them shifty-eyed snake oil salesmen. I don't want Krugman to be a shifty-eyed snake-oil salesman, 'cause I mostly agree with his views. I worry, however, that his methods make him seem like the "balanced" types who mostly lack the spine to call a spade a spade.

Posted by: K Harris on April 1, 2003 12:31 PM

Unless economic growth is being supported by spending on security and added munitions, there is every reason to believe we have just about stopped growing. Almost every macro release for the past 5 weeks shows less and less growth. There is no help from abroad and even Asia is likely to slow rapidly until the effects of the spread of SARS dissipate.

We are growing very slowing at best, and there may well be a world recession at this time.

Posted by: anne on April 1, 2003 12:35 PM

What is clear to me is that the Administration tax cut proposals will do very little to stimulate the economy. A cut in taxes on stock dividends is not what we need at this time and will only add to the budget mess being created by the last set of tax cuts.

Posted by: anne on April 1, 2003 12:51 PM

Continuing with the column by Paul Krugman -

"The study carried out by the Center on Budget and Policy Priorities, estimates the present value of the revenue that will be lost because of the Bush tax cuts those that have already taken place, together with those that have been proposed using the same economic assumptions that underlie those Medicare and Social Security projections....

"The simple truth is that the Bush tax cuts have utterly transformed our fiscal outlook, for the worse. Without those tax cuts, the problems of an aging population might well have been manageable; with them, nothing short of an economic miracle can save us from a fiscal crisis...."

Posted by: lise on April 1, 2003 01:04 PM

it would be nice to see democrates propose a revenue neutral bill: one that would eliminate the double taxation on dividends and raise (or stop) the reductions of the top tax rates to compensate for the loss in revenue.

This would allow economists (like Brad Delong(and everyone else)) to support a bill that increased market efficeincy without affecting our perilous debt situation.

I recall hearing Brad Delong on KQED a while back talking about the tax proposal, saying the idea of getting rid of the double tax on dividends was a good thing, lowering the incentive to keep high debt to equity ratios and letting people invest money themselves instead of companies.

With a proposal like this on the table the real issue of whether further tax cuts to the wealthy should be given. Hopefully I think the obvious answer to this question by most Americans would be no.

Posted by: markmeyer on April 1, 2003 01:51 PM

For another analysis of the president's budget, this is what John Spratt and the Democrats on the House Budget Committee had to say about it.

http://www.house.gov/budget_democrats/pres_budgets/fy2004/pres04_long_summ.pdf

How does Murray get off with saying the effects are relatively small?? Relative to what? If debt service goes over 20% of budget, then the effect is not "relatively small". WSJ does a terrible disservice in promoting widely discredited supply side theory.

Posted by: bakho on April 1, 2003 02:02 PM

When I was in college I took a Latin American history and political science class. I ended up with a bruise on my forehead from slapping it every time I saw the US make an obvious mistake,

Once again i feel completely out of my depth here. It's so completely obvious that this plan is a bad idea, and yet... even the "sensible" types are agreeing to pass a tax cut? Oh, this one is only SLIGHTLY whopping!

How did these people get into office? Oh, wait, they cheated.

RRRrrrrrrr.

Posted by: verbal on April 1, 2003 02:10 PM

In an earlier set of posts, P O'Neill let us know about the 3/26 WSJ oped piece by Glenn Hubbard and Kevin Hassert. He rightfully claimed they were whiney and he could not see a point in their piece. I think I finally found the point they were trying to make but it is a dishonest one. H&H are suggesting that tax cuts do increase long-term growth but it is the spending increases that lead to the crowding-out and overall negative consequences. I guess one could rightfully argue that a balanced baudget reduction in spending and taxes could lead to favorable incentive effects without the crowding-out effects that then CBO analysis highlights. But then wouldn't it be up to the policy maker to actually tell us what government spending he wishes to cut?

Posted by: Hal McClure on April 1, 2003 02:17 PM

> The theory is that people will work harder
> between 2004 and 2013 because they know that
> their taxes will be going up, and will want
> earn more money before those tax increases
> take effect.

Ok, economists are going to have to decide if they are hard scientists or pop psychologists. I've been honestly trying to make sense of the world of $$ by digging through "user friendly" economics papers and sites like this, but if I keep coming up with these type of turds- and this is not the first- I going to write of the whole field as a religious cult without even any good sex or druggie side benefits.

People- guess what? Nobody on God's green earth invokes a thought process anywhere like what was described in regards to their day-to-day professional existence. So not only are you looking like pop-psychologists, you are looking like extremely bad ones to boot.

Posted by: a different chris on April 1, 2003 04:18 PM

a different chris misses the point. No-one actually has to say to themselves that they'll work harder coz they're paying more tax in the future - rather they'll just be saying to themselves "well I guess I need about x dollars in my 401k to retire on", and work towards it. But what that x dollars will buy, and hence (according to the theory) what they think is a reasonable amount for x, is affected by the future tax burden.

The point is people optimize their behaviour *all the time* without having to be consciously aware of it - indeed as Larry Summers said "life is a series of problems in constrained optimization".

So there's nothing wrong with Ricardian equivalence as an *idea* - the problem is that it happens not to have a great deal of empiric support, at least in America (now maybe in Japan ...). So the proper criticism of Barro is *not* that he has posed an unrealistic psychological model, but that evidence for his idea is 'mixed', in the sense that George Stigler once sarcastically described 'mixed' evidence ("When an economist says the evidence for a proposition is mixed, he means theory says one thing and the data another").

Posted by: derrida derider on April 2, 2003 04:07 AM

And how many people believe that taxes will have to go up in the future? If people believe that the tax cuts will pay for themselves ....

Posted by: Barry on April 2, 2003 06:02 AM

a different chris, economics IS a behaviorial science. The field has proven fairly successful at modeling some behavior since it turns out certain types of behavior of exchange are fairly predictable. I think most here would agree with your review of the "intertemporal substitution of labor" theory of behavior as P O'Neill terms it.

Posted by: Stan on April 2, 2003 06:43 AM

Why don't more economic commentators point out the 'patriotic duty' to pay taxes?

Every public road, bridge, power generating dam, food inspector, Social Security benefit, etc. (I could go on) is paid for with...you guessed it...taxes. This fact seems absent from any discussion of taxes.

By logical extension, if ALL tax rates were reduced to zero, wouldn't the result be anarchy - the absence of government? Does anybody really want this?

Posted by: InMarin on April 2, 2003 06:45 AM

Barry you make a good point. This bunch doesn't think taxes need to go up in the future. They want to rework Medicare, Medicaid and Social Security and rewrite the social contract. They would like to do with govt programs what the private sector has done, switch from defined benefit to defined input.

I can see from the business picture some of the disadvantages of defined benefit. Big steel is a prime example of an industry that has downsized and is now unable to meet obligations. This is forcing big steel states to pick up the medical benefits for these retirees.

However, one would hope that the US government would still be operational in the far future and that our economy would not collapse in the manner that big steel profits have vaporized.

It is easy to cut taxes in the absence of discussing the big picture because those who benefit from the tax cut are happy and those that don't benefit rarely complain. That is why Bush has pushed so hard on tax cuts and not pushed the rest of his agenda on Medicare and SS changes that are political losers at the ballot box and in Congress. However, this postpones the public debate about national priorities and the role of government. Since the Republicans control Congress and therefore the debate, these issues are just being ignored.

Posted by: bakho on April 2, 2003 06:54 AM

Because honestly, they don't believe that paying taxes is patriotic. I can never believe it each time I hear it, but there are people who truly believe that, and believe that it is their right to try and game the system and get out of as much taxes as they can (and this includes the lovely -let's incorportate in Jamaica, mon- crowd).

And some people really do want minimal government - or they want someone else to have to pay for it.

Posted by: Trickster Paean on April 2, 2003 06:56 AM

"I find no rationale in either tax for spurring economic growth, rather I find a desire to force a contraction of the what conservatives take to be a welfare state."

I hate to sound like the nihlist among the economists, but sometimes you guys remind me of the people who look for hidden messages in Biblical word counts, or in the geometry of the pyramids. Maybe the reason why it is so hard to identify the hidden economic rationale behind the adminstration's tax policy is because there is nothing there! Rember, the GWB tax policy didn't chage when the ecomony turned from good to bad, or when we went from surpluses to deficits. The reason to cut taxes for the rich is simply so that the rich pay less taxes. The economy, the size of government, are all things that will sort themselves out somehow or other in due cours--who cares how--in the long run, we are all dead.

Posted by: rea on April 2, 2003 08:15 AM

It's the time between when I retire and the time when I'm dead that I'm concerned about. It's a bit grating to see how revenue from payroll taxes (which were raised in 1983 to safeguard the long-term viability of Social Security) are now being abused to help cut more progressive taxes. Which is what this is really all about, although I konw that for some idealists it's a matter of downsizing the welfare state.

Posted by: David Wilford on April 2, 2003 08:50 AM

Has there been any official confirmation of a "tax cuts to bankrupt the state" policy? It looks to me like the work of some bright but puzzled Republicans trying to rationalise their team's wayward economic behaviour. In any case I have three objections (to the idea of this being the true policy)

A)It didn't really work out that way under Reagan a far as I can tell, instead it caused an unpleasant hangover and cost Bush MkI his reelection chances.

B)Unless the argument against state spending is an atomic moral absolute the policy must pass some kind of dynamic scoring test. At the moment that isn't looking like a runner.

C)Those pursuing it at the have not only not cut spending but have introduced farm subsidies and steel tariffs, not to mention the war.

I would like to see this meme out in the open, not lurking in the shadows like an economic Screwtape. Either it is policy and soeone should be called on it or it is not and it should be forgotten about.

Posted by: Jack on April 2, 2003 09:20 AM

A pretty basic question on the "double taxation" of dividends. I think I understand the efficiency argument for getting rid of them: taxing dividends makes debt financing relatively more attractive than equity financing. I'm not sure one is better than the other, but there's no reason the tax code should encourage one over the other unless we're damn sure one is better.
But what's "double" about it? Companies earn income and pay taxes on it. They give some of that after-tax income to someone else and it is taxed as income to the recipient. So? I earn a salary on which I pay taxes. Some of my after-tax income goes to pay my plumber and grocer, who, in turn, pay taxes on it. Why is one "double taxation" and the other not?
This is not a rhetorical question. It's on the level.

Posted by: CJ Colucci on April 2, 2003 09:40 AM

Jack, here's link to an archived entry from Max Sawicky on the Republican 'ratchet' strategy that pertains to your question:

http://maxspeak.org/gm/archives/00000435.html

Posted by: David Wilford on April 2, 2003 09:49 AM

May the goal of the GOP be to go from the Republic of the United States, to the Reprivate of the United Estates? In effect a going back to the feudal middle age, the richest had not to pay taxes and the job of owner of the land, and effective lawmaker, was an hereditary one. The suppression of the estate tax goes a long way in that direction. Since to participate in lawmaking implies disposing of a significant fortune in the USA.

DSW

Posted by: Antoni Jaume on April 2, 2003 09:53 AM

Ricardian equivalence and claims such as "people will work harder between 2004 and 2013 because they know that their taxes will be going up" require people to get some actual feedback and it should be possible to trace what that feedback might be.
Pension funds provide one route. Some experts look at interest and mortality rates and adjust their risk appetite accordingly. It is hard to see how 401k funds will match this level of rationality. They are distributed which is good but the connection between interest rate moevements and 401k holder behaviour is unlikely to be that of a well-informed rational actor. Indeed much of the input data is clearly in the wrong format.
For example:
Dow up? Good surely.
Interest rates down? Good too.
But even so the pension fund actuary with a discount curve and forecast annuity prices at her fingertips may well be contemplating suicide.
On top of which there will undoubtedly be an attempt to learn from recent market experience. That will surely be as an experiment without any kind of control. What lesson will investors have drawn from the recent boom and bust?
To add to that, uncertainty and spin concerning macroeconomic implications of various policy measures can't be making the quality of feedback better. This is where Brad's criticism of Glenn Hubbard is really important.
If there is no certainty about what a deficit means, how can it provide correct stimulus? A policy cannot be entirely separated from its justification. Give it the wrong justification and you could undermine the policy altogether. For example what is the official view of the likelihood of tax rises after 2013? For sure the spin won't be "buy now, pay later".

Posted by: Jack on April 2, 2003 09:56 AM

"When an economist says the evidence for a proposition is mixed, he means theory says one thing and the data another"

Snicker. Ok, I promise try to be less of an outraged Converted-Catholic type and let some of this stuff roll off my back. I said I was a newbie.

Posted by: a different chris on April 2, 2003 10:11 AM

Thanks David, the link is spot on. I don't know whether I feel better or worse now. In any case we seem to be a long way from "To ensure that the Federal Government continues to pay down the debt, the President proposes limits that would allow discretionary spending to grow with inflation over the next five years" (http://w3.access.gpo.gov/usbudget/fy2002/pdf/blueprnt.pdf p172). There is a big gap between claiming that politicians will tend to spend surpluses and the proposition that bankrupting the government is a good idea.

Posted by: Jack on April 2, 2003 10:11 AM

I could not agree more with the objections to the 'theory' that individuals work harder when tax rates are lower. And I disagree that the evidence for this is 'mixed', because not only is the theory empirically wrong, the idea itself makes no sense. The sad, but obvious, truth is that for the vast majority of the population, our demand for money is essentially inelastic within a realistic range of potential earnings. I 'need' every single dollar of my salary. I will work as hard as I can to get my next promotion because I need to ensure that I can pay for my children's college expenses. If I get to keep 70% of the money, great. If I can only keep 60%, too bad, I still need every cent of it. If I can only keep 40%, I need every cent all the more. This is true for everyone except three small groups: (1) people who have 'enough' money and for whom work is a choice, including those who are very close to retirement; (2) married people who have a working partner and have the luxury of making the choice between working and paying for child care or staying at home; and (3) very poor people who are making choices between wellfare/indigency and work. Everybody else lives on the flat part of their income elasticity curve and work as hard as it takes to earn as much as we can, regardless of the current tax rates.
-- sebastian

Posted by: sebastian on April 2, 2003 12:04 PM

I could not agree more with the objections to the 'theory' that individuals work harder when tax rates are lower. And I disagree that the evidence for this is 'mixed', because not only is the theory empirically wrong, the idea itself makes no sense. The sad, but obvious, truth is that for the vast majority of the population, our demand for money is essentially inelastic within a realistic range of potential earnings. I 'need' every single dollar of my salary. I will work as hard as I can to get my next promotion because I need to ensure that I can pay for my children's college expenses. If I get to keep 70% of the money, great. If I can only keep 60%, too bad, I still need every cent of it. If I can only keep 40%, I need every cent all the more. This is true for everyone except three small groups: (1) people who have 'enough' money and for whom work is a choice, including those who are very close to retirement; (2) married people who have a working partner and have the luxury of making the choice between working and paying for child care or staying at home; and (3) very poor people who are making choices between wellfare/indigency and work. Everybody else lives on the flat part of their income elasticity curve and work as hard as it takes to earn as much as we can, regardless of the current tax rates.
-- sebastian

Posted by: sebastian on April 2, 2003 12:07 PM

I could not agree more with the objections to the 'theory' that individuals work harder when tax rates are lower. And I disagree that the evidence for this is 'mixed', because not only is the theory empirically wrong, the idea itself makes no sense. The sad, but obvious, truth is that for the vast majority of the population, our demand for money is essentially inelastic within a realistic range of potential earnings. I 'need' every single dollar of my salary. I will work as hard as I can to get my next promotion because I need to ensure that I can pay for my children's college expenses. If I get to keep 70% of the money, great. If I can only keep 60%, too bad, I still need every cent of it. If I can only keep 40%, I need every cent all the more. This is true for everyone except three small groups: (1) people who have 'enough' money and for whom work is a choice, including those who are very close to retirement; (2) married people who have a working partner and have the luxury of making the choice between working and paying for child care or staying at home; and (3) very poor people who are making choices between wellfare/indigency and work. Everybody else lives on the flat part of their income elasticity curve and work as hard as it takes to earn as much as we can, regardless of the current tax rates.
-- sebastian

Posted by: sebastian on April 2, 2003 12:12 PM

sorry about the triple post...

Posted by: sebastian on April 2, 2003 12:19 PM

CJ Colucci, thank you for being level,

the dividend tax is a "double" tax. A company is taxed on its income (but this company is just a representative/collective of its owners so the owners of the stock are taxed at this stage.) When the dividend is paid, another tax is levied against the same people, the owners of the company, for the same economic activity (the business' selling goods/services).

When you recieve income that is taxed and then pay someone else money which is then taxed, there are two economic transactions. You did/made something and recieved payment. Then someone else did/made something for you, and they recieved income.

Taxing of dividends is more like taxing your income when you get a check from your boss and deposit it into a bank, then taxing the income when you take money out of the bank.

You said you are not sure you want to encourage either form of financing, but you have to keep in mind that the current tax code already favors debt financing. Getting rid of the dividend tax would eliminate incentives to use debt rather than create incentives to use equity.

And again i would say big amounts of debt financing are not so good: they increase the opportunity for systemic debt problems like the Asia crisis in 99.

And remember getting rid of dividend taxes doesn't mean you to let corporations off easy: just raise corporate tax rates. You could also just raise the taxes of the people who most often get dividends: the wealthy. This way you can ease off the poor old folk living on stock dividends (who the Republicans like to talk about to get this dividend thing through), get ecnomic gains, and still get the cash needed to fund the US gov't. The tax elimination also has a little direct tangible bonus for the (above) average american: you don't have to keep track of your dividends for tax purposes.

I will also admit that as a student I don't even own stock right now and am currently debt finacing markmeyer inc.

Posted by: markmeyer on April 2, 2003 12:23 PM

There was a big political flap about dynamic scoring. The previous Republican CBO directed refused to do it saying it would be too political and not helpful. So now we see that dynamic scoring produces a muddle (13 different scenarios). The point of having CBO or OMB budget numbers (no matter how flawed) is that everyone can refer to the same data in order to communicate effectively.

Producing 13 scenarios is just confusing. Despite the political pressure from borrow and spend Republicans, dynamic scoring may die a quick death as just plain unworkable.

Posted by: bakho on April 2, 2003 12:32 PM

"A company is taxed on its income (but this company is just a representative/collective of its owners so the owners of the stock are taxed at this stage.) When the dividend is paid, another tax is levied against the same people, the owners of the company, for the same economic activity (the business' selling goods/services)."

You guys always want to disregard the status of a corporation as an entity seperate from its shraeholders when convenient, but insist upon that seperation when convenient. If corporate debts exceed corporate liabilities, do the shareholders have to pay? No? Then a corporation is NOT simply "a representative/collective of its owners".

Posted by: rea on April 2, 2003 12:42 PM

"double taxation" wraps up several issues and debates often don't get past disentangling them. I'm not sure I have a point to improve on rea's though. If corporations are people enough to deserve free speech they are people enough to pay tax.

The only point on which everyone seems to be in agreement is that the current tax set up favours debt financing over equity because profit distribution via dividends is subject to tax while distribution via interest payments is not. How great a problem this is is hard to discern however. The discrimination is not quite as bad as it may seem because much capital investment is tax deductible and because many investors are compensated for the difference. On the other hand higher debt makes equity more risky which is bad for investors.

The second issue is about the appropriate tax rate on investor income. The double taxation issue is not just that tax is levied on both company income and the dividend but that the investment in the company might have been money that has already been taxed. Again this is a smaller issue than this description might suggest because many investors will have had taxbreaks on their investments and also on dividends (think 401k).

How it might be improved is perhaps the most important point because of the possible side effects.
You could

A) tax interest payments
But: much trade would become inefficent and other aspects of trade would be abused to avoid it (gaps between delivery and invoicing are effectively loans but would be hard to treat.

B) abolish corporation tax
But: see rea's objection and consider how easy it would be to abuse. People would manage all their affairs through companies and income tax wold disappear.

C) provide rebates on dividend income
But: many people receive this already so it would only benefit a minority of investors who are almost all very rich. It would also reduce incentives to invest by reducing the advantage of reinvestment over distribution because of capital gains tax

D) provide rebates on dividend income AND capital gains
But: this is more or less the same as abolishing income tax but more complicated so only open to abouse by those with expensive accountants. This is what has been proposed.

A point to take home is that these changes only make a difference to a minority of investors. Microsoft has just announced that it will start paying dividends so it will save Bill Gates hundreds of millions of dollars but make no difference to most 401k investors.
It will also make the tax code incredibly complicated which is always a bad thing. When the flat tax was popular double taxation played a key part in making it fair by raising the effective rate for rich investors.

Posted by: Jack on April 2, 2003 03:00 PM

Sebastian, you said:This is true for everyone except three small groups: (1) people who have 'enough' money and for whom work is a choice, including those who are very close to retirement; (2) married people who have a working partner and have the luxury of making the choice between working and paying for child care or staying at home; and (3) very poor people who are making choices between wellfare/indigency and work. Everybody else lives on the flat part of their income elasticity curve and work as hard as it takes to earn as much as we can, regardless of the current tax rates.

You forgot about people who are planning to start a business. If I create a business plan, run all the numbers and determine that at a 60% tax rate my return is not large enough, I won't create the business. If I run the same numbers with a 30% tax rate and decide to create the business, I've just created X number of jobs.
This benefits not only me, the soon to be rich business owner, but also everyone I've hired.

Does lowering tax rates make sense to you now?

Posted by: Jim on April 3, 2003 10:51 AM

Jim, usually the tax rate is linked to the return, so to have to pay a 60% tax you should make quite more money than when you pay a 30%.

DSW

Posted by: Antoni Jaume on April 3, 2003 12:18 PM

DSW
Yes, you should make more money. If the business isn't going to make more money, you might not start it up. The economy suffers because the tax rate was too high.

Posted by: Jim on April 3, 2003 01:30 PM

On Jim v. DSW's debate on the issue of whether lowering the corporate tax rate will spur more investment, a point is being missed here. DSW's point is simply that it is expected future cash flows relative to the cost of capital. Jim's point is that tax rates might matter to this calculation. While true, lower corporate tax rates tend to directly increase the after-tax cost of debt as well as after-tax profits. But that is not my main point. If the tax cut induces more consumption (as President Bush keeps saying) and if it it is financed by less government purchases, then the lower national savings increases interest rates, which reduces the net present value of those cash flows. But then Jim is not alone in missing this aspect - as Bush's economists seem to forget this harsh aspect of the law of scarcity when they deny its corrollary: the crowding-out effect.

Posted by: Hal McClure on April 3, 2003 04:03 PM

If the tax cut is NOT financed by cutting government purchases is what I MEANT to say in the earlier post. My apologies. I must be reading too much of the econdribble from the National Review to form a coherent post today.

Posted by: Hal McClure on April 3, 2003 04:09 PM

In order for the tax cut to stimulate investment, it must be assumed that the tax cut will be invested in business. Is this a realistic assumption given the state of the economy? I would argue that it is not a good assumption. The current sluggish economy is chacterized by OVERCAPACITY in production and inventory. GIven the overcapacity, it makes ZERO SENSE to invest in MORE CAPACITY. As evidence to support my position, look at all the capital that is sitting on the sidelines waiting for investment opportunities to appear. The problem with this economy is NOT a LACK of INVESTMENT dollars. The problem is in overcapacity, a lack of demand and a lack of good investments. Thus using tax cuts to increase the money available for investment when there is already more than enough is a worthless policy.

Thus, very little of the tax cut is going to productive business investment. Those on the edge will spend the cut or decrease their debt load. Those flush with cash will add their tax cut to the piles of cash that are already sitting on the investment sideline. Where to park the cash? Much of it is parked in government bonds issued to cover the increase in debt. Thus the Bush tax cut provides very little stimulation. In fact, the tax cut policy is making things worse because the tax cut limits the ability of the government to stimulate the economy through purchases and demand. I argue that it would be better to tax the rich and use the tax money and the debt service to stimulate demand by giving money to the states, investing in infrastructure and education and training of the workforce. That will best position us to work off the overcapacity and have the workforce ready to go when the economy recovers.

Since the wealthy have much capital that is idle, why not take it in the form of taxes and put it to more productive use in stimulating demand? It sure beats, making interest payments to the wealthy for parking their money in government bonds. The rest of us are going to have to make up the deficit and make the debt service payments. A problem with this economy is too much money is concentrated in the hands of the wealthy that don't have enough productive use for it and not enough is in the hands of those who need it to improve their life. This has come about due to a retrenchment in the minimum wage and the standard of living of the workers while the top management is receiving salary beyond fair compensation. The economy cannot be efficient if the resources are too skewed in their distribution.

Posted by: bakho on April 3, 2003 05:59 PM

rea, *i* don't want to disentangle a corporation from its shareholders. The current policy of not going after shareholders assets is like a forced insurance plan for shareholders who invest in a corp; not such a bad idea. The shareholders pay the "premium" through higher interest rates a company must pay on its loans/bonds- decreasing the companies profits.

The point is that there is one act of production and exchange, not two, whether the US Supreme Court calls a Corp. a "person" or not.

Jim, the proposed tax cuts of this bill and the
ones passed last time 'round (I believe) don't effect corporate tax rates, but personal income taxes (and the dividends).

Also, here is how personal income tax is structured: *Everyone's* first 15k(about) is taxed at 10%. then, the amount made from, say, 15K to 30K is taxed at 15%. And so on, so when you get these high rates (the top tax rate is around 36%, it only applies to the money a person is making above around 200k). So if you make 200k (I hope you do if you keep making these arguments) your first 15k is still taxed at 10%. (I wish I had my tax statute with me to give you the right #'s)

It would be a little strange not to start a business because that high tax rate (for the money you make over 200k) will not go down a couple percent further. Though, I admit it could have an effect.

More likely a person will not start the business because the loans you will need will cost too much(the interest rate will be too high), because the government has increased the demand for money(loans) by cutting taxes to wealthy individuals.

cheers.

Posted by: markmeyer on April 3, 2003 08:55 PM

Mark you wrote : Jim, the proposed tax cuts of this bill and the
ones passed last time 'round (I believe) don't effect corporate tax rates, but personal income taxes (and the dividends).

Most small start up business pay tax at personal rates.
Also, I'd prefer to pay my higher rate mortgage and other debt down with a tax refund and then be liable for my portion of increased government 4% debt.

Posted by: Jim on April 4, 2003 08:14 AM

Mark,
The interest rates could be zero, but if the expected aftertax return is too low, the business won't be started.

Also, cutting taxes doesn't raise interest rates. Clintons tax hikes didn't lower interest rates. Rubin was/is wrong.

Posted by: Jim on April 4, 2003 02:50 PM

Posted in reply to CJ Colucci's query about double taxation:

The idea is that the stockholders are the "owners" of the corporation and so, when the corporation earns a profit, *they* have earned the profit. Of course, since they are legally insulated from liability for the corporations mistakes and failures, this idea of ownership is not the same as that of a sole-proprietorship or partnership. The "owners" are in fact owners only of a security representing a claim on a portion of the assets and future earnings of the enterprise, *not* the enterprise itself.

It seems to me that progressives need to draw this distinction publicly. It's subtle, but I believe it is sufficient that if the people of the country wish to make a tax distinction, it is defensible.

I agree that the "efficiency" argument is probably true, but IMHO any tax abatement as a result should be to the corporation, if the goal is to reduce debt to equity burdens. Since nearly half of dividend paying stocks are held in existing tax sheltered instruments and in any case dividend payments are at all-time lows of 1.5% of the value of the S&P 500, any effect on market valuations will be diluted until average dividends paid out at least double. We all know how much attention corporate management pays to the wishes of the "owners" these days, so expect that doubling of dividend payments to take a decade or more under the "reduce the tax to the recipient" play.

Finally, (and I'm going to duck down to avoid a fusillade of back fire here), I have never understood why speculating in paper should be rewarded by the tax system. If there is a defensible need for a "capital formation" tax abatement, it should only go to sole proprietorships and partnerships and the *first* purchaser of a security from a corporation's treasury. Follow-on speculators who purchase and trade a security in the third party market provide no economic benefit to the corporation except to establish a market price for corporation's securities, should further treasury shares be sold.

You may say, "Well, that market function is necessary to the corporation", and of course, you'd be right. Certainly the market price of all securities would fall initially due to the elimination of the tax subsidy; non dividend paying securities would fall more because they depend entirely upon capital gains projections for their price. But once they had fallen, they would stabilize at a new, lower price level. You might say, "Well, that would mean that the treasury shares held by the company at the time such a change took place would be devalued, and any new shares issued would be less valuable."

But that's not true because the initial purchaser would *still* get the tax subsidy. For instance, assume for easy math that XYZ Corp were selling for $10/share before such a change was proposed and adopted, and that $10 is the fair market value for the security. Since the bulk of holders of individual securities are in at least the 32% marginal tax bracket and current long-term capital gains rates are 20%, that's a 12% tax subsidy for one year or longer holders (I think there's a lower rate for longer term holders, but let's just use these figures for simplicity). Assume that XYZ is a tech stock which pays an insignificant or nonexistent dividend, so that any gain on the stock will be entirely capital gains.

The question is "What portion of the $10 price of XYZ corporation represents an inflation of demand for it caused by the tax subsidy?" You may take offense at some of the words in the sentence, but it is in fact a true statement of what is occurring. Much has been made of the assumption that the price of an equity security represents the "net present value of the future expected cash flow of the underlying enterprise". But in fact, for a non dividend paying corporation, there is no way to receive one's portion of the future cash flow of the enterprise except by selling the security. So in fact, a large part of the price of such a non dividend paying security is a bet on other investors' behavior. It is not an investment in a dividend stream.

So in effect, the price on a non dividend paying security is the vector sum of the expectations held by all the parties to the market aware of and potentially interested in owning the security of the likely response by all the other interested parties. That expectation is compared to the net average demand of reasonable return held by all the parties yielding appreciation or depreciation in the security's price.

So, at one extreme, ALL of the $10 price could be imputed to demand created by the tax subsidy, but that would be a ridiculous position. At the other 12% -- the difference between 32% and 20% -- would represent the demand generated by the tax subsidy, because it must have some effect. Clearly, the true situation lies between the two figures: for ease of computation, lets assume that it is 12/32 or 37.5% of the value of the stock. I doubt it's that much, but better to err on the side of the opposition than get blasted for self-serving arguments. That means the stock price for XYZ would fall to $6.25 during the adjustment to the new tax system.

However, it's my assertion that the *value* of the treasury shares and newly issued shares to the corporation will not fall as far. In a sense, a bifurcated market will arise; people in high tax brackets would value the now more valuable subsidy much more than those in lower brackets. It would become de riguer for the very rich to hold as much of their equity portfolios as possible in such advantaged issues. They would receive a tax subsidy of 19/39 -- the difference between 39% and 20% -- or 48% for purchasing such a security. That would restore nearly 1/3 of the lost value to the corporation, and given the voracious appetite of the wealthy for tax reduction strategies, probably more. Assuming that the very conservative estimate of 37.5% inflation due to the subsidy is an overstatement, the value to the higher brackets would be relatively greater, though less so absolutely.

So, while there would be some devaluation of treasury shares and new issues, it would be less severe than some will charge. For a dividend paying corporation for which the holders *do* receive an income stream, the devaluation would be less severe. For companies like REIT's and utilities which pay dividends in the neighborhood of 5-7% but have little capital appreciation, there might be even be a *gain* in stock value since a regular income stream would be relatively more valuable absent the "capital gains" subsidy. It seems probable to me that the tax change which would result in the *most* efficient allocations of capital would be to make dividends a legitimate cost of business to the corporation, like interest, and pay for the loss of revenue by repealing the capital gains subsidy for follow-on holders of securities.

I would even do away with the time period; what difference does a day, a week, a month, or year make? The longer the period of holding, the greater the liklihood of gain, but if Richie Rich buys a treasury share on Monday and sells it on Tuesday for a 2% gain, so what if he gets his tiny subsidy? He did provide the corporation with working capital to use as its management (the REAL owners) see fit. How the enterprise uses it may be stupid or it may be wise, but Richie has parted with his money in the hope of creating real wealth. That is NOT true of the follow-on holders though. They have parted with their money in hopes of finding a "greater fool". Why is the government subsidizing such behavior?

Posted by: Richard Bullington on April 8, 2003 02:22 PM

Richard, you're looking at it backwards:

Finally, (and I'm going to duck down to avoid a fusillade of back fire here), I have never understood why speculating in paper should be rewarded by the tax system.

Don't ask why the speculator (taxpayer) should be rewarded for speculating, ask why the government deserves to take a piece of the money made by speculators.

And as far as the "benefit" only going to first purchasers, then people would gripe about only the "rich" being able to participate.

Posted by: Jim on April 8, 2003 09:14 PM

Jim,

The problem with your reply, "ask why the government deserves to take a piece of the money made by speculators" is that it is too simplistic. I expect you'd be offended to be grouped with Anarchists, but that is exactly what you are advocating.

If government has no source of funds it cannot supply the services that even 'Publicans want: courts to enforce contracts and try offenders, peace officers to protect life and property, a military to protect the nation, public roadways and navigable waterways, and service of the existing national debt at a minimum. These simply cannot be provided by the private sector because they require an element of sovereignty be held by the agent of provision.

There are many other things that a modern society needs to function well which might be *provided* by the private sector: universal education, public health services, environmental remediation, libraries and basic research, and so forth. Still, they require public funding because there is only potential profit in the act of provision, not in the product itself. Either the "free rider" problem would eviscerate the potential profitability of any solely private sector plan to provide these services or the cost would be too great for many families to obtain the service and needed human resources would be denied to the society.

Then there are other services which ameliorate the business cycle and improve the overall productivity of the economy but around which political controversy swirls such as regulation of business and markets, social provision (retirement, health, and disability systems), and government aid to higher education.

All of these things cost money. You are probably one of those who would completely eliminate the third category. But that's irrelevant. Yes, social provision is a significant part of the government's budget today -- more than half. But even were one to stipulate elimination of this entire third category of Federal activities, the first two portions would still have to be provided. And that requires money.

So, yes, the government certainly "deserves to take a piece of the money made by speculators". All that's left to argue about is how much, based on one's belief in the need for third section activities. Which is what the politics of a representative democracy are largely about.

The reason I term it a subsidy it that it is a form of spending by the government. True, it's spending by foregoing revenue which would otherwise be demanded under the remainder of the tax code. Nonetheless, spending it is. Again, the crux of the matter is the rate of taxation, not the principle that it is right or just.

And, by the way, I don't quarrel with your assertion that given a lower tax rate more economic activity will result. But it's only true in the shortest of terms. I would assert that elimination or even serious curtailment of the third section would cripple the US economy's ability to excel in the new century. Please don't be too offended, but the wealth of the nation does not consist of plumbers and dry cleaners, and those are the sort of businesses that sole proprietorships create. While it's true that such small businesses create lots of jobs and are *definitely* the best way to provide these sorts of personal services, they also destroy lots of jobs silently, too, when they fail as 60% do. And they really can't produce the sort of technological innovation and products which a $7 trillion economy depends on for its health.

Applying your National Association of the Self Employed ideal would put the US back to about 1860, just before the private limited stock corporation matured into its present legal form. It would be a much nicer society, to be sure, but it would produce 1/50th the economic activity it does today, if that. And of course, wir wurden Deutsch gesprachen sein.

I do recognize the potential for the criticism you mentioned in the third paragraph. In fact, non rich people would not be excluded from being the first purchaser of a security. They would just benefit less and that means that they would *probably* be out-bid by people in higher brackets for whom the benefit would be greater. As it is today. But today the "supply" of the benefit it essentially unlimited, so there is no "demand" for it. Given a limited supply of such first purchase securities, there would be a differential demand based on the return to the purchaser.

Posted by: Richard Bullington on April 9, 2003 10:47 AM

Richard, not advocating anarchy, just that government can collect funds more efficiently with less damage to the economy.

If your only concern was the amount of revenue the government collected (and not punishing the wealthy) you would agree that capital gains taxes should be cut, not raised.


Because its a voluntary tax, cap gains revenue is very sensitive to the rate. Everytime the rate is cut, revenue jumps.

Not sure what third section you keep refering to, environmental remediation?

As far as your comment about plumbers and dry cleaners, I was in no way saying that only small business would benefit, just that those examples are easiest for most people to understand.

If you really want people to invest in those new companies with those great technological innovations, cut cap gains to zero.

Non rich people would not be excluded from first purchases, but rich people do more business with firms issuing those securities and would get lions share, aside from the fact that they could pay more.

Posted by: Jim on April 10, 2003 08:18 AM

All right, then, how *would* you replace the revenue lost from eliminating the capital gains tax? Would you be willing to increase marginal rates to replace it?

Of course you wouldn't. You'd just shift your attack to that section of the tax code, because you genuinely don't want to contribute to your society. To you and those like you, taxes are all theft. You refuse to admit that the opportunities that have been presented you are largely a product of social action taken by progressives in the past; you are hypnotized by the chimera that you have shaped your economic life. Yes, certainly you have contributed; if you were a slothful or immoral person, you would not have the material comforts you enjoy today. But by the same token, if a democratic socialist party had not been in power for much of the 20th century in the US, you wouldn't have them either. That and the abundant hydrocarbon deposits in North America exploited to build America's industrial might -- now almost completely depleted.

In 1900 Argentina had an almost identical GDP per person as did the US, and look at them now. They followed a VERY laissez faire, low tax economics, allowing the rich to become vastly richer than the poor and today they wallow in a cesspool of social venom. It's also true that they did not have lakes of oil underlaying their land, so they didn't have the advantage of drawing on a 180 million year old bank account. In any case, I for one do not cherish the idea of the US becoming Argentina, but that is exactly what will occur over time if "conservatives" get what they want in the US.

As a final thought, let's both pray that when SARS comes to our communities our local Public Health service offices have not been starved too severely by the last eight years of Republican cuts to "non-essential services".

Posted by: Richard Bullington on April 10, 2003 04:20 PM

Since the goal of a capital gains tax cut is increased entrepreneurial activity and capital investment, not simply keeping the same level of government revenue, reducing the rate to 10 percent would be an even better economic option. That would result in some loss of revenue, probably $10-15 billion per year (a reasonable guess), while reducing the impediments to capital reallocation and encouraging stronger economic growth, and perhaps more tax revenues in the long run. http://www.fb.com/issues/analysis/Cap_Gains_Background.html

I think it's interesting that you consider the taxes I pay to be my only contribution to society.
I don't consider all taxes to be theft, only those that are wasted. So that would be about 50%.

So, you blame Argentina's current troubles on too little government. That's pretty funny. Their government consumes much more of GDP than ours. If you went back to 1900, you'd probably see the same.

As far as SARS, I've got a funny feeling that our evil profit driven medical system will handle it much better than China, Cuba, England or Canada's government run healthcare systems.

Posted by: Jim on April 11, 2003 07:26 AM

Jim,

You just do not get it, do you? I wrote that I was OK with a capital gain preference for the people WHO ACTUALLY INVEST MONEY. That is, sole proprietorships, partnerships, and first purchasers. What I said was I wanted to revoke it for speculators in paper.

You keep arguing that capital gains subsidies for investors are wonderful things because they stimulate economic activity. Where did I dispute that? What I said and continue to believe is that follow on speculators in corporate securities are NOT "investors". They provide no working capital to the enterprise whose paper they hold. Please don't make the specious argument that by holding the security the speculator is continuing to provide working capital passively. Once a security is sold to the public the holder first or subsequent has no right to demand that it be bought back by the company. Some corporations do of course mount share buyback programs, but it is entirely up to the enterprise. A normal shareholder cannot actually get his or her portion of what s/he "owns" back from the enterprise. "Owner"? I don't think so.

The people who give money to enterprises are investors; the others are simply speculators, betting on the activities of others like them. It's a giant ponzi scheme.

As for the SARS issue I haven't said anything against our medical providers. What I said is that the Public Health Service, the people responsible for co-ordinating the response to infectious diseasee, have been woefully underfunded since 1994 because they are "unnecessary" given our excellent medical system -- and I'd venture unwelcome to the ideologues in Congress.

However, do you REALLY think that for-profit hospitals will be able to care for a flood of SARS patients? What I read in reputable publications is that most areas of the country have little excess bed capacity, because it's expensive to carry. Hey, their primary responsibility is to make a profit, not care for people. That's so 19th century!

A few dozen "super-spreaders" in the US and we very likely could have chaos, as they do in Hong Kong. Yes, there are signs that the organism may be weakening; it's not native to humans as a host and may be losing its virulence as does often happen with trans-species infections.

Posted by: Richard Bullington on April 11, 2003 11:35 AM

Richard, do you think that the fact that the second owner misses out on the benefit may have a negative effect on the value of these securities.The problem with punishing "evil speculators" is that they are the people who buy from those "saintly first purchasers"

Were you in favor of Bush 1's luxury tax? To punish those pesky rich people George Mitchell wanted to tax expensive boats, cars, jewelry etc.

Funniest thing I ever saw, those rich people stopped buying boats and all the boat makers in Maine laid off their workers.

My point is that your desire to punish speculators (you sound almost Marxist in that respect, weren't they always railing against speculators, bloodsuckers whatever) you will end up punishing everyone but the rich. They'll get lawyers and acoountants and figure out ways around your plan but middle income people will just lose out.

Posted by: Jim on April 11, 2003 01:47 PM

You didn't even read the previous post in which I dealt with the problem of the likely deflation in value to follow-on purchasers. As I said, it will have an initial effect, but much less so for dividend paying securities. But I'm not going to bother to answer any more of your objections since you don't think about the text; you just look for the phrases that morons like Gush Bimbo and Bill O'Lielly jump on.

I do note that the death rate from SARS has risen to 6% in the latest statistics. Since the first wave of infections hit relatively vigorous young health care providers most strongly, they were able to recover. The death rate among people over 60 is 18%, and those over 75 35%. How is your vaunted private medical system going to make a profit on this looming disaster? Hmmm?

Posted by: Richard Bullington on April 25, 2003 12:19 PM

Well, I'm glad its ok to punish first buyers of securities so that speculators can be punished.

As far as SARS and our private medical system, what do you think of the idea that Canada's public health system is to blame for the outbreak in Toronto? http://www.nationalpost.com/commentary/story.html?id=88370F42-163E-4959-9867-00F390C7368C

Posted by: Jim on April 28, 2003 12:53 PM
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