Will Munis Lose Their Tax Exemption?

According to an article in today's Wall Street Journal, President Obama and Speaker Boehner are willing to consider deductibility limits on municipal bonds. Municipal bonds are bonds sold by state and local governments.  For many years, the interest earned on municipal bonds were exempt from federal income taxes. The idea was to reduce the costs of borrowing for state and local governemnts. Investors are willing to accept lower yields on municipal bonds because the interest is tax-exempt.  Investors care about their after-tax return, so an investor in the top tax bracket can recieve a lower interest rate on municipal bonds than on equivalent corporate bonds because of the tax difference.  One can argue that munipical bonds should or should not be treated differently. I suspect many people would like to see the interest on school bonds remain relatively low. But the rationale offered by politicians, according to the article, is interesting. Clearly, one goal is to increase federal government revenue. The article quotes a portion from the administration's budget documents arguing that limiting interest and other tax breaks for the higher-income households would, "reduce the benefit that high-income taxpayers receive...and help close teh gap between the value of these [breaks] for high-income Americans and the value for middle-class Americans."

I would have hoped there would have been some discussion about the impact on state and local governments and their ability to raise money for capital projects.  In general, I favor removing tax breaks across the board. Favoring some groups over others distorts capital markets. But if decisions are made based on income-redistribution concers only, then I don't see that as an improvement.

A Longer-Run Look at the U.S. Debt

An article in the most recent Federal Reserve Bank of St. Louis REVIEW by Daniel Thornton offers a long-run perspective on the U.S. Deficit and Debt Problems. It is very interesting and sheds light on what has caused the increase in debt.  Several findings are of interest:
1.   For most of our history, federal debt was associated with war, and during the time after a war, the debt/GDP fell for a number of years.
2.  The exception is the increase in debt associated with the Great Depression, but the increase in debt was not that large.
3.  The increase in annual deficits began in the early 1970s.
4.  Tax revenues as a percent of GDP stayed relatively constant but federal expenditures as a percent of GDP increased.
5.  The increases in government spending are associated with increases in Social Security and Medicare/Medicaid, and other payments to individuals.  That is, to transfer payments.
6.  The two major sources of government revenue are the individual income taxd and social security taxes.
7.  The individual income tax revenue relative to GDP has not been greatly affected by changes in the highest marginal individual income tax rate.
8.  The average individual income tax rate paid by households based on income shows that the highest quintile pays an average income tax rate about four times higher than the lowest quintile.
9.  Since 1979, the lowest income-earners have benefited the most from all the tax law changes.

Different people are likely to draw different inferences from these "facts."  Those who believe that we have to have substantial redistribution will argue that the rise in expenditures is necessary and to close the deficit, more tax revenues need to be raised from the higher-income households.  Those who believe the size of government is too large, will call for reduced expenditures.  But any future plans should at least acknowledge that historical record.

Are We Becoming Europe?

I met a sociologist once who commented that he had visited at Princeton University while on sabbatical. He said, "I used to hate the rich; now I hate them with cause." I understood what he meant, for the rich, especially those who grew up rich, seem to feel entitled to all sorts of benefits and expect others to behave deferentially to them. It might seem then, that I would be ready to raise taxes on the rich. But, other things are involved than merely trying to punish the rich for being rich.  While greed is one of the seven deadly sins, so is envy.  (My former colleague, Victor Claar, has written and spoken on envy in recent years.)

If we are to receive the benefits of a stable government, we have to pay taxes.  But, as noted in a book years ago entitled, THE LAW AND THE PROFITS, governments do not have a tight budget constraint. If they want to spend more they can either tax or borrow more. What should be the amount of people's income that go to taxes? There is no "correct" answer, but one that gets worked out through our political process. 

Recently, Steven Rattner had an op-ed in the New York Times, in which he argues for higher taxes on the rich. He writes, "Don't forget that the taxes on capital gains and dividends are absurdly low."  I don't know on what he bases that other than personal opinion, and maybe he is correct. But, he completely ignores that the dividends have already been taxed as corporate profits. Rattner wants all of the extra revenue to come from the wealthy, even thought the wealthy already pay the vast majority of federal income taxes. When forty percent of households pay no federal income tax, what skin do they have in the game?

Another piece in the NY Times is by Eduardo Porter. He argues that we should increase the share of GDP that goes to taxes in order to maintain a better safety net than we now offer. Progressivity isn't the key but broader taxes that collect more revenue as well as more generous welfare programs. He argues that that is what the richer countries in Europe do and we should too.

These two pieces are just a sample of editorials and op-ed pieces in which an argument for larger government is offered. Porter is more forthright in his plan by saying we should be more like Europe. But, the European countries are having a harder time maintaining their programs, and this is not just the case for the basked cases like Greece. Germany has made reforms that have  loosened labor markets; France is still resisting such liberalization, but is also seeing downgrades to its debt.

A book I am reading, and will do a review of when finished, is The Redistribution Recession by Casey Mulligan. He shows that the generosity of the benefits we offer the unemployed and others has increased substantially since 2007. A result is that many unemployed would need a high-paying job to be better off than they are receiving govenrment benefits.  We may be moving closer to Europe whether intended or not. For a couple of decades unemployment in Europe remained higher than in the U.S. The Great Recession altered that briefly. The question now is whether we will follow Europe's path, which has included persistently higher unemployment and slower economic growth.

We Can't Return to the "Golden Age" of the Postwar Era

Robert Shiller's column in yesterday's New York Times epitomizes an approach and argument that I find totally fallacious and even silly.  The title is "Taxes Needn't Discourage Philanthropy."  He begins by asking the question--"How high can taxes go?" He notes that the top marginal rate in 1944 was 94%.  Yet, we didn't have class warfare and we didn't have an economic disaster. Of course, we were in World War II at the time, which he acknowledges.  He notes that one reason for the high rates was to ensure that the war would not create new millionaires.

After the war, the rate came down a little but not much. In 1963 the top rate was still 91%. Shiller argues that the high rates didn't impact growth negatively since the real GDP growth rate from 1948 to 1963 was 3.7%. This was higher than the overall average growth rate of 3.2 % from 1929 to 2011. He argues that one reason was that we had greater social harmony in those fifteen years, some of which was a hangover from the patriotism felt during WW II. It takes a while, but he eventually gets to his theme of encouraging philanthropy by encouraging positive feelings of reciprocity.  While worthy of comment on its own, I want to focus on the idea of using the first fifteen years after the war as evidence of things we could do today.  I think it is wrong.

People often regard the way things were when they were teens and young adults as some sort of norm.  For people older than I am, this time period was the fifties and early sixties--a time when American business was strong and the economy grew rapidly, as noted by Shiller.  However, this "golden age" was not a normal time period. In fact, it was an aberration.  The was was not fought on US soil and American industrial facilities were not destroyed. The same can not be said for most of Europe and Japan.  We faced no competition for most of that period.  In the sixties, Japanese goods were considered to be cheap and junk by most Americans.  American business people did not have to be particularly wise or innovative to be successful.  Few people talked about the importance of small business since the presumption was that big industry was the norm.  Major industries were oligopolistic and the firms often viewed as invincible.  General Motors was the quintessential American firm.  The economic situation was not viable in the long run.  Europe recovered, as did Japan, and new compeition came along.  To argue that any government policy that persisted at that time must have had either good or benign effects because of the success of the American economy at the time is misguided.  America's role in the world was unique and not sustainable over time.

Another point Shiller makes is that the American public was more harmonious at the time. He writes, "Many people sacrificed their lives during the war, and, for a while, it seemed that the survivors were especially chartiable to one another, on both a personal and an institutional level.  I wonder if African Americans in the deep South who lived at that time would agree with Shiller.  It was a time of white, male dominance that is totally unacceptable today.  Even at the end of  the war, Jews still often could not get into Ivy League schools, or at least could not get on the faculty.  People thought diversity at the time referred to Italians and Irish, not Hispanics and Cambodians.  To me, it is more difficult to see solidarity when society is increasingly diverse.

As the political and economic debate in the country has focused on whether the role of the federal government should be constrained or more dominant, I see references to the early-postwar times as evidence that high marginal tax rates can be associated with strong economic growth.  Shiller's piece is just one of a number of examples I could have used.  But the world has not stood still since 1963.  We need better evidence than appeals to a bygone "golden age."

The Complexity of the Tax System

Today's Wall Street Journal has an article on firms passing up some tax breaks because of the complexity and the hassles.  Since many of the breaks are for small firms, the cost of compliance tends to be more relative to benefits.  The Small Business Administration estimates that the tax-compliance cost per employee for a firm with fewer than 20 employees is about $1600 compared to less than $800 for firms with 20-499 employees.  The article notes that many in Washington decry the complexity of the system, yet the system persists. Why?  The author of the article offers an answer, "...both theWhite House and Congress can't seem to resist fine-tuning the tax code to satisfy their diverse goals."  Precisely.

The complexity is there for the code we pay as individuals also.  Most people don't itemize deductions even though anyone paying a mortgage is likely to have lower taxes by itemizing.  Again, is it the complexity and not wanting the hassle that leads to this behavior? 

During the early years of the Reagan presidency, when the Republicans had captured the Senate for the first time in decades, there was talk of tax reform and simplification.  If I remember correctly, Bob Dole was the head of the appropriate committee in the Senate and he said that he didn't believe in simplification  for the sake of simplification.  I do.

Apple and Taxes

The New York Times today has a long and detailed article on how Apple, the most profitable company in the U.S., pays little taxes as compared to most non-tech firms.  The key idea is that Apple is able to locate parts of its company where revenue is generated in low-tax areas. Nevada rather than California, for example.  So, while a firm like Wal-mart pays about a 20% tax rate, Apple pays less than 10%.  Apple is able to use both states in the US and other countries in this process of minimizing taxes.  The things Apple and other tech firms can do cannot be replicated by more standard businesses where it is diffiult to relocate production facilities.  Perhaps the Occupy Wall Street folks should think about occupying Apple. They can use their Iphones to organize their activities.

Happy Tax Day

Today is the last day for filing 2011 taxes with the IRS. Sunday's New York Times had an interesting article on taxes, including post-war history of taxes, tax rates and the economy. It can be found here. It also deals with the impending increase in taxes set for January 1 and what the effects might be. One could hope that Congress and the president would deal with the issue prior to the end of the year, but given this is an election year, that is unlikely.

It would also be nice if our elected officials would think about the tax system as a way to raise revenue needed by the federal government to operate rather than as a way to do favors for some and to denigrate others. I can dream, can't I?

Tyler Cowen on Taxes

In his Sunday New York Times column, Tyler Cowen challenges the "no new taxes" pledge many of the Republican candidates are stressing. It is a worthwhile column to read as he notes that no new taxes today, without spending cuts that are not going to happen, means a pledge to higher taxes in the future--at least if one is "fiscally conservative."

Back when the Reagan tax cuts were being discussed, I favored the cuts for two reasons. The first is that I thought the marginal tax rates were too high and discouraged investment while encouraging tax avoidance behavior. Second, lowering federal income would be the only way to lower government spending. I still think I was correct on the first point but not on the second point. Government tends to borrow when its income is reduced. Now, one of the points Cowen is making, is that eventually taxes will have to be raised. But we are still able to delay that because of the position of the US in the world economy. We are not Greece. But postponing deficit reduction is not a sustainable position. Fiscal conservatism consists of two major points--over time we must balance the [operating] budget, and the size of the federal government should be limited.

Who is Rich?

Andrew Ross Sorkin of the New York Times has an article in Sunday's paper on how $250,000 became the dividing line between the rich and everyone else. It is worth a look.

Taxing the RIch at the State Level

Article in the weekend edition of the Wall Street Journal talks about states that rely on taxing the rich for most of their revenues suffered significant declines in revenue as a result of the last recession. Incomes of the wealthy tend to be more volatile than for other people. Much of this is due to the fact that most wealthy people have substantial income from equity markets. A sharp fall in the stock market reduces their incomes a lot. For example, the article reports that earnings of the top 1% of households in California fell by more than twice as much as the rest of the state's population. In New York the top 1% of earners paid 41% of the state's income taxes in 2007, compared to 25% in 1994. A result is that when the economy declines, state tax revenues decline even more. The federal government increasingly is relying on tax receipts from the top earners. The problems associated with volatility are less at the federal level, but increasing. Taxing the rich sounds good to many, but there are costs. Once again, there are not free lunches.

GE Avoids Paying Taxes

A front page article in the New York Times concerns how General Electric managed to pay zero corporate income taxes in 2010 even though its profits from U.S. operations was $5.1 billion. It's total profit was $14.2 billion, with the difference not repatriated to the U.S. One can imagine the hue and cry this may cause among liberals, but I think all of us should be concerned.

Taxes distort decision making; there is virtually no way to prevent that. But the U.S. tax code distorts at so many levels it is hard to know the final effects. From the high rate on repatriated profits, to the high corporate tax rate, to tax credits for some activities--the code encourages firms to spend huge amounts of money on lawyers and tax accountants to understand and take advantage of the code. But, that isn't all. The article shows that GE often takes the initiative in lobbying for tax breaks. They have a lot of lobbyists and utilize them. The article ends with a quote from Gary Sheffer, a G.E. spokesman, "We are a diverse company, so there are a lot of issues that the government considers, that Congress considers, that affect our shareholders. So we want to be sure our voice is heard."

I do not object to lobbying since it is difficult to see how a representative democracy would operate if people cannot make their views known to their representatives. Of course, corporations are not people, but the shareholders and workers are.

The recent task force that made recommendations on ways to reduce the deficit argued for lowering of rates but reducing loopholes and tax breaks. I enthusiastically endores such a plan. On the other hand, I am somewhat pessimistic or cynical. If Congress enacted a simplified tax code for both individuals and corporations that eliminated tax deductions and credits for every item Congress has thought needed support, we would have a better system. But, I would expect that breaks, loopholes, credits and other distortions would creep back in over time, so that a decade from now it would look a lot like the current code.

Mankiw on Taxes and Spending

Mankiw's column in yesterday's New York Times is worth a read. He discusses tax and spending policies, noting how a tax credit is often like a spending increase. He argues, as do most economists, that the tax rate should be lowered and the base extended. The latter is done, at least in part, by removing many credits and deductions.

Two interesting articles

Two interesting pieces in the business section of the NY Times yesterday. Mankiw's column illustrates the effects that higher taxes on high-income earners can have on work effort. He uses himself as a case study. An article on the historical gains of the stock market after the midterm elections provides astonishing data. The article writes about the data from the perspective of it being the third year of a presidential term, but data I received from a former student showed that the 200 days after the midterm election consistently had high returns while the 200 days prior to the midterm elections returns were much lower, with many years showing negative returns. It is difficult to know what to make about the data.