Taxes

When Dan and I were first invited to join Chicago Boyz Jonathan mentioned my high quality posts on energy and taxation.  Recently I have not been writing too often about taxation because the news from the US perspective has been almost universally negative.

Two core principles of taxation are:
1) the tax should be effective, meaning that if it intends to raise a certain amount of revenue that it should be designed to achieve that end
2) the tax should minimize negative impacts on overall economic behavior

Japan Considers Lowering Its Corporate Tax Rate

There was an old joke that Arkansas’ motto was “thank god for Mississippi” because else Arkansas would have been #50 in the rankings by state on various metrics.  In that same vein, when ever I talk corporate taxes and about how the United States is the least competitive corporate tax environment in the world, they would say that in fact, Japan was worse.

Now even Japan has woken up to the fact that high corporate tax rates push investment overseas (since companies can choose where to invest in new plants, subsidiaries and businesses) and are a relatively poor way to raise incremental tax revenues.  According to this Wall Street Journal article titled “Kan Seeks Cuts in Japan’s 40% Corporate Tax Rate” the newly installed Japanese government is considering reducing this punitive rate, which would take away our “Mississippi” per the analogy above.

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On the opinion page at the Wall Street Journal Alan Reynolds of the Cato Institute wrote an excellent article titled “The Rich Can’t Pay for ObamaCare“.

The key concept is what he describes as “the elasticity of taxable income” or ETI. ETI measures how taxable income is impacted as tax rates increase; if you use a rate of 0.5 you assume that an increase in tax rates that would yield $1 if prior behavior held stead would yield 50 cents after the impact of behavioral changes is taken into account. However, instead of an ETI of 0.5, per the article:

For incomes above $500,000, Treasury Department economist Bradley Heim recently estimated the ETI at 1.2 – which means that higher tax rates on the super-rich yield less revenue than lower tax rates.

The article describes, in practical terms, how rich individuals can take action that illustrates this ETI:

– dump dividend paying stocks (you will probably want to do this anyways because they are likely to fall in price because part of their value is tied to the reduced tax rate) when the 15% rate is raised
– avoid selling stocks with capital gains when the rate rises, or sell stocks with unrealized losses at the same time to “net out” any gains owed to the government
– reducing income near the $250k range when “phase outs” raise the MARGINAL tax rate to a very high rate through tax deferral strategies such as 401(k) contributions and the like
– consider becoming a one-earner couple instead of a DINK if the penalty on incremental income becomes too great to make up for the cost of child care and the general decremented quality of life

I really like this paragraph that should be an epitaph for tax policy:

Punitive tax rates on high-income individuals do not increase revenue. Successful people are not docile sheep just waiting to be shorn.

A sound tax policy has two main elements 1) it raises the amount of revenue that it is supposed to raise 2) it provides the minimal distortion of productive economic activity.

Super high tax rates on the rich accomplish neither of these two attributes. They don’t raise the money as planned (in fact you could likely end up with LESS money overall) and they distort the economy by having our most valuable members of the economy step back from working at a time when their entrepreneurial drive is needed most to jump-start the economy.

Cross posted at LITGM

Back when Dan and I were invited over to Chicago Boyz they mentioned my posts on taxation and the energy industry as particularly interesting. Over the last few years I have not written that much on tax policy, because the news has been so uniformly bad that it is quite depressing to contemplate.

This article from the Wall Street Journal is titled “Escape from Taxation” and reviews the negative impact on the state of New Jersey caused by ever-increasing state income tax rates. As you can see in the table, the highest marginal tax rate on income in New Jersey has increased from 2.5% in 1976 to 10.75% in 2009. New Jersey’s growth used to be in part attributed to its lower tax burden when compared to New York state; today that gap has been (mostly) erased and with it has gone inbound migration of wealthy individuals and corresponding growth.

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As a “solution” to our economic problems, the government has been spending money on stimulus programs. Since the government can’t directly incent business development, this type of money ends up going to 1) minor infrastructure projects and 2) funds for local governments and states to spend on salaries, programs.

As we know, the government has to raise revenues to pay for these programs in the form of taxes. Then the taxes, which distort business activities in myriad ways, are paid out in the form of salaries and grants in a relatively inefficient manner through a variety of poorly managed government programs.

While it isn’t popularly known, the US has among the highest corporate tax rates in the developed world and it isn’t just a co-incidence that other venues such as Hong Kong and Brazil are seeing an upsurge in IPOs and stock listings. The US today is not a competitive place to start a business, all else being equal.

The current government is not only taxing the US at an unsustainable rate as far as competitiveness, it is spending money that it doesn’t have (deficit spending), which will burden the US and future generations with high interest payments. The current deficit for 2009 is estimated to be about $1.6 trillion dollars, which will add about $100 billion / year in interest payments (fluctuates depending on rates).

All of these taxes don’t help put people in meaningful (non-government) jobs. In fact, they hurt our competitiveness and hurt the businesses most likely to grow and create jobs. Since unemployment is important even to our elected officials (unlike debt, competitiveness and future interest burdens, apparently) because an unemployed electorate is an angry electorate, institutions like the NY Times have to start thinking about tax cuts as a way to spur job creation.

From the article, titled “Tax Cuts Might Accomplish What Spending Hasn’t“,

When devising its fiscal package, the administration relied on conventional ideas based in part on ideas of John Maynard Keynes. Keynesian theory says that government spending is more potent than tax policy for jump-starting a stalled economy. (Per the administration) it says that an extra dollar of government spending raises GDP by $1.57, while a dollar of tax cuts raises GDP by only 99 cents.
 
According to the Romers (on the President’s Council of Economic Advisors), each dollar of tax cuts has historically raised GDP by about $3 – three times the figure used in the administrations’ report. That is also far greater than most estimates of the effects of government spending.

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