Taxes

“Candy” Tax – or how not to raise taxes

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Recently I wrote about incentives and how to review tax programs on these two criteria

– Effectiveness – does the tax program raise the revenue in a manner that is cost-effective and have the lowest level of harm and distortion to the overall economy?
– Incentives – if the tax program is designed to promote a certain type of activity or “deter” a different type of activity, do the incentives actually drive the behavior that the law is intended to achieve?

The photo above is from an excellent Chicago Tribune article about a change in the Cook County (Chicago) sales tax rules which mean that “candy” is taxed at the highest rate (10.25%) rather than as “food” which is at a significantly lower rate (2%).

This tax shows the “down the rabbit hole” elements of tax complexity when incentives and effectiveness go haywire.

From a complexity standpoint, this makes no sense. Lots of items contain flour and are thus counted as “food”, but for the small shop owner, explaining this to staff and customers will be a difficult and time consuming process. For large retailers it likely won’t be as big a deal because this is all calculated by the register.

From an incentive standpoint, this makes even less sense. Since sales taxes are highly regressive, which means that they sock the poor harder than the rich (since the poor consume almost all of their income, and pay a high percentage on food), you could understand how the state might want to exempt food. But the line between candy and food is now blurry and complicated.

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Business Week Article on Stock Buybacks

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A recent Business Week article titled “The Buyback Boondoggle” discusses stock repurchases.

As the unemployment rate hovers near 10%, the economic debate is focused on how the government should aid recovery… but it’s business’ task to get the economy back on track – by investing in innovation and job creation. And if the recent past is any guide, corporations may stall the recovery by investing instead in something else – stock buybacks.

This article is an example of poor journalism and populist reasoning right from the start. You can see the writer’s view on business – that its purpose is somehow to create jobs – and that this should be the main goal of a business. Which, frankly, is a terrible assumption.

Businesses are created to make money. Businesses are (usually) run by smart people who want to invest their equity capital (raised from the stock market) in the place that will earn them the most money, and if they have a lot of equity capital outstanding (in the form of stock proceeds and retained earnings) they have to put this money to work on new projects that are at least as profitable as their current portfolio, or they are decreasing their company’s profitability, which is severely disliked by investors.

And the United States nowadays is a poor place for new investment. Want to know which country in the developed world has the least friendly tax outlook? The good ol’ USA. Per that highly recommended site “The Tax Foundation”

Currently, the average combined federal and state corporate tax rate in the U.S. is 39.3 percent, second among OECD countries to Japan’s combined rate of 39.5 percent… Many states impose state corporate income taxes at rates above the national average of 6.6 percent. Iowa, for example, imposes the highest corporate tax rate of 12 percent, followed by Pennsylvania’s 9.99 percent rate and Minnesota’s 9.8 percent rate. When added to the federal rate, these states tax their businesses at rates far in excess of all other OECD countries.

The US also has a surplus of lawyers and a highly litigious culture that requires businesses to spend an inordinate amount of time preparing for lawsuits of every sort. And if you want to build something, such as a manufacturing plant… you must be kidding, right? The environmentalists and regulators will tear you to shreds, with protests, forms, and a never-ending stream of bad publicity. And if you have unions, or are in a state loaded with unions (such as the Midwest, sadly enough) you have a militant work force demanding gold plated benefit plans and happy to walk out and crush your operations at a moment’s notice.

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Quote of the Day

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Chet Richards, in a comment on this thread at Belmont Club:

For an economics professor, Gregory Clark has a very poor grasp of U.S. economic history. The real question is: what have we lost through our current redistributionist (i.e. socialist) policies?
 
LBJ instituted the “Great Society” as a redistributionist scheme. I well remember that at the time critics were saying that LBJ’s program was grossly underfunded and that it would have a very negative impact on the US economy. LBJ not only publicly admitted that the critics were right, he even openly gloated that future generations would just have to live with the consequences. On top of LBJ’s ego we had to suffer from the adoption of the “Limits to Growth” policy that was enacted in the early 70’s by liberal neoluddites including Nelson Rockefeller’s gang (and Richard Nixon). This policy choked off growth during the 1970’s by doubling the Capital Gains Tax.
 
So what have we lost? The long term economic growth of the US from its founding to 1970 was 4.5% through thick and thin. Growth losses during recessions and depressions were compensated by growth overshoots during the recovery period. Since the population was also growing, the per capita growth rate works out to about 3.5%. In 1970 the long term per capita growth rate dropped to 1.5% and has remained at that level ever since. (These days an annual total GDP growth of 4% is regarded as phenomenally good!)
 
Working the numbers for the period from 1969 to 2009 we have a per capita GDP growth of 4x with a 3.5% per capita growth rate. With the true per capita growth rate of 1.5% the per capita growth during this period was actually 1.8x. If we had not had LBJ and “Limits to Growth” our per capita economy would now be about 2.2x larger than it currently is. Factoring in the population growth gives us about the same ratio.
 
Conclusions: 1) Almost all of us have suffered a profound loss of the prosperity that should have been ours. 2) Revenues to the Government would have been substantially larger than they currently are and taxes would have been much lower. 3) Inflation would have been much lower which means our savings would not have been eaten away (and taxed) by inflation. 4) Current policies to expand redistribution are going to create even more loss of wealth and increase in poverty.
 
Shed a tear, folks, for what might have been, and what we likely will still lose.

Government Incentives

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When I review tax programs, whether they are for local, state, or federal governments, there are two critical criteria:

– Effectiveness – does the tax program raise the revenue in a manner that is cost-effective and have the lowest level of harm and distortion to the overall economy?
– Incentives – if the tax program is designed to promote a certain type of activity or “deter” a different type of activity, do the incentives actually drive the behavior that the law is intended to achieve?

I thought about the “incentives” element of the program as my parents rushed out to take advantage of the “cash for clunkers” program which provides a credit (on the spot, to the dealer) for turning in cars that basically get less than 18 mpg and purchasing a new car off the dealer lot. This program has their own website (where they unhelpfully refer to the program as “Cars” or “Car Allowance Rebate System” rather than the far more effective “cash for clunkers”). My father’s car barely made the cut because it was right around 18 mpg and they have been clarifying the program and making him sign form after form (to prove that he has owned it for several years, that he had it scrapped, etc…) but generally this program was a “shining star” of an incentive because 1) the government wanted him to go out and buy a new car off a dealer’s lot right now 2) they wanted to make sure that his old 18 mpg car was taken off the road 3) they wanted to make sure that he actually owned the car and didn’t just swap it with someone else to get the $4500 in trade in when the car was only worth maybe $1000. All of these criteria were met, in this case.

While the FDIC isn’t a tax program, the agency that guarantees deposits at insured banks (with your tax dollars) also provides incentives. I was involved in the early 1990’s when the Resolution Trust Corporation was created by our Federal government in order to take control of insolvent banks (basically banks that made dud loans, generally for property) and pay back depositors. I was on one of the teams that would go into banks right at the time they were being shut down and secure the cash and assets as a lowly auditor. We weren’t exactly the CIA – we sat in cars outside the bank and everyone knew it was coming and the staff were generally very polite – but that was where I frequently heard the phrase

Heads – I win, Tails – the FDIC loses

By this phrase they exactly summed up the banking game at the time – make a lot of big and risky loans with “guaranteed” customer deposits, and if it goes well and the loans are repaid, you make a bunch of money. If the loans go sour, oh well, you just walk away and leave the FDIC holding the bag.

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It’s Worse Than Mere Corruption

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At USA Today via Instapundit:

Counties that supported Obama last year have reaped twice as much money per person from the administration’s $787 billion economic stimulus package as those that voted for his Republican rival, Sen.  John McCain, a USA TODAY analysis of government disclosure and accounting records shows. That money includes aid to repair military bases, improve public housing and help students pay for college.

 

The reports show the 872 counties that supported Obama received about $69 per person, on average. The 2,234 that supported  McCain  received about $34.

The article spends a lot of time explaining that there is no  evidence  that the distribution of the “stimulus” money occurred owing to  favoritism  or political corruption. I think that is true. If nothing else, the stimulus was rammed through so quickly I don’t there was time for corrupt allocation on such a scale.  

The real  explanation  is much, much worse.

This pattern reveals that the Democrats have created a hardwired system that automatically takes from Republican-leaning areas and gives to Democrat-leaning areas. This means that people in those areas don’t have to be convinced with intellectual arguments to vote for Democrats, because they will do so automatically out of economic self-interest.  People vote for Obama because they expect themselves and their immediate communities to  receive  money taken from areas that didn’t vote for Obama.  

Corruption can be fought by bringing down corrupt individuals. A legal, hardwired distribution system that creates an incentive for one group of citizens to loot other citizens is a much more serious and intractable problem.

[edit (2009-06-09 3:18pm) expanded quote to show per capita spending.]