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A Better Way to Tax the Rich

Some advice for the new president from economist John Cochrane in the Wall Street Journal, Don’t Believe the Economic Pessimists:

The ideal tax system raises revenue for the government while distorting economic decisions as little as possible. A pure tax on consumption, with no corporate, income, estate, or other taxes is pretty close to that ideal.

The U.S. tax system is the opposite: By exempting lots of income, the government raises relatively little money. Yet an extra dollar is heavily taxed, greatly lowering incentives and encouraging people to find or create exemptions. This massive complexity and obscurity undermine faith in the system.

Progressives, ponder this: With a sales tax of only 25%, the government would likely have gotten a lot more money from Donald Trump—who has employed complex but legal tax-avoidance schemes—than it did by purporting to tax income at high rates.

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The Cost of a High Estate Tax

From The NYT and economist Greg Mankiw,  Why Taxing Fairly Means Not Taxing Inheritances:

Excerpt:

But there is one thing that everyone can agree on: The estate tax you owe should not depend substantially on the exact moment you happen to expire. A person who died in 2010 paid no estate tax, no matter how wealthy he or she was. A year earlier or later, things would have been very different.

To avoid this particular unfairness, we need more stability in the tax code than we have had in the past. This stability is possible only if those with opposing points of view reach a compromise that, while not perfect from either perspective, is acceptable enough for everyone to live with. Neither Mrs. Clinton’s proposal of 45 percent nor Mr. Trump’s proposal of zero passes this test.

International comparisons are a natural benchmark. Over all, the United States is a low-tax country compared with many of our developed-nation peers. But that is not true when it comes to the estate tax.

Many countries do not tax inheritance at all, including Australia, Canada and Sweden. Most do, but the tax rates are usually much lower than what we impose in the United States. Among the nations in the Organization for Economic Cooperation and Development, the average for the top estate tax rate is 15 percent. The median is only 7 percent, which is the rate in Switzerland.

If the United States were ever to adopt such a low estate tax rate, it would surely put a lot of the estate planning industry out of business. Hiring expensive legal talent may make sense when the rate is 40 or 45 percent, but not when it is 7 or 15 percent. Yet that would be a good thing. The time those lawyers spend helping the rich skirt the estate tax is, from an economic standpoint, pure waste.

HKO

Consistency is important. While the estate tax only affects a relative few, it has far greater impact on the decisions that affect investment and economic growth.

 

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Violating Horizontal Equity

From The NYT and economist Greg Mankiw,  Why Taxing Fairly Means Not Taxing Inheritances:

Excerpt:

From my perspective, the estate tax is a bad way to tax the rich because it violates a principle that economists call horizontal equity. The basic idea is that similar people should face similar tax burdens.

Consider the story of two couples. Both start family businesses when they are young. They work hard, and their businesses prosper beyond anything they expected. When they reach retirement age, both couples sell their businesses. After paying taxes on the sale, they are each left with a sizable nest egg of, say, $20 million, which they plan to enjoy during their golden years.

Then the stories diverge. One couple, whom I’ll call the Frugals, live modestly. Mr. and Mrs. Frugal don’t scrimp, but they watch their spending. They recognize how lucky they have been, and they want to share their success with their children, grandchildren, nephews and nieces.

The other couple, whom I’ll call the Profligates, have a different view of their wealth. They earned it, and they want to enjoy every penny of it themselves. Mr. and Mrs. Profligate eat at top restaurants, drink rare wines, drive flashy cars and maintain several homes. They spend their time sailing the Caribbean in their opulent yacht and flying their private jet from one luxury resort to the next.

So here’s the question: How should the tax burdens of the two couples compare? Under an income tax, the couples would pay the same, because they earned the same income. Under a consumption tax, Mr. and Mrs. Profligate would pay more because of their lavish living (though the Frugals’ descendants would also pay when they spend their inheritance). But under our current system, which combines an income tax and an estate tax, the Frugal family has the higher tax burden. To me, this does not seem right.

HKO

The estate tax encourage conspicuous consumption, and discourages long term thinking and investment. Redistribution of inherited wealth seems to take care of itself.

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The Loss of American Competitiveness

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from The Great Degeneration by Niall Ferguson

Experts on economic competitiveness, like Michael Porter of Harvard Business School, define the term to include the ability of government to pass effective laws; the protection of physical and intellectual property rights and lack of corruption; the efficiency of the legal framework, including modest costs and swift adjudication; the ease of setting up a new business; and effective and predictable regulations.  It is startling to find out how poorly the United States now fares when judged by these criteria.  In a 2011 survey, Porter and his colleagues asked HBS alumni about 607 instances of decisions on whether or not to offshore operations.  The United States retained the business in just 96 cases(16%) and lost it in all of the rest. Asked why they favored foreign locations, the respondents listed the areas where they saw the U.S. falling further behind the rest of the world.  The top ten reasons included:

  1.  The effectiveness of the political system
  2. The complexity of the tax code
  3.  Regulation
  4. The efficiency of the legal frameworks
  5. Flexibility in hiring and firing
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A Hard Shift Left

from The Wall Street Journal, Fred Barnes writes The No-Growth Democratic Party

In 1997 President Bill Clinton signed the Taxpayer Relief Act, cutting the tax rate on capital gains to 20% from 28%. Senate Democrats voted 37-8 in favor of the bill. House Democrats backed it 164-41. In 2015 Mr. Clinton’s wife, Democratic presidential front-runner Hillary Clinton, wants to raise the current 23.4% rate on capital gains, nearly doubling it for wealthy investors.

In 1982 Sen. Bill Bradley and House member Dick Gephardt, both Democrats, unveiled an ambitious tax-reform plan that would spur economic growth by eliminating loopholes, broadening the tax base and reducing the top rate on individual income to 30% from 50%. What Mr. Bradley and Mr. Gephardt started, President Reagan and Congress finished in 1986. A bipartisan tax-reform package was enacted, with a top rate of 28%.

Now Democrats have a new definition of tax reform. “They want to broaden the base and raise tax rates,” says Douglas Holtz-Eakin, the former head of the Congressional Budget Office. Rather than promote economic growth—a goal of Mr. Bradley and Mr. Gephardt—this approach is almost certain to hamper it. After nearly seven years of sluggish growth during the Obama era, the party seems to think that even an anemic 2% annual increase in GDP is too much.