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Neutered Tax Cuts

The drive for tax cuts obscures the greater benefit of tax reform and simplification.  Taxes, however, are only a single component of friction costs. If the purpose of tax reform or tax cuts is to stimulate investment and productive activity then it can not be isolated from other friction costs. If taxes are cut but regulations are increased then the expected benefits are muted. Taxes and regulations are only two of the friction costs. The real cost of capital which is dependent on Fed policy and debt is also critical.  Trade policy  can open and close markets for raw materials and finished products. A  litigious culture plagues some industries more than others.

The dynamics of the tax cuts also matters: What taxes are cut? By how much?

One friction cost that is commonly overlooked is uncertainty.  Uncertainty is different from risk.  When the rules are known the investor can make rational decisions about risk. When the dealer can randomly change the value of an  ace, the black jack table will become vacant.

Kevin Williamson addresses the very real cost of this uncertainty in Regime Change in National Review:

One of the basic problems here — perhaps unexpectedly — is the national debt and the deficits that contribute to it. The debt presents straightforward problems: Keep running up the debt and eventually debt-service payments become so crushing that the federal government has no money left for anything else. But there are other problems related to the national debt, problems rooted in earlier efforts to reduce the deficit. Because of the way our budget rules now work, tax cuts passed by Congress frequently are temporary. They have sunset provisions, and have to be renewed. Hence all that endless talk a few years ago about “renewing the Bush tax cuts,” which eventually became the Obama tax cuts. The Byrd Rule, which is part of the 1974 Budget Control Act, allows senators to block bills being passed through the reconciliation process if those bills would add to the deficit over a ten-year budgetary horizon. Hence, lots of tax cuts expire in ten years. It doesn’t do any good, really — it’s just a way to keep statutory spending controls from doing their jobs.

There is not going to be any certainty on the big domestic-policy items — taxes, health care, the entitlements, and much else — until there is a reasonable, sober, sustainable settlement on our national fiscal challenge. So long as the charade of ten-year sunsets and CBO-satisfying accounting shenanigans rule the day, there is not going to be any predictability — and that is going to impose real costs on economic growth, employment, wages, and future prosperity.

 

The Real Loser from Tax Reform

From my article in American Thinker, Save the Swamp:

I call the difference between the statutory rate and the actual rate the ‘special interest spread’.  It is the difference between the official stated rate and the actual rate paid after deductions and credits.  True tax reform should seek to reduce this spread to zero. 

But there remains a great benefit to meaningful reform in the form of simplification.  The influence of the Federal government is less because of its growth in size that because of its proxies in the private sector. Nonprofits, state and local agencies, and special interests do the work of the federal government and much of this is done through tax preferences and benefits. These proxies will all be fighting to retain their part of the swamp. 

Taxes should be low and broad based, as simple and as permanent as possible, while minimizing the ‘special interest spread’ and the marginal rate.

Such a reform castrates much of the federal power over the economy, requiring the separation of operating revenue requirements from their desire to engineer and design social outcomes. Any transition to such a system will not be equally shared and there is no need to pretend otherwise.  Many who lose their mortgage deduction will make it up in lower rates, but some will not. This is the problem with reforming complicated systems with an accumulation of special provisions.

The benefit to the economy, however, would be so strong that those who are comfortable in the swamp should not be allowed to derail it. 

The Social Engineering Trap

From Kevin Williamson at National Review, A Conservative Tax Hike

The federal government uses the tax code for all sorts of social-engineering purposes: to encourage and subsidize investment in manufacturing or green-energy businesses, to reward charitable giving, to encourage home-ownership. The federal government is not very good at social engineering: Its efforts to help low-income Americans with bad credit borrow money to buy houses they could not afford was a significant contributor to the subprime meltdown and financial crisis of 2008–2009. Encouraging home ownership through subsidizing mortgage interest (which is what that deduction actually does) can encourage the wrong kind — the low-equity, high-interest kind — of homeownership. Likewise, offsetting state income taxes encourages states to jack up their levies: Because some costs are passed on to the federal treasury, Sacramento can get $1 in state income-tax revenue at a real cost to California taxpayers of less than $1.

The federal government really should not use the tax code to encourage or discourage any kind of behavior. It should use the tax code to raise the money necessary for the operation of the federal government in a way that minimizes economic damage and market distortion.

Let California Be California

From Kevin Williamson at National Review, A Conservative Tax Hike

Eliminating deductibility for state and local income taxes is of course politically satisfying for mean-spirited conservatives such as myself — it constitutes a very substantial tax increase on the sort of well-kept and comfortable lefty Californians and New Yorkers from whom we tend to hear more than maybe we really want to on all sorts of political issues. Rich Democrats in Santa Monica and on the Upper West Side think we should have higher taxes, and we knuckle-dragging right-wingers down in Texas and Florida disagree. This way, everybody gets what he wants.

California is very expensive by American standards and a bargain by world standards. As it turns out, people are pretty good at figuring that out: California has for some years been losing its native-born population to the other 49 states, but those emigrants are more than replaced by immigrants from around the world, many of them from places that make California look lightly taxed and well governed. (Which it is, by comparison with India or Venezuela.) That isn’t how I’d do things if I were the Emperor of Malibu, but Californians, so far, seem to be content with their own way of doing things. Let California be California.

And let Californians pay for it.

 

True Tax Reform

from An Anti-Growth Tax Cut by Kevin Williamson in The National Review

In economic terms, there are two things going on with those revenue and deficit numbers. One is the structural issue, i.e., tax policy, spending, etc. The other is the cyclical issue, i.e., the ups and down in the economy. Both structural and cyclical factors have an effect on growth, revenue, and deficits — and they both have an effect on each other, too. Disaggregating those is a complicated business, one that does not necessarily provide any clear answers. But if you want to stick with the naïve supply-siders’ story, then you have to credit essentially all of the economic growth following their favorite tax cuts (Reagan’s in the 1980s, Kennedy’s in the 1960s) to tax policy in order to arrive at the conclusion that these tax cuts not only paid for themselves but actually added to federal revenue. Given the fact that the economy is growing right now, that is not a very plausible story.

The Kennedy tax cuts saw the top individual income-tax rate reduced from 91 percent to 70 percent, and the Reagan cuts saw it reduced from 70 percent to 50 percent. The current top rate is 39.6 percent, which kicks in at $470,700 for a married couple. President Trump’s preferred policy would reduce the top rate to 35 percent, while congressional Republicans have aimed at 33 percent, along with modest reductions in other brackets and, possibly, a large reduction in the corporate tax rate. Our corporate tax rate is one of the world’s highest on paper, but the effective rate — what corporations actually pay — is on average unexceptional, though it varies significantly from industry to industry and firm to firm.

HKO

A good idea can not be held responsible for the people who espouse it. The Laffer Curve is a sound statement of the theory that under certain circumstances a cut in the statutory rate can yield an increase in revenues. This is really nothing more than the fundamental principle that price affects demand: the more you charge for work and risk the less of it you will likely generate.

But the application of the theory is subject to several variables. There is an apex on the curve where lower rates will yield lower revenues.  Kevin appropriately states that there is a big difference from starting at a rate of 90% and a rate of 38%.  There are several factors that affect economic growth and taxes are only one.  It is hard to distinguish the source of growth when so many other factors, cyclical and other, influence growth.

The Laffer Curve will apply more to taxes that are easily avoidable that those that are not. Capital gains taxes can be avoided or at least controlled by when you sell you asset. A payroll tax can only be avoided by not working.

The Laffer Theory does not claim that all tax cuts pay for themselves or that spending cuts and debt control are irrelevant.

Kevin is also correct to distinguish the statutory rate from the effective rate. The amount you pay after deductions and credits is the effective rate. The greater the difference between the statutory and the effective rate the more the government is using the tax code for social engineering and economic meddling.

True tax reform is much more than the mere lowering of rates. True tax reform is a lowering and a broadening of the tax.  We can collect the same or more by lowering the statutory rate but eliminating the special deductions that favor one investment over another, one industry over another, and one crop over another. This would eliminate much of the incentive for lobbying that so pollutes our politics. It  eliminates much of the power of the elected to control the economy and to leverage that control for political donations.  Only half of the problem of money in politics is bribery, the other half is extortion.

True tax reform would drastically simplify the tax code and the compliance costs which may be as high as 25% of the revenues.  This may adversely affect the accounting and tax planning industry, but this would eliminate massive unproductive work.  It would stimulate new business creation and expansion and could have as much of a positive effect as targeted tax cuts, with much less effect on tax revenues.

True tax reform would stop villainizing  the wealthy. High estate taxes incentivize conspicuous consumption and divert resources into nonproductive schemes to avoid the death tax. High corporate taxes make tax strategies an unwelcome partner with productivity to achieve financial success. Both should be much lower. All corporate taxes are ultimately paid by consumers.

True tax reform would be consistent. Hillary Clinton complained of the short term thinking of American business, but the greater problem is the short term thinking of American tax policy. Every Congress votes for tax reform of some matter. Few business people believe that any meaningful tax reform will remain in place long enough to consider in their long term planning.  Immediately after every tax increase some political fool will find a microphone to shout that the rich are not paying their fair share and that “you didn’t build that.”

True Tax reform respects the words as much as the numbers. Wealth is needed to support our government and the welfare state. Wealth goes where it is welcomed. Anti wealth rhetoric also impairs wealth creation and its tax revenues.