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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.

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Jaded at Tax Reform

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From Robert Samuelson at The Washington Post, The coming middle-class tax increase

There is a broader message here. Both parties have constructed rationales for avoiding middle-class tax increases, which would be highly unpopular. It’s not that these rationales are illegitimate: The effect of tax policies on economic growth is clearly important; similarly, redistribution is a central function of the welfare state. But the resulting tax policies don’t come close to covering the real costs of government.

HKO

For all their soak-the-rich talk higher taxes on the rich will raise revenues minimally and will barely impact inequality. If they raise it too high production and investment – and its accompanying job and wage growth  - suffer and the outcome is totally counterproductive.

With tax rates where they are lower rates, even with fewer deductions, will still leave lower revenues even when scored dynamically.  There is the further risk, rarely addressed, that the  voters and investors have such little confidence that the rates and the policy will remain unchanged for very long that they are less likely to respond to tax incentives in any long term way. They have become jaded at tax reform.

There is one other option that Samuelson omits: reduce payments from the welfare state to only those that truly need it. There are many benefits that are aimed at middle class tax payers.  As the author noted there is no way that revenues can be significantly raised without the middle class paying a significant portion- one way or the other.

 

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Driving Corporations Overseas

from the Wall Street Journal, The Corporate Tax Political Divide

 ‘Why is the tax code making it better for foreign companies to invest in the United States than U.S. companies?” That was the pungent question posed by Pfizer Chairman and CEO Ian Read in an interview last week with this newspaper. Washington has no good answer, and President Obama shows no inclination to reform the worst system of corporate income taxation in the industrialized world. So Mr. Read’s Pfizer, currently located in New York, is considering a merger with Dublin-based Allergan. Basing the combined company in Ireland would free up more cash for shareholders, employees and research.

And yes, moving the business overseas would ironically make it easier to invest in the United States, thanks to the insane tax burden the Treasury now applies when U.S. firms want to bring profits back from overseas and invest them at home.

Mr. Read was speaking in general terms and not discussing the particulars of the potential merger his firm is now discussing with Allergan, but he neatly explained the competitiveness problem faced by U.S. companies. He noted that after paying Irish corporate income taxes, a firm based there still retains roughly 88 cents on each dollar of profits, which it can choose to invest in the U.S.

But if a U.S. company makes the same dollar in Ireland and pays the same local tax to Irish authorities, its 88-cent after-tax profit gets whittled down to 65 cents if the money is invested in the U.S. That’s because the U.S. is one of a small handful of tax collectors worldwide that demands to be paid even after a domestic company has already paid the overseas territory where it made the money.