Tax Loopholes and Tax Reform

Not sure they will get around to tax reform this year, but I am told that tax reform is high on the legislative agenda. Tax reform usually involves significant changes in income and/or business tax rates. For example, we hear talk that US corporations pay tax rates that are very high. A tax reform might, therefore, reduce the rate to something lower. Tax reform might instead lower tax rates for the middle class or for rich people. There are many ways to do tax reform.

As a result of the lower tax rates of a tax reform, tax revenues would likely fall. So an important part of any tax reform that lowers tax rates but does not want to create larger government deficits is the accompanying ways to raise tax revenue. One approach would create a totally new tax. Some thought was given to the USA adopting a value added tax or perhaps an import tax. More likely, however, is the closing of existing tax loopholes. That approach sounds much better to most of us. But as I will show below, it is not so easy and the attempt to close loopholes may actually doom tax reform.

First, our friend Wikipedia says a loophole is an ambiguity or inadequacy of a system, such as a law or security, which can be used to circumvent or otherwise avoid the purpose, implied or explicitly stated, of the system. That makes a loophole sound pretty bad. It should be easy to eliminate tax avoidance. But a further look at tax loopholes suggests that many of the biggest ones are there for specific reasons.

We sometimes use the word tax expenditure for myriad reasons that allow people to avoid paying tax. Tax expenditures are defined as special provisions of the tax law such as exclusions, deductions, deferrals, credits, and tax rates that benefit specific activities or groups of taxpayers. Tax expenditure? Tax loophole? Pretty much the same thing. But the wording is kinder. Why? Because it implies that it isn’t an error or a deficiency in the system. Rather, it is an intent to promote an end. Getting rid of a loophole sounds easy. But a tax expenditure has a purpose. Do we really want to end it? If so, who gets hurt?

Below I list only some of the major tax expenditures and the amounts (in billions of dollars) estimated by the Tax Policy Center for 2018 (http://www.taxpolicycenter.org/briefing-book/what-are-largest-tax-expenditures)

Exclusion of employer contribution for medical care premiums

  and medical care $235.8

Exclusion of net imputed rental income $112.7

Deferral of income from controlled foreign corporations $112.6

Capital gains $108.6

Defined benefit and defined contribution employer health plans $140.4

Mortgage interest expense on owner-occupied homes $68.1

Earned income tax credit $63.6

Deductibility of state taxes $63.3

Child credit $54.3
Charitable giving $51.2

There are plenty more but this list adds up to just short of a trillion dollars. Thus we learn two points. First, that’s a healthy amount of money if we are looking for loopholes to close. Second, who is going to resist closing each one of these? People who want cheaper healthcare? People who receive rental income and capital gains? State and local governments? Poor people and those who represent poor people? Parents? Homeowners?

Other federal government tax loopholes?

            American Opportunity Tax Credit to reduce the cost of education

            Savers Tax Credit helps low income people save for retirement

            Lifetime Learning Credit to reduce cost of education

            Retirement Saving Accounts

            Carried Interest Loophole for mostly high income taxpayers

  529 College Saving Plan for parents saving for child’s education

                      

Finally comes the fun part. There are so many loopholes in our tax system that you would have difficulty listing them all. Investopedia (http://www.investopedia.com/financial-edge/0512/americas-most-outrageous-tax-loopholes.aspx) found some interesting ones that relate to state and local taxes:

            The Florida Rent-A-Cow Credit

            Washington DIY Cigarette Discount

            The Arkansas Credit for Naturally Destroyed Autos

            The Accelerated Depreciation of NASCAR Tracks

            Larry’s JD exemption (just kidding)

Even with these last few loopholes, there were reasons for instituting them. Closing tax loopholes is not a slam dunk. Tax reform and reducing our tax rates is valuable for many reasons. But if tax reform is not going to blow a hole in our national deficit and debt, then some of these tax loopholes have to go. Which ones will you vote for? 

Medical Care Costs

(I apologize for the formatting this time. This one looks pretty bad. This blogspot is not user friendly when it comes to formatting and formatting is not my thing.)
On July 18 and 25 I wrote blogs that  focused on government spending on healthcare. I got some questions and decided to look a little further into medical costs. 

Below are words I lifted from the Bureau of Labor Statistics which define the two medical price components found in the US Consumer Price Index. Medical Care relates mostly to Commodities like pharmaceuticals and medical devices. The larger of the two components measures the prices of Medical Care Services from regular doctor's office visits to hospital services to buying a pair of glasses.

Medical care in the CPI is broken down into medical care commodities (mostly prescription and non-prescription drugs) and medical care services.

Medical care services is the larger of the two components, representing over three-fourths of the medical care weight and about 6 percent of the entire CPI market basket.

Exactly what does the CPI price in medical care services? The largest components are hospital services and physicians’ services. Also included are dental services, services by other medical professionals, eyeglasses and eye care, and nursing homes.

In other words, the medical care services index in the CPI reflects the cost to consumers not only of trips to the doctor’s office or to the hospital, but also of trips to the dentist, psychologist or chiropractor, or even buying a new pair of glasses or staying in a nursing home.

The goal today is to compare the long-term behavior of these two medical price series to the performance of the overall Consumer Price Index which includes everything purchased by typical US urban consumers. 

The first table below presents the inflation rates for five decades beginning in 1966 and ending in 2016.  You can see, for example, that the CPI rose 8% per year from 1966 to 1976. In the next decade it rose by 9% per year. Since then inflation has been falling to where it grew by a mere 2% per year from 2006 to 2016. In each of those decades the price of medical care rose faster than the CPI. For example, in the decade from 1976 to 1986 Medical Care Commodities was increasing by 13% per year while the CPI rose by 9% per year. Medical Care Services rose even faster than Medical Care Commodities in three of the five decades. It rose, for example, by 14% per year from 1976 to 1986. 

The second table lets you see more directly how Medical Care Commodities and Medical Care Services were changing relative to the overall CPI. For example, from 1966 to 1976 Medical Care Services rose by 12% per year relative to the CPI at 8% per year. That implies that Medical Care Services were rising 50% faster than the CPI. Did that relative performance change? As you read down the last column of the second table you see the numbers 50, 56, 125, 67, and 100. The general trend has been upward for 50 years. Medical Care Services from 2006 to 2016 rose twice as fast as all goods and services. 

For the last 50 years Medical Care Commodities and Medical Care Services have grown much faster than overall prices of consumer goods and services. There is reason to believe from these numbers that the gap has increased over time and while the gap has been larger (1986 to 1996) it was very high from 2006 to 2016. 

The obvious next question is to ask is why. But answering that is no easy task. The provision of healthcare has changed much since 1966 and again since 2006. Medicaid and Medicare made for major changes and more recently Obamacare added new layers of delivery and payment. Today we nail down one point -- the medical sector has been and continues to be highly inflationary when we compare it to the other things we buy. 

The CPI attempts to make adjustments so that we compare apples with apples over time. Therefore, a rise in price should not indicate an increase in quality -- it should be a rise in price for a like or similar good or service. But we know that technology in medicine has been very important and while the Bureau of Labor Statistics may try to adjust for quality, I am guessing these adjustments are not perfect. Healthcare is both better and more expensive. I fear much of what the numbers show is that we are paying more to stay healthy and alive. 

One upshot of today's data. If government is spending more for healthcare today it is not just because of Obamacare. Healthcare prices have overshot just about everything for half a century. If we want to control how much we pay either through or without government, we need to better understand pricing of healthcare goods and services. 

Annual Inflation Rate Per Decade

1966 to 2016, in Percent

CPI All items, Medical Care Commodities, 
and Medical Care Services

			Medical
		Medical	Care
	All	Comm	Services
66 to 76	8	10	12
76 to 86	9	13	14
86 to 96	4	8	9
96 to 06	3	5	5
06 to 16	2	4	4

Relative Annual Inflation Rate Per Decade

1966 to 2016, in Percent

CPI All items, Medical Care Commodities, 
and Medical Care Services

			Medical
		Medical	Care
	All	Comm	Services
66 to 76		25	50
76 to 86		44	56
86 to 96		100	125
96 to 06		67	67
06 to 16		100	100

Fed Policy and a Rubber Seesaw

You know what a seesaw is, right? It’s a lot of fun. It’s a long board with a fulcrum at the center. Tuna sits at one end and Peter sits at the other. When Tuna move downward, Peter moves upward. You can do that all day. Or until the board breaks.

Lots of things in economics are like seesaws. The price of JD goes down and demand for JD goes up. The value of the dollar goes down and the Scots buy more JD. The Fed reduces the interest rate and the economy expands. Lots of seesaws out there.

In the past, the Fed believed in a seesaw called the Phillips Curve. This Phillips Curve said that if the unemployment rate went down then inflation would go up. Since inflation and unemployment were so rigidly related, either one could be used to indicate a need for monetary policy. A reduction in the unemployment rate meant inflation was rising and the Fed could back off. That is, the Fed would give less stimulus to the economy.

But that was in the past. Now the Phillips Curve is no longer rigid. It’s like the Phillips Curve has a bend in the middle, and both ends are going down. Think of the Gateway Arch in St Louis. Imagine a seesaw with both ends on the ground. Weird. Tuna and Charlie would sit there and nothing would happen. How sad.

Dr. Yellen is very confused about all this. Inflation and unemployment are both down. The thing that is curious about her reaction to all this is that she ignores the unemployment rate being down as she favors the information she is gleaning from the inflation rate. The unemployment rate is so low many folks are being tempted to return to the labor force. That should be a sign that Fed stimulus is no longer needed. But Dr. Yellen doesn’t want to be guided by this. She would rather focus on the inflation rate’s downward status. If the inflation rate is down then, by gosh, she is going to keep stimulating the economy.

It seems crazy and backward to me. Unemployment is very personal. People are getting jobs. We should like that. But we also know that pushing unemployment too low can bring very undesirable results. Just like a racer who runs the first lap much too fast, she may not have enough gas left to finish well. Inflation is also very personal. Most of us prefer a lower water bill to a higher one. Ask your neighbor. Is she complaining about prices being too low?  I don't think so. So why would the Fed want to continue with a policy of making things more expensive for us? 

Answering that question requires a fresh paragraph. Why does the Fed want to make things more expensive? The answer is that the Fed associates a low or falling inflation rate with dismal expectations and a lack of buying power. So even if everyone had a job, the Fed would still worry that something is amiss in the economy. And Dr. Yellen would keep stimulating.

What could be wrong with that? There are a couple of problems. One I mentioned above. We often associate over-stimulus with bad future events such as recessions. The second reason is that lower inflation rates might be the result of things the Fed simply does not and should not control. Maybe that thing is global competition. Or maybe the low inflation rate is the result of innovation that lowers prices. Clearly the Fed has no business or tools to interfere with either of those things.

Dr. Yellen has her teeth clenched like a dog with a bone. And she is not going to stop clenching until she gets us back to the good old days when inflation was soaring. She might coax output and income growth above 3% for a while. But if we learned anything from the past, an economy that grows too fast too long gives us a recession and higher unemployment. It is quite possible and highly desirable for her to implement a less stimulating policy. She should get to that task immediately and quit using low inflation as an excuse. Demand too low out there? Ask Amazon.com. I don’t think our problem is insufficient demand. 

Net Neutrality: David Versus Goliath?

I was thinking about words and names and it occurred to me how misleading they can be. Social Security is a good one. Who feels secure about their retirement years because of the Social Security checks they may or may not receive? It should have been called Pin Money or maybe Chump Change. It is a damn shame that so many people will retire with little in the bank and must rely on so-called Social Security.

And then there is Net Neutrality. At first I thought NN had something to do with not touching the badminton net. Then I realized it had something to do with the Internet, and it made total sense – the Internet should be neutral. The Internet should not be for or against Tom Brady. But then I read on and realized NN is all about a war between ISPs (Internet service providers like Comcast and AT&T) and all those content providers (like Amazon, Google, Facebook, and thousands of others).

The issue took on significance when President Obama’s FCC initiated a rule that concluded that Internet service is a basic need. It’s like weed – we all need a little from time to time. No, that’s not true. It is like the pavement between your house and your job. We all need to get to work. Your sexy neighbor with the big smile and hot red car should not have better access to that concrete than you. Be proud of that Lada and drive it right down the middle of the road!

The FCC enacted the Open Internet Order in 2015 to treat Internet service more like a road or a public utility. And thus the issue got hot. President Trump’s FCC reopened the case and is wondering what to do about it, so it is approaching a boiling point. I like the article I just found by Nelson Granados https://www.forbes.com/forbes/welcome/?toURL=https://www.forbes.com/sites/nelsongranados/2017/05/31/the-net-neutrality-debate-why-there-is-no-simple-solution/&refURL=&referrer= ) 

The article is pretty unbiased as indicated by the title – The Net Neutrality Debate: Why There is No Simple Solution. Granados concludes that NN is much like any government regulation – the basic premise might be correct but the unintended side-effects need to be considered. On the one hand, the right amount of NN means more fairness to content providers. Too much NN means a lack of progress, investment, and innovation on the part of ISPs.

When Granados says there is no easy solution, he basically means it is not easy to find the exact point of net benefit to society with NN. As in many cases, the answer lies not in the perception of government versus the company but rather impacts on one set of companies (and consumers) versus another set of companies. As you can imagine, both sets of companies are lobbying the government when it comes to NN. The ISPs (e.g. Comcast, Verizon, AT&T) want lighter regulation. The content providers (Amazon, Facebook, Google, Netflix, and many more) want tougher regulations.

In this blog post today I don’t pretend to know enough about which side is right. Perhaps you will educate me. But what I do think is curious is how many people are phrasing this as a David (content providers) versus Goliath (ISPs) confrontation. And of course, we are supposed to favor tiny sweet David over huge ugly Goliath. So today’s post is a look at the relative size and wealth of some of these companies.

I got the data from the Internet and mostly from Forbes.com. Most of it is for year 2016. So here goes…CP means content provider and ISP means Internet Service Provider.

The largest companies in terms of market value are CPs – Alphabet, Amazon, and Facebook. The largest ISP (AT&T) is valued at $255 billion with Verizon at $199 billion. The main point here is that there is no David and no Goliath if the biggest CPs are duking it out with the largest ISPs.

I will admit that this data may be misleading. For example, saying that AT&T is a CP might be misleading because it operates in numerous business activities. The same goes for Alphabet which owns Google. But the data are relevant in the sense that these companies lobby, and the entire wealth/sales of the company is an indicator of what they are capable of spending on government support. The column presenting each company's sales data is not more helpful in the David/Goliath breakdown. ISPs AT&T and Verizon have huge sales but so does CP Amazon.

I had a limited purpose today. NN is not a David/Goliath story. It is more a government regulation story. We consumers don't really care who wins but we want two things. We want continued investment and innovation from the Internet. We also want fairness in the sense that some content providers are not elbowed out of competition simply because they are friends with the right people. We want our Internet cake and we want to eat it too. Hopefully a public discussion will move the regulatory needle so we at least get a nice brownie with some ice cream on top of it. 

                                             Sales      Market

                                                            Capitalization

                                             $Bil        $Bil

CP          Alphabet                90         583

CP          Amazon               136         423

CP          Facebook               28         411

ISP         AT&T                  164         255

ISP         Verizon                126         199

ISP         Comcast                 80         178

ISP         Charter                   29         101

CP          Priceline                 11          88

CP          Netflix                      9          64

CP          Salesforce                8           58

1969 Was a Good Year

I wanted to compare some data and found a nice series for government spending going back to 1969. Not sure why they started the data in 1969, but they did. So I started thinking about what things were like about 50 years ago.

I started with my favorite subject, me. I finished my BS in Industrial Management at Georgia Tech in June of 1968 and to escape the draft, I started an MS program there. Strangely enough, the draft was not impressed by my love of Industrial Management, so they sent me a draft notice in late 1968. They let me finish two quarters of my new program and asked me to report for basic training in March of 1969. So in 1969 I was about 23 years old and was spending time training in Texas and Colorado. I finally settled into an Air Force base in Tucson, Arizona. I was an Airman First Class. I had one stripe. I think I made less than $100 per month.

On that salary I was lucky that a stamp cost 6 cents and a gallon of gas was about 35 cents, which made it economical to drive down to Nogales, Mexico to buy rum. A dozen eggs was 62 cents. For real people who could think about such things because they had a median income of about $8,300, a car cost about $2,000 and a decent house ran $30,000.

I was fully employed in the USAF in 1969. The national unemployment rate was 3.5%. A recession started in December 1969 so the unemployment rate started rising in 1970. The inflation rate was 4.5% in 1969. I could remind you of more – but that’s probably enough for the purposes today.

My main purpose is to look at how we spend the government’s money today compared to 1969. The table below shows 1969 spending in billions of dollars and as a percent of total government spending. 

                                          BIL$      %ofTotal

       Total Government      183.6          100

       Total Mandatory          53.6            29

       Social Security            26.7            15

       Medicare                       6.3              3

       Medicaid                       2.3              1

Our beginning situation finds government spending of about $184 billion in 1969. What we refer to as Mandatory Spending comprised a little more than a quarter of that total spending. Social Security spending was responsible for most of that – and amounted to 15% of total government spending. Medicare and Medicaid were toddlers in monetary terms – accounting for about 4% of all government spending in 1969.

A lot of water has passed under the bridge since then. For example, my forehead has grown several thousand percent since I was 23, and my time in a 10K race might have tripled. In basic training we had to run a mile in less than 6 minutes with combat boots on. I am not kidding. Anyway, let’s look at our government in 2016.

                                          BIL$     %ofTotal

      Total Government       3,853          100

      Total Mandatory         2,428            63

      Social Security              910            24

      Medicare                       693            18

      Medicaid                       368            10

As you might expect, if all the things we buy went up in price then government spending would do the same, and it did. Government spending went from $184 billion to $3,853 billion. That’s an increase of 21 times. Notice that if median income had gone up 21 times, it would now be about $174,000. So let’s give a big cheer for government growth. Way to go, government.

The above table shows that total Mandatory Spending went from being 29% of total government spending to 63% in 2016. That means – tada – that Mandatory Spending went up a lot faster than overall government. Mandatory Spending went up 45 times in 47 years! If median income had gone up that much, the median person today would be making $374,000 per year. You guys all make that amount, right?

You smarty-pants are starting to get my drift. Now let’s look at Social Security, Medicare, and Medicaid. To cut to the chase, Social Security went up 34 times; Medicare by 110 times; Medicaid by 160 times. These three programs have gone from being 19% of all government spending to 52% of it. Or put another way, all the other things the government spends on went from being 81% of the budget to 48%.

I know I harp on this point a lot. But the baby boom generation is just getting started. We were born from 1946 to 1964. Those born in 1964 are mere babies in their fifties. If we don’t focus more on how we spend money on the old folks, then the rest of you are going to have to live on a lot less. Maybe you should think about it a little more. In case you are interested, if median income had gone up by the same number of times as Medicaid (160 times) we'd each be making about $1.3 million a year. Sweet.