Tuesday, November 21, 2017

The Tax Pizza

Happy Thanksgiving. I hope you are not having pizza for Thanksgiving!

Charlie, Pete, Diane, and Pat wanted to order a pizza. Charlie, of course, wanted tuna on it. Pete, a long-time lover of squid, voted for octopus. Diane favored brussels sprouts while Pat hoped for a nice sprinkling of calf liver. Eventually they compromised and decided to add all those ingredients together. Those of you who have not yet tossed your lunch will get my point. Compromise is not always a good thing. And that’s the way I feel about current tax legislation.

What seems to be missing in all the jockeying and the zillions of words vomited by the media these days is that tax change is done for many reasons. While one should expect that these reasons might conflict as much as liver and squid, it is not unreasonable that we should try to find a compromise. But it is also very possible that compromise will lead to a very bad tasting pizza.

Tax changes can be used for at least the following six reasons:
  1. Taxes might be raised to generate government budget surpluses to reduce the government's outstanding debt. This might also reduce the government’s footprint in financial markets and give more breathing room for firms to attract investors to their assets.
  2. Short-term spending management is part of the Keynesian approach to fine tuning the economy. We give tax breaks to people and firms in a recession so they will spend more. By design these tax changes are temporary and should not have lasting impacts on government debt.
  3. Taxes can be rearranged to create incentives. This need not impact the total amount of revenues collected – only their composition. Reducing taxes (by giving subsidies or deductions) can be useful to promote more work, saving, investment, baby-making, JD production, etc.
  4. Tax changes might be used to affect poverty or the distribution of income. Progressive taxation wherein wealthier people pay higher rates of taxation is part of that effort. But that is just the tip of the iceberg. It is possible to use the tax code to subsidize housing and feed the poor while limiting, say, how much mortgage interest a richer person might deduct.
  5. Taxes can also be used to absorb your time and subsidize the consulting industry. A tax code with many deductions, subsidies, and tax rates means you either spend a ton of time doing your taxes or you hire someone to do them for you.
  6. Taxes can be used to stimulate long-term economic growth. The way to do this usually involves creating incentives for more production. Note – this is VERY different from any of the above goals for tax changes. This one is meant to create an environment in a largely market-oriented economy for businesses to make more money. The idea is that when firms try to make more money they often need to hire more workers and raise their wages. Despite the fact that the immediate impacts of this kind of tax reform are aimed at higher income people and firms, we expect most people to benefit, though not equally.
Okay so that’s six toppings for the tax pizza. So what? If it isn’t already obvious, the main idea here is that we might want to prioritize our goals when it comes to the current tax debate. Putting all six toppings on the tax pizza will likely taste bad. At best, trying to serve six masters dilutes all of them and the end result is a lot of people who are unhappy they didn’t get their fair of the total benefit.

An alternative approach is to prioritize the goals. Of those six goals, which one or two are the very most important for the country today? I tend to harp on economic growth. But I have friends and neighbors who would rather see income distribution as the number one goal of tax change. I say let the political process work that out. While I might disagree with the outcome, at least we might get a policy with a clear intent to improve a difficult problem.

The problem is that our talking heads don’t want to create such a clear set of choices. They survive and profit through obfuscation. They think we are stupid or maybe too busy on our mobile phones to participate. Isn’t it sad that they might be right? Another slice of pizza for you?

Tuesday, November 14, 2017

Trickle Down Tax Policy

Last week I wrote about the Tower of Babel we call tax reform. The main point was the incredible lack of clarity when it comes to changing or reforming taxes. Given all the deductions and other special preferences and the many conflicting goals of tax change, it is very easy to never meet a tax change you ever liked. It is hard to see how legislative progress can be made and even with it, how it might have a discernible positive impact on the country.

But there is even more to the story that I came across in some remarks I read by critics under the rubric of “trickle down”. As an elderly gentleman, I try not to be offended by terms like trickle down, but as an economist I get annoyed when I hear people throwing those terms around. These words are the heart of an argument made by those who are primarily motivated by issues of distribution of income. Trickle down is vivid. A lovely flow of benefits come to the rich folks and by the time they are finished gorging themselves, a couple of drops trickle down to the poor. We could switch the analogy to a lovely and delicious cake consumed by royalty with nothing left but a few crumbs for everyone else. But whether it is a trickle of water or a few nasty crumbs, the point is the same. It is all about how any policy tilts the flow of income or benefits towards the rich. No matter what the intended impacts of the policy might be, all we hear about is trickle trickle trickle.

Common sense allows for the possibility that the true or full impact of a policy could differ from its initial incidence. Let’s suppose a professional team has always done poorly. Its players are paid commensurately. Then the owner decides to bid for a new quarterback. The immediate impact is the apparent unfairness as the new player makes much more money than the others. If the new QB is as good as heralded, the team will win the championship and all the players get bonuses and a big raise. The ultimate impact is what counts despite the apparent unfairness of the initial one. While it is true that these other players still earn considerably less than the handsome, young, sensation with TV contracts and important friends, they are making more than they did before and most would not vote to fire the new player.

Think about one of the many elements of tax reform – significantly reducing the rate of taxation on corporate profits. The immediate impact is easy to envision – a bunch of very rich company owners or stockholders in their condominiums in Vail smoking fine cigars and drinking Spanish brandy. While I cannot deny that owners of corporations will get richer, there is obviously more to the story. Think accounting. I was not a stellar accounting student in Professor Gamoneda’s class at Georgia Tech in 1966, but I do know that if you apply a smaller tax rate to a company’s profits, the company has some additional money to play with. What can that company do with that extra money afforded by the lower tax rate? Here are some examples in no particular order:

            Bribe a government official
            Give it to the owners
            Give it to the employees
            Give a new or improved benefit to employees 
            Add a new wing to the factory
            Buy new production equipment
            Buy new software
            Lower price to get a competitive advantage
            Give more to the local Boys and Girls Club
            Pay off debt faster
            Save it
            Give it to Larry

I am sure I missed something in that list but you get the point. It is tempting, and there might be times when giving most of the extra proceeds to the owners might make sense. But most companies have to compete, and it is pretty clear that they will spend a lot of money to gain an advantage over their adversaries. 

Though this list is long, keep in mind that if your concern is employees, many of those items in the list contain indirect impacts on the incomes of those employees. Any expense – whether it is to better train the employee or it gives that person better equipment to work with  should result in higher productivity. Higher productivity makes it easier for firms to pay them more.

The above can be extrapolated to any element of tax change. There is an immediate and obvious impact followed by less certain and/or less obvious ones. If a tax cut for a higher income person leads to more saving and lower interest rates, that might reduce what a middle income person pays to borrow for a house or a car. Maybe you want to call that trickle down. I just call it economics. To ignore these subsequent but undeniable impacts is folly. 

It is very bad economics to pretend that the only impacts of a tax change make rich people richer and poor people poorer. My advice for those of us who care about the income distribution and poverty is to quit harping on tax reform and spend a few minutes focusing on the real problems that prevent people from leaving poverty status. Or maybe that is too hard to do. If Lyndon Johnson were around and saw the results of his War on Poverty, he might wonder who won the war. 

Tuesday, November 7, 2017

Lesson 20 Taxes (Tower of Babel)

I am sitting at my desk reading all the articles about the latest proposal for tax change in the US. What a mess. Despite it being morning, it makes me want to reach for the extra-large bottle of JD. Have you ever tried JD on Honey Monster Puffs? Wow.

So I scratched my head hoping for some sort of stimulation in brain activity and decided it was time to start at ground zero with a lesson on taxes. Imagine us regular folks trying to decide the best route to Mars. I could begin by wondering about rocket fuel, sun spots, and billboards. And that might lead to discussions with neighbors and perhaps heated arguments, but the truth is that we amateurs might never converge on a realistic answer about the best way to get to Mars. There are so many issues! Better to argue about landscape issues.

So how does any of the above relate to taxes and recent tax proposals? The answer is that while the main idea of a tax is pretty simple, it is the use of taxes that makes the topic so complex. What is a tax? A tax is a way for the government to raise money so it can buy its citizens things. We take for granted that cities, states, and the nation should provide things to their citizens. 

Our Bloomington mayor wanted some shiny, new trash collection trucks so he added a new tax for that purpose. He already gets lots of our money for silly things like fire and police protection but he needed a wee bit more for these pretty new trucks. Each house got equally attractive new garbage cans that come in three sizes so it all made sense and none of us complained.

I think I already got off track. The main idea so far is that governments provide for their citizens, and they need money to do so. So they tax us. Taxes come in all shapes and sizes. In the USA, the main taxes the federal government collects are based on our incomes. State and local governments tend to tax incomes as well as goods we buy. Regardless of the source, these governments use the proceeds to take care of their citizens. That seems pretty simple. If the government wants to spend more, it has to tax more. So why are our friends in Washington, DC, so wild and crazy about the recent tax proposals? Have they been watching too many Steve Martin reruns? 

I can see at least three reasons beyond Steve Martin why the tax proposal generates so much commotion. First, the Federal government is allowed to go in debt. So we have a choice when we want to spend more. We can raise taxes or we can incur more debt or we can have a little more of both. Second, we not only raise most tax revenues based on income but we have a progressive tax system that charges higher rates on higher incomes. Third, the tax system is “holier” than Swiss cheese. No offense to Roger Federer implied. These holes are there for a purpose. Most of us are the recipients of at least one tiny little hole. For example, realtors love it when people can write-off the interest they pay when they borrow to buy their new tiny house. It makes it a lot easier to sell a house when the buyer is being subsidized. The same goes for electric cars and pain pills. Geez, how many of these so-called loopholes or deductions are there? Please don’t count them all up – you have better things to do today.

So what have we learned?  Taxes are pretty simple in principle but in practice they are more complicated than a mission to Mars. It is not simply a matter of government raising taxes so it can buy us shiny new garbage trucks. It becomes a series of questions about how every single person – dare I saw every voter – will react to any given specific way to raise those taxes.
            Tax increase or debt increase?
            Tax high-income people or low-income people?
            Tax young people or old people?
            Tax workers or retired people?
            Tax savers or spenders?
            Tax students or professors?
            Impact housing industry or stockbrokers?
            Tax heirs or new children?
            Tax sexy persons or economists?
            Should I go on?

If you answered yes to the last question, then you need help. If you thought the above stuff was fun, keep reading. It gets even more complicated. We blandly assumed that the tax increase is about raising the resources to spend more. But that is never the whole truth. We use the tax system to cure everything from male impotency to invasive Asian carp.

Think of all the hidden tunnels in our discussions today. Some of us want to use the tax change legislation to reform the tax code so it will create more growth. Others want to use it to address the distribution of income. Still others want to use it for short run stabilization of national spending. While all these goals are laudable, a tax change that improves growth might not immediately improve the distribution of income. A tax program that favors more short-term spending might damage sustainable economic growth. And of course, many of us worry about how these tax changes will affect the price of JD.

I am getting close to my word limit so I better sum up. I can do that with two words – Tower of Babel. Okay, that’s three words. That’s not many words compared to the number you will see and hear in the next days about tax reform. And I bet you this: Few if any of the authors of those words will explain what taxes are and what they should be used to accomplish. Each of these selfish people will take the easy road and will loudly point out how one group is to be favored over another. Having a realistic and thoughtful approach to taxes is beyond them. They would rather achieve star status by fussing about the low hanging fruit. Inasmuch, it is difficult to see any proposal that would have any beneficial impacts passed by the mental institution we call Congress. No one wants to be a loser, and no one will admit what goals they hope to accomplish. 

Even if a proposal is passed into law, we will accomplish no national goals, and we will end up pointing more fingers at each other after the tax change than we did before it.