Be not afraid of growing slowly, be afraid only of standing still.
Chinese proverb
A Good Example of Counterproductive Tax Policies
"In 1695 a window tax was introduced. This caused many homeowners and shopkeepers to brick up their windows." - ASI
Obama, the Buffett Tax and Capital Gains
Obama is engaging in sheer, desperation demagoguery, not bipartisanship or leadership. I seriously want to raise a question here of whether a President can be impeached for acts of gross incompetence and negligence. The recent jobs bill and this deficit plan were specifically written to be DEAD ON ARRIVAL and were little more than public posturing for next year's election. If Obama was seriously interested on negotiating with the Republicans, he would have backed or started with the Bowles-Simpson plan (Obama's own bipartisan deficit reduction committee) and/or with his framework with Speaker Boehner during the debt ceiling talks a few weeks ago. His "jobs bill" is little more than a reworked version of his 2009 stimulus plan, and this deficit plan is just absolutely unacceptable.
Just to list a few points:
- The Medicare/Medcaid "cuts" basically involve cutting NOT market-based prices for health services but the same type of disingenuous "savings" (cuts in already inadequate price lists) used in smoke and mirrors accounting for ObamaCare. Recall the Democrats deliberately misled the American people by knowingly excluding doc fixes from their calculations and matching fewer years of benefits against a larger number of costs. Their "cuts" were NOT "real cuts"--they weren't changing eligibility, they weren't changing benefits, they weren't asking for higher premiums and/or co-pays. Right now some doctors are refusing to accept new Medicare and Medicaid patients; they have to subsidize their care through other patients. Obama is totally ignoring the fact that the government has grossly underfunded reserves for Medicare and has tens of trillions in unfunded liabilities.
- "Balanced deficit reduction? Fair?" I swear--this guy is so predictable, it exasperates me. How many times have I written in these posts that he has a pattern of denying exactly what he's saying? This is a typical gimmick for him I've heard dozens of time: simply deny the fact--today, for instance, he denies that he's proposing is class warfare: it's "math". Let me be clear: the top 1% pay 40% of the income tax burden, more than twice their share of the national income, yet Obama is arguing they aren't paying enough. Half of American workers do not pay a penny towards federal government costs at all through income tax (payroll tax is actually a mandated benefit program, and other programs, e.g., earned income credit, can offset even these costs).
- Tax increases? Only for the well-to-do economic success stories, on some theory they improperly benefited from the lawful Bush tax cuts? Absolutely unconscionable.
- Balanced approach to deficit cutting? WHERE
IS THE BEEFARE THE SPENDING CUTS? What government departments is he shutting down? What programs is he eliminating? How many government personnel is he laying off? What across-the-board cuts? What kind cuts is he applying to baseline budgets? What "sacrifice" is he asking of anyone below the top 2%? This is NOT a serious plan.
Now as to the Warren Buffett millionaire tax rate, a class warfare proposal: there are a number of issues: the effective (vs. marginal) tax rate, different sources of income (wage vs. investment), etc. I will simply refer to a Roberton Williams post to point out Warren Buffett's disingenuous points using the MARGINAL tax rates (incremental income) vs. effective (total income) tax rate and the fact that most high-earners pay a higher effective tax rate than he does and higher than other subdivisions of (lower) income. In a separate post Williams shows that the effective tax rate within the top segment earners ranging from an effective tax rates of 12% for mostly-investment-tax income to 16% for mostly-high-wage income.
There's a subtle point between the optimal (growth-maximizing) vs. revenue-maximizing tax rate. Basically, from a government revenue perspective, the latter is the tax rate at which the government collects the most taxes. Keep in mind we have the laws of supply and demand: when you raise the price of anything, say tax rates--you get less demand (economic activity). The revenue-maximizing tax rate is disputed; obviously we get no taxes at a 0% tax rate and the same holds true at 100%.
There is a well-known amusing anecdote regarding JCT modeling regarding the 100% tax rate:
In 1988 Senator Robert Packwood (R-OR), then ranking Republican on the Finance Committee, asked the JCT to estimate the revenue impact if the government confiscated all income over $200,000 annually. The revenue estimators at JCT responded that such a tax would raise $104 billion the first year, $204 billion the second year, $232 billion the third year, and $263 billion and $299 billion in the fourth and fifth years, respectively. Needless to say, this was a nonsensical estimate. As Senator Packwood noted, the JCT's calculation "assumes people will work if they have to pay all their money to the Government. They will work forever and pay all of the money to the Government when clearly anyone in their right mind will not."Ranges on this revenue-maximizing tax rate value have ranged between roughly 20% on the right and 70% on the left. Democrats essentially argue that tax rates (for higher income) are set below the maximizing rate (i.e., the Bush tax cuts lowering marginal rates from Clinton's 39.6% to 35%) and essentially leaving money on the table, a giveaway to the wealthy. I'll simply point out the undeniable facts that federal revenues reached their highest levels, not under the Clinton tax hike but after the Bush tax cuts and that high earners have assumed the highest relative burden and low earners the lowest relative burden.
The Republicans object to a class warfare tax hike on multiple grounds, but primarily on decreased economic activity or tax base. In essence, the optimal or growth-maximizing rate (i.e., that maximizes national income) is less that the revenue-maximizing tax rate and is a more suitable target for public policy. According to Martin Feldstein:
Why look for the rate that maximizes revenue? As the tax rate rises, the “deadweight loss” (real loss to the economy) rises. So as the rate gets close to maximizing revenue the loss to the economy exceeds the gain in revenue…. I dislike budget deficits as much as anyone else. But would I really want to give up say $1 billion of GDP in order to reduce the deficit by $100 million? No. National income is a goal in itself. That is what drives consumption and our standard of living."When examining the capital gains tax, capital transactions enhance the efficiency of the economy by allocating capital assets to their highest valued uses." In fact, we've seen some zero capital gains rate legislation, e.g., 2004's Working Families Tax Relief Act, which provided such to encourage investment in the DC Enterprise Zone. The idea is simple: the government may not get anything on the transaction, but it is essentially taking a property that generates little, if any tax revenue and gets payoff in the long term. The existing landowner gets to pocket the market appreciation of the profit without the government demanding its cut; it gives him a chance to invest in other, more profitable investments; the buyer also wins because the seller's net proceeds are relevant (factoring in the cost of the tax). Depending on the target project, say, a widget factory, it could also attract other businesses to the area, boost home values, etc. Think of it as starter dough for economic development--and a strategy for improved tax receipts in the long run.
Liquidity in the capital markets is a good thing (e.g., reduced uncertainty in pricing ), and tax rates are inversely related to tax base.
I don't want to get into excess details here, except to point out some key issues involving investment income in particular:
First is the issue of double taxation--the same profitable transactions get hit twice. The corporation pays tax; when it issues say dividends or capital gains to the stockholder, it gets hit a second time. The true rate is what the corporation and the individual pays on the same profit. The double-hit is a big reason behind the notion of a S corporations, e.g., an individual incorporates himself.
Second, there are a number of nuances that Buffett doesn't call attention to (over and beyond toxic, counterproductive, anti-economic growth policies to raise investment taxes as if businesses and individuals didn't already have enough reasons to keep cash on the sidelines without investing in business creation/expansion). There's an interesting paper from the Adam Smith Institute (a European libertarian think tank) called Estimated Revenue Losses From Capital Gains Tax Increases. The following extract discusses what happened when a Swedish conservative government cut capital gains taxes from 30% to 12%; the liberals reinstated the 30% take after coming back into power:
Professors Sven-Olaf Daunfeldt, Ulrika Praski-Stahlgren and Niklas Rudholm of the University of Gavle studied the effect of these rate changes during the period 1993-1995 and concluded that a 10% increase in capital gains tax reduces the number of realisations of capital gains by 8.7% and the realised amount, given the decision to realise, by an additional 1.9%.
They also found that wealthy individuals responded more to changes in CGT rates than less wealthy individuals, realising more gains at lower rates and locking-in gains at higher rates. This accords with the evidence presented in the earlier ASI paper that it is poorer people who are most affected by increases in CGT rates. Also validating the earlier ASI paper, they found that older individuals are more likely to realise capital gains and to realise larger amounts of capital gains than younger individuals.The first paragraph confirms what we already know: the liberals thought they could nearly triple their take of capital gains tax receipts but at the higher rate, they barely increased their receipts--and not at the expense of wealthier investors whom had time to wait until a more market-friendly administration.
Could it be, for instance, that during periods of high capital gains taxes than middle-class or older people can't afford to lock-in (i.e., wait out counterproductive capital gains tax hikes) because they need to sell an asset for income under tough economic times? Wealthier individuals like Warren Buffett have plenty of income to live on and can wait out tax-and-spend administrations, like the fiscally irresponsible Clinton and Obama Administrations (don't try to talk to me about the Clinton Administration's "surpluses"; a lot of that dealt with a GOP House and unsustainable capital gains, largely propped up by easy money from the Fed. One could only wonder what would have happened without Clinton's anti-growth tax hike).
The US experience?
A 1988 paper by Professor Lawrence Lindsey in 1988 concluded “in the long run about 5.4 percent more capital gains will be realized for every one percentage point reduction in the capital gains tax rate.” In 2003 the rate was cut to 15% and revenues grew by 45% over the following three years.Overall observations?
A conservative approach to taking an average of the international evidence would suggest that for every 1% point increase in CGT rates revenue will fall by roughly 2%. (This assumes that the starting point for the revenue rise is above the revenue maximising rate, which evidence suggests is about 10%).This paper also looked at the question of whether there was income-source gaming of lower capital gains rates (remember the Tax Reform Act under Reagan where everything got taxed at 28%)? Basically the authors claim there's scant evidence of that. (In fact, in the US, capital gains on assets less than a year are taxed as ordinary income.)
As a rough summary, the percentages of capital gains that come from different classes of assets are:
• Short-term (held for < 1 year), all assets: 2%
• Medium-short term (1-4 years), non-business assets: 3%
• Medium-long term (5-8 years), non-business assets: 7%
• Medium term (1-8 years), business assets: 33%
• Long term (> 8 years), all assets: 55%
Musical Interlude: My Favorite Groups
Fleetwood Mac, "Second Hand News". This is my favorite track on Rumours, and I've probably played this more than any other Fleetwood Mac song. The lyrics aren't masterful, and booty calls don't reflect my values, but the melody and arrangement are infectious, the guitar work sparkles, and Buckingham's vocal performance and Nicks' harmony are spot on. (I'm sure Stevie was underwhelmed by Lindsey's romantic overture...)
