Fiscal Cliff

[ArtK78]

I would suggest "top effective marginal tax rate" is a more useful number than "top marginal tax rate". And yes, there's a point where it's too high and you lose money by people working even harder than they do to figure out loopholes that reduce the Effective tax rate. But one of the things we saw this year clearly was that a top marginal tax rate of 30ish percent can be reduced to zero if you have enough money to set stuff up, and if $200K to hire a top tax accountant for the whole year will give 5, 6-fold returns.

"Top effective marginal tax rate" is a meaningless term.

 

And, with all due respect, the rest of your post is also meaningless (perhaps fantasy is a better term).

[mycroft]

I'll believe you - given who you are. WADR has its usual internet meaning, of course :-) So give me a less meaningless one that measures what that intends to - that, back in those days, nobody was paying anywhere near 90% tax on the money they earned out of the top marginal tax bracket, but it had to be that high to get the amount of tax that the country needed? And that now that the top rate is 28% or so, that they're still not paying anywhere near that percentage? And what percentage is it? Well, nobody knows, because "effective tax rate" is a meaningless term. That is particularly convenient if you make enough money to hire a full-time tax accountant, or if enough of those people exist and you *are* a full-time tax accountant.

 

Absolutely, fantasy it may be. Show me where reality is, then. Because the stories are that after a point, the bigger you are, the less of that bigger you have to give the government, at least in percentage terms. I'm sure the stories lie, or only show the outliers.

[ArtK78]

"Effective tax rate" and "marginal tax rate" and "top marginal tax rate" are meaningful terms.

 

A person's effective tax rate is tax paid divided by income.

 

A person's marginal tax rate is the tax rate on the last dollar earned (or next dollar earned, to be more precise).

 

Top marginal tax rate is the highest tax rate specified in the tax code which was 35% in 2011.

 

"Top effective marginal tax rate" is a meaningless term. Does it mean the highest effective tax rate paid by any person subject to tax?

 

There are other odd situations. For example, if one is entitled to the earned income credit, it is possible that one's marginal tax rate is very high, as for each additional dollar earned not only is that dollar taxed but the amount of the credit allowable may decrease. And there are other situations in which one's marginal tax rate may be higher than the rate specified in the tax code because of the loss of deductions or credits with increasing income.

 

The main reason why many very wealthy individuals pay less tax at the margin than ordinary working stiffs is that the wealthy earn much of their income as capital gains and dividends, which have favorable treatment under current law. Mitt Romney revealed that he paid income tax at an effective rate of about 15%, which is, by coincidence, the rate charged on capital gains and dividends. 15% is of course no where near the top marginal tax rate of 35%.

[awm]

While Mycroft didn't express himself very well, perhaps what he means is: "What is the mean effective tax rate for people who are well above the threshold for the highest marginal rate?" It's naive to think this will be close to the top marginal rate -- it will be increased by state/local taxes and decreased because of capital gains rates and other deductions. It seems that a lot of million-per-year incomes (for example) are paying closer to 15% than they are to 35% under the current system (because of capital gains mostly; it also helps to be able to declare residency in a no-income tax state, which is easy when you have multiple residences).

[Zelandakh]

Art, take the last dollar being earned by a top-rate taxpayer and then calculate all taxes, including indirect taxes, that are taken from that dollar. I guess this is what is meant.

 

On the spending game, I got down to 189 on a quick run-through; I am sure I could do better if I considered everything in detail. Out of interest, does anyone know how much a small reduction in Corporation Tax would cost? It seems to me that throwing tax cuts that are targeted towards businesses (not individuals) might be a good way to appease Republicans while still improving the overall debt situation without causing a sudden spending crash. But perhaps these are too costly(?) I certainly would not be voting for spending cuts that add an extra load on business, which some of those in the list seemed to suggest.

[kenberg]

I believe that Congress should support the National Science Foundation and NSF should support mathematical research. I don't expect Congressmen to prove , or even to understand, mathematical theorems.

 

The point is that while I will take this quiz (I haven't yet but I will) it is not my thought that I should be able to write a budget and then Congress should thank me and pass it. They took on the job of constructing a budget and they are supposed to do their jobs. And they are supposed to advance the interests of the country. Yes we must live in the real world, yes we know that money talks, etc. But enough is enough. If Republicans really want to hold to the idea that under no circumstances is any rich person to be remotely inconvenienced then they will thoroughly deserve their coming slide into irrelevancy.

[Cthulhu D]

Art, take the last dollar being earned by a top-rate taxpayer and then calculate all taxes, including indirect taxes, that are taken from that dollar. I guess this is what is meant.

 

On the spending game, I got down to 189 on a quick run-through; I am sure I could do better if I considered everything in detail. Out of interest, does anyone know how much a small reduction in Corporation Tax would cost? It seems to me that throwing tax cuts that are targeted towards businesses (not individuals) might be a good way to appease Republicans while still improving the overall debt situation without causing a sudden spending crash. But perhaps these are too costly(?) I certainly would not be voting for spending cuts that add an extra load on business, which some of those in the list seemed to suggest.

 

The only workable plan I could come up with entailed ~1000 million dollars of tax hikes, which the house republicans won't pass. Can anyone come up with a workable plan that doesn't include that much in the way of tax increases?

 

Anyway, as for the cost of corporate tax cuts, Romney's plan was a 10% corporate tax cut (from 35 to 25%) which cost $100 billion per year or so. Not that the defacto corporate tax rate in the US is actually much lower due to dumb accounting rules you let corporations use, tax treatments for oil and gas companies that amount to huge subsidies because Exxon is notoriously unprofitable etc. Cleaning those up would let you fund the 10% cut in corporate tax rates straight up.

[blackshoe]

A person's effective tax rate is tax paid divided by income.

To me, this is the interesting number, particularly if we want to talk about "fair share". Have there been any studies or reports published showing this figure across the broad spectrum of income?

 

Edit: thinking about it a little more, Federal Income Tax isn't the only tax burden on folks. Can we compute an effective tax rate that includes all taxes? I think perhaps this is what that website does that tell us we're working for the government until Christmas or whenever it is, and for ourselves afterword.

Edited December 14, 2012 by blackshoe

[phil_20686]

To me, this is the interesting number, particularly if we want to talk about "fair share". Have there been any studies or reports published showing this figure across the broad spectrum of income?

 

This is not actually a good number. Mainly because, so defined, the effective tax rate is highly age dependent. For example, suppose I was in reasonable job earning $100,000 a year. But i never got promoted. Early in my life, I might get mortgage deductions and child benefit, plus there should be adjustments for benefits received, like public education for children. By the time I was into my fifties, with children all grown up and mortgage paid off, my effective tax rate would be much higher.

 

The structure of life/the economy is such that the young should generally pay less tax than the old, and often when you look at figures aggregated by income you obscure these essential facts.

[blackshoe]

So also collect age data, and then show the breakdown of various income brackets by age.

 

A decision as to tax structure without examining such data is purely political. It makes more sense, to me at least, to base such a decision on facts.

[mycroft]

Thanks, Art. Sorry I was so flippant last time - I thought I truly was being at least reasonably clear, and got tripped up by jargon meaning of terms. It sounded, given that I didn't understand the jargon, that I was being told "it's meaningless to try to work out how much tax is actually being paid by the people who are in the top bracket, they'll never make that clear, it's fantasy to think otherwise". I wasn't. I'm sorry.

 

Yes, what I meant was "the top marginal tax rate is 35%. What rate is actually being paid on money in that bracket, by the group of taxpayers that are far enough above that limit that the money earned below that rate can be effectively ignored". Back in the day, they needed that rate at 90% to get 50%; so what's being paid on 35%?

 

I don't *really* have a problem with cheaper capital gains taxes (the argument that we want to subsidize real business growth is a good one); I do have a problem with the way things are determined to be capital gains rather than income (especially when it becomes "mandatory bonuses" or "stock options with 'guaranteed' payouts after vest" (by the board "revaluing" the options if they turn out to be valueless), or "money taken from a company is a capital gain even if the company is fatally harmed by it" - because it has nothing to do with business growth and everything to do with disguising income as capital gains. I have an issue with the fact that business buying (from the stock market up to some of the more - selfish - things that Bain Capital was doing) is so more favoured by the tax laws that money making things that get sold to make money is "a chump's game" compared to money making money.

[ArtK78]

Thanks, Art. Sorry I was so flippant last time - I thought I truly was being at least reasonably clear, and got tripped up by jargon meaning of terms. It sounded, given that I didn't understand the jargon, that I was being told "it's meaningless to try to work out how much tax is actually being paid by the people who are in the top bracket, they'll never make that clear, it's fantasy to think otherwise". I wasn't. I'm sorry.

 

Yes, what I meant was "the top marginal tax rate is 35%. What rate is actually being paid on money in that bracket, by the group of taxpayers that are far enough above that limit that the money earned below that rate can be effectively ignored". Back in the day, they needed that rate at 90% to get 50%; so what's being paid on 35%?

 

I don't *really* have a problem with cheaper capital gains taxes (the argument that we want to subsidize real business growth is a good one); I do have a problem with the way things are determined to be capital gains rather than income (especially when it becomes "mandatory bonuses" or "stock options with 'guaranteed' payouts after vest" (by the board "revaluing" the options if they turn out to be valueless), or "money taken from a company is a capital gain even if the company is fatally harmed by it" - because it has nothing to do with business growth and everything to do with disguising income as capital gains. I have an issue with the fact that business buying (from the stock market up to some of the more - selfish - things that Bain Capital was doing) is so more favoured by the tax laws that money making things that get sold to make money is "a chump's game" compared to money making money.

The "back in the day" comment is interesting. It is true that during WWII the top marginal tax rate reached 91%. But what is often ignored is that there was a 50% cap on compensation income (wages and salary income). So, the only income that could be taxed higher than 50% was income from investments - interest, dividends, capital gains, rental income, royalty income, etc. I cannot tell you whether capital gains had any preferential treatment back then. I do know that at one time within my memory (1960s? 1970s?) net long-term capital gains income was determined completely separately and then it was given a 60% discount before being counted as taxable income. So, if that were the case during WWII, even at a top marginal tax rate of 91%, the tax would be less than 40% of the realized capital gain.

 

By the way, the primary reason that capital gains is given a tax preference is not due to some public policy such as business growth or job creation (although the public policy reasons are often cited by advocates of reduced taxes on capital gains). The primary reason is that capital gains accrue over the course of a number of years, and it is deemed to be improper to tax multiple years worth of gain at the same rate as income earned within a single tax year. That is consistent with the distinction between short-term capital gains (taxed the same as any other income) and long-term capital gains (which are given a preferential tax treatment).

[barmar]

By the way, the primary reason that capital gains is given a tax preference is not due to some public policy such as business growth or job creation (although the public policy reasons are often cited by advocates of reduced taxes on capital gains). The primary reason is that capital gains accrue over the course of a number of years, and it is deemed to be improper to tax multiple years worth of gain at the same rate as income earned within a single tax year. That is consistent with the distinction between short-term capital gains (taxed the same as any other income) and long-term capital gains (which are given a preferential tax treatment).

I always thought the policy goal was to discourage churn. Otherwise, what's wrong with taxing multi-year growth at the full rate? Why should the government get different tax on a $20 gain depending on whether it happened quickly or slowly?

 

MA used to have 5 capital gain rates, for <1-, <2-, <3-, <4-, and >4+ year holdings. What a PITA that was.

[mike777]

I always thought the policy goal was to discourage churn. Otherwise, what's wrong with taxing multi-year growth at the full rate? Why should the government get different tax on a $20 gain depending on whether it happened quickly or slowly?

 

MA used to have 5 capital gain rates, for <1-, <2-, <3-, <4-, and >4+ year holdings. What a PITA that was.

 

 

Yes, the debate is do taxes affect behavior. If not ok.

 

If they do then what behavior do you want to encourage or discourage via tax laws.

 

As many posters and others point out perhaps what is more important is to use tax laws for fairness and social justice.

 

 

For example do you want to use tax laws to create a bigger social safety net or to provide incentives for risk taking?

 

As for the deficit in 2013 it seems economists/bbo posters dont even agree whether we should have a goal which decreases the projected 1000B deficit or to increase it.

[Mbodell]

If you want fairness, which I do, then you really need to look at wealth, not income. Unfortunately those calculations are hard, and income and wealth are correlated, so we tax income. Also the estate tax can be used as a method to tax wealth, since calculating wealth once a lifetime is more doable than each and every year.

 

The big money, in addition to higher rates, is in attacking the tax expenditures. These are more than one trillion dollars a year (I.e., you'd close the deficit just through eliminating these). Of course these are really popular - but due to the nature of the way they work they are generally regressive with the greatest gain going to the people with the most income (top 1% get 24% of tax expenditures, 66% go to top 20%, just 3% go to the bottom 20%). Some of the numbers include (these are 2008 numbers):

 

1. Exclusion of employers’ contributions for their employees’ medical insurance premiums and medical care ($131 B)

2. Net exclusion of contributions to and earnings of employer-provided and individual pension plans. These include 401(k) plans, Individual Retirement Accounts (IRAs), the savers’ credit, and Keogh plans. ($117.7 B)

3. The deductability of mortgage interest on owner-occupied homes. ($88.5 B)

4. For businesses the accelerated depreciation of certain types of machinery and equipment. ($55.9 B)

5. The deductability of nonbusiness state and local taxes other than on owner-occupied homes. ($49.1 B)

6. Deductions of charitable contributions to nonprofits. ($46.8 B)

7. For businesses the deferral of income from controlled foreign corporations. ($31.5 B)

8. Homeowners may exclude up to $250,000 ($500,000 for a couple filing jointly) of capital gains on the sale of their principal residence. ($30.0 B)

9. The deductability of state and local property tax on owner-occupied homes. ($29.1 B)

10. Taxpayers with one or more children under age 17 qualify for a partially refundable child credit of $1,000 per child. ($28.4 B)

11. The reduced tax rate on long term capital gains is the another large tax expenditure. ($24.2 B)

12. The step-up in basis of capital gains precludes assets from being taxed on any gains accrued, but not realized, at the death of the owner. ($21.5 B)

 

Some of the above we'd want as good policy (but there might be more efficient ways. Medicare is much more efficient than private insurance, so perhaps eliminate 1 and move people to a pure public model - and note the billions we spend above doesn't cover everyone as many with no jobs or with jobs with no health coverage don't get the benefit). But some is bad policy, like the ~$150 billion we give to encourage home ownership that helped to create the housing bubble, when in reality it is not at all clear that home ownership should be encouraged (recent research suggests we as society might be better off with more renting to help shift people geographically as jobs and other demographics suggest moves and as people change their housing needs through their lifetimes). Note also that this $150 billion a year is more than the budget of Department of Housing and Urban Development.

 

But regardless of if you like the policy or not, the fact that they are regressive in implementation, and once given really hard to cut (Grover Norquist wouldn't mind, and would probably cheer, if you cut the budget of HUD, but he'd scream bloody murder if anyone reduced the tax expenditures on home ownership or anything else) makes them a perverse form of spending.

[mike777]

Of course one problem with the estate tax is defining just what is an estate. Keep in mind tax lawyers can pull much of your wealth out of your "estate".

 

 

But once you state fairness is your goal, that will help define the rest of what you want to do regarding tax policy and who gets to have the power to make that policy.

It becomes more a discussion over power and less over policy.

[blackshoe]

The purpose of taxes should be solely to finance those necessary functions of government, if any, that cannot be funded in any other way. "Social justice" shouldn't enter into it, and "fairness" only insofar as everyone should pay his fair share of the necessary government revenue.

 

So the first question ought to be "what functions that government performs are 'necessary'?" Rand suggested there are only three: the police function, the (civil) court function, and the military function. Whether you agree with her or not, you have to admit that the more things government sticks its fingers in, the more it becomes about power and the less about "necessary functions".

[awm]

To take another tack, perhaps the goal should be to maximize economic efficiency and growth.

 

Perhaps fortunately, this might lead to some of the same conclusions as a more "fairness" oriented approach. Extreme wealth inequality is not good for the economy (it leaves a lot of people wanting/needing things without the money to buy them, while a small number of people have too much money to effectively spend). Children lacking good nutrition and education is bad for the economy (leads to a shortage of skilled workers and may indirectly increase crime). A large amount of government debt is not necessarily bad for the economy (short-term government spending may yield more of a boost than a balanced budget, especially when the government borrowing costs and inflation are low). Large amounts of pollution tend to be bad for the economy (for example we spend a lot of money fixing messes from hurricanes, flooding, oil leaks in the gulf, etc) and its probably better policy to tax or criminalize the externality than to pay for the cleanup.

[mike777]

If your goal is to maximize efficiency and growth then I would think you want to point tax policy towards incentives for investors to take risks with their capital.

 

 

Perhaps the biggest problem with govt spending/asset allocation decisions is the people making the decisions dont have skin in the game.

[Winstonm]

If your goal is to maximize efficiency and growth then I would think you want to point tax policy towards incentives for investors to take risks with their capital.

 

 

Perhaps the biggest problem with govt spending/asset allocation decisions is the people making the decisions dont have skin in the game.

 

There is a distinct difference between tax policies that encourage business growth and blanket tax breaks. There is also no evidence to support the idea that the wealthy will do anything more than invest in treasury bonds with excess tax savings without enough demand to stir their interest in expansion.

 

As to the idea that the government makes poor investment decisions, I would say that claim is empty rhetoric as the government has produced such innovations as the interstate highway system, the Colorado river dam project (which created the conditions for Southern California to prosper), and Medicare (with its 3% administration costs compared to 18-20% in private health insurance).

[phil_20686]

Its hard to know what to do about the global elite. Its good macro economics to reduce capital gains to zero. In the end, saving your money rather than spending it on holidays is good for the economy. Ultimately, all savings are translated into investments, and investments make the economy more productive.

 

Ultimately, businesses invest when the (forecast risk adjusted) return on investment is better than the interest rate. The interest rates are set so as to match saving behaviour with investment preferences. The central bank can move interest rates a little around their natural rate to smooth consumption, but ultimately that is a second order effect. Interest rates are low because the world has a savings glut/lack of investment opportunities.

 

When interest rates are low, marginal technologies to replace labour become profitable, and labour share loses out to capital, which is to say, that lots of jobs are replaced by technology, as the economy channels savings into the most marginal of savings.

 

When you see it this way, you see that it is basically impossible for governments to counter this dynamics. Confiscating wealth amounts to capital destruction, in a very real sense, your business is funded out of someone's savings. If you tax it, and give the proceeds to the poor, they will spend it on consumption, and the result will be less investment, and lower overall productivity.

 

This might seem pessimistic, but in fact it is not. The key is to realise that inequality will fall with the next "technology shock". Technology shock is what happens when a new idea or product renders a large fraction of the current capital stock essentially valueless. It necessarily imposes huge losses on the current wealthy, interest rates rise to induce increases savings rate, to invest in the new technologies. Labour migrates rapidly into the new industries, the rising competition for capital (higher interest rates) means that replacing workers with technology is harder, and so labour share increases.

 

Predicting technology shock is a mugs game, but fwiw, my money is on automated distribution networks, ie. driverless cars, post delivered by fleets of self navigating quadrocopters.

 

=========================

 

The other thing that drives the interest rate dynamic over the long term is demographics. In a very real sense, inequality is a result of the baby boom generation + women entering the work force. The rapidly growing work force put capital investment in sufficient demand to drive double digit real interest rates, saving relatively modest amounts at those kind of rates of return, leads to extremely rapid wealth accumulation. That is why the baby boom generation has such relatively high rates of savings, and such large accumulated wealth. Similarly, when they are rapidly saving for retirement (now) they drive interest rates lower, and when the dis-save during their retirements, they will drive rates higher.

 

It should be obvious that a growing working age population leads to higher interest rates, but somehow many people don't seem to see it.

 

=========================

 

A lot of prominent people talk about the fed creating a boom by holding down interest rates during the long boom, and creating asset bubbles. It is important to realise that they are wrong. Interest rates fell because of declining returns to new technologies compared with the past, and because of the population dynamic, which created a perfect storm to drive real interest rates lower. The fed has no real control over the natural rate of interest, and sure, it can set interest rates, but only in a narrow band around the natural interest rate, otherwise you get either recession or inflation.

[phil_20686]

I would say that claim is empty rhetoric as the government has produced such innovations as the interstate highway system, the Colorado river dam project (which created the conditions for Southern California to prosper), and Medicare (with its 3% administration costs compared to 18-20% in private health insurance).

 

When talking about markets its important to realise their limitations. Markets are the best invention imaginable for channelling capital based on realisable profits. The problem with infrastructure, is that the best design does not generate any profits. It instead generates huge externalities. The government `loses' a huge amount of money on the highway, it simply hopes, in a vague sense, that the externalities, including "creating the conditions for buisness to prosper" plus even more vague benefits like "citizens like visiting their extended families more easily".

 

The same reason that markets channel money to companies that provide the minimal levels of environmental compliance, is the same reason they will never do sensible infrastructure planning: markets do not price externalities.

 

Any market where the externalities are more important than the profit incentives, are a bad place for markets.

[mike777]

There is a distinct difference between tax policies that encourage business growth and blanket tax breaks. There is also no evidence to support the idea that the wealthy will do anything more than invest in treasury bonds with excess tax savings without enough demand to stir their interest in expansion.

 

As to the idea that the government makes poor investment decisions, I would say that claim is empty rhetoric as the government has produced such innovations as the interstate highway system, the Colorado river dam project (which created the conditions for Southern California to prosper), and Medicare (with its 3% administration costs compared to 18-20% in private health insurance).

 

 

Winston I never said the government makes only poor investment decisions but please if you are going to list success stories please list the failures also. You present only one side. Lets be clear when we use the word innovation or asset allocation.

 

In any case yes my point is still that the biggest problem is that those making these decisions dont have skin in the game.

 

I certainly agree with your point about blanket tax breaks but am surprised you did not bring up issues such as "too big to fail" or agency issues and moral hazard when it comes to tax policy.

[mike777]

"This might seem pessimistic, but in fact it is not. The key is to realise that inequality will fall with the next "technology shock". Technology shock is what happens when a new idea or product renders a large fraction of the current capital stock essentially valueless. It necessarily imposes huge losses on the current wealthy, interest rates rise to induce increases savings rate, to invest in the new technologies. Labour migrates rapidly into the new industries, the rising competition for capital (higher interest rates) means that replacing workers with technology is harder, and so labour share increases.

 

Predicting technology shock is a mugs game, but fwiw, my money is on automated distribution networks, ie. driverless cars, post delivered by fleets of self navigating quadrocopters."

 

 

Thus it is a crucial competitive advantage to encourage risk taking. To be open and embrace uncertainty and volatility.

 

If your money is on it, you got skin in the game. It means something to put your money on your predictions.

[y66]

anyone who invokes ONE TRILLION DOLLARS to make a point about the budget has no idea what he’s talking about.

 

http://graphics8.nytimes.com/images/2012/12/15/opinion/121512krugman4/121512krugman4-blog480.jpg