A Flea in the Fur of the Beast

“Death, fire, and burglary make all men equals.” —Dickens

Tag: Tax policy

The wealthy tax exodus (the evidence)

by pdxblake

Offered without comment from the Tax Justice Network (ht Mark Thoma):

In a population of 65 million we have one confirmed departure, one effort to leave… We see kind of story this again and again: hyperventilating threats from a country’s wealthiest citizens that they will depart in droves if they have to pay higher taxes – yet when their bluff is called they fail to act – but still keep on grousing and issuing the threats. It’s tiresome. …

One of the best testing grounds for the ‘tax migration’ theory is among individual states in the United States, which each levy variable state taxes … and where cross-state migration is far easier than moving, say, to a different country…

And here the evidence is unambiguous. Take this Stanford paper, for instance, which finds ‘negligible’ effects from a large state tax hike in New Jersey. Or this ITEP paper entitled “Where Have All of Maryland’s Millionaires Gone?… Or this, on New York, or this, on Oregon.

The last thing I write about the ‘fiscal cliff’ (I hope)

by pdxblake

Hey, I’m still just as sick of the “Fiscal Cliff/Slope” as I was before.  The main reason of course, is that it was an unforced error beginning with its own creation, after the failure of the “Stupor Committee” around the Debt Ceiling increase.  That whole saga (which could repeat itself in 2 months) was based on the Republican willingness, and even enthusiasm, to let the US government default on its debt for political reasons (something which would put the US in Argentinian territory).  Anyway, the issue at hand is whether the Bush tax cuts are finally allowed to expire, whether a few annual ‘fixes’ are made to, for example, make up for the Alternative Minimum Tax threshold not being indexed to inflation, as well as make across the board cuts to government spending.

There are some political considerations that make one or the other thing more likely than another (here’s one suggestion of how it could go down and here’s a viewer’s guide to the negotiations), but the more interesting issue is the economics of the various aspects of the plan.  I’ll break it into a few different components:

1) Taxes go up on the non-wealthy – It is pretty well accepted that higher taxes on the non-wealthy is not the best way to help the economy grow right now.  However, the bulk of the discussion in Congress has omitted the most important contractionary tax rise that  will kick in in 2013: the end of the payroll tax cut.  The current tax cut reduces the payroll tax by 2% (from 6.2% to 4.2%, of taxes that are dedicated to funding Social Security, and are made up for by funds transferred in the budget so that Social Security remains funded at the 6.2% rate).  Since payroll taxes are capped (you only pay Social Security tax on the first $110,100 of payroll income), the tax cut is targeted to the income groups where the stimulative impact is the greatest, because it goes to people in small amounts every other week, at payroll time, who are most likely to direct a big portion of that towards additional spending.  As Krugman has reminded time and time again, your spending is my income, which is how the impact of the additional spending is higher than just the amount that everyone spends from the payroll tax cut (there is a ‘multiplier effect’).  So, the discussion around the ‘fiscal cliff’ should focus more on stimulative issues, like extending unemployment insurance and the payroll tax cut.

2) Taxes go up on the wealthy – This is the biggest focus of the negotiations, as far as I can tell, with much of the debate going to the somewhat pointless argument of what the threshold is between someone being wealthy and not wealthy.  That threshold is arbitrary, but even if it is set pretty low ($200,000 for example) it would only affect a small proportion of the population.  According to IRS data, setting that threshold (according to data collected for 2009) would affect 7.8 million people, or just 5.6% of all the returns filed.  Of course, it would be more likely to see a number somewhat higher, between $200,000 and $400,000, which will pretty dramatically reduce the number of people affected.  So, we should not worry too much about the effect of taxes going up on the wealthy, simply for the reason that it will not have much of an effect because, well, because they’re wealthy (the higher taxes will have a limited impact on their spending, which will mean little contractionary impact on the economy as a whole).

3) Defense spending is cut – The reason I separate this out from the non-defense spending cuts is that there is a flavor of Republicans who want to cut government spending and claim it will not affect the economy, but who then warn that any cuts to defense spending will cripple the economy.  Hypocritical?  Yes.  Opportunistic?  For sure.  The key thing to remember is that economics is not a morality play.  The impact of government spending on the economy will be the same (more or less) whether you personally approve of that spending.  Defense spending, non-defense spending, infrastruture improvements, whatever.  More spending will move through the economy, building on itself through the multiplier and in a severe recession like we are seeing now, it will be supportive to economic growth.  Cutting it severely before the recovery is strong enough to withstand the drag from the cuts is not smart, but for some reason people (Republicans) who hate the government want to pretend that since they don’t like government spending, cutting it will not act as a drag on the economy.

4) Non-defense spending is cut – As I said before, spending is spending is spending.  And in a slow recovery, increased government spending will be supportive to the recovery and spending cuts will act as a headwind.

So, there you have it, my thoughts on the economic impact of the various parts of the ‘fiscal cliff’.  Not the most scientific analysis, but that’s not really necessary since it is mostly a political exercise.  It will have an impact on the economy, but not in the ‘cliff’ sense that if there is no deal on January 1, everything goes to hell.  It is more analogous to going off a cliff with a hang-glider that has a motor that isn’t started now.  There is a glide downward, but once the deal gets done (the motor turns on) most of the damage can be reversed unless it takes so long that you are already close to the ground, in which case you could crash and burn.   But that’s months and months away, so if there’s a deal in the first couple months, no biggie.

Fake Headline: Romney tax policy advisers say “Math is hard!”

by pdxblake

There are many ways to demonstrate that Mitt Ronmey is not speaking honestly about his plan to cut taxes.  First there was the “20% tax cut, paid for by removing deductions”, then it was shifted to “rich people won’t pay a lower percentage than they do now” and throughout it has been “I won’t raise taxes on the middle class”.

In all of these shakes of the etch-a-sketch, there was a core idea that *everyone* loves to repeat on cable television: cut rates and broaden the base.  Cutting rates is self-explanatory: if the marginal tax rates are 10%, 15%, 20%, 28%, 25% now, Romney wants them to be lower for each level.

Where the math catches up with Romney is on the ‘tax cuts will be paid for by cuts in deductions’.  He has never once proposed which deductions will be cut, or for whom.  Will the cuts only affect the wealthy, or people lower on the income spectrum, as Martin Feldstein suggested when he was actively moving the goalposts to try make the math work.

However, all of that discussion becomes irrelevant with the introduction  of an analysis from the Joint Committee on Taxation (the tax policy equivalent of the Congressional Budget Office).  No matter which deductions you target, no matter how you torture the numbers, you can no make the base broadening strategy pay for a 20% tax cut (ht Mark Thoma):

Repealing all itemized deductions in the U.S. tax code would pay for only a 4 percent cut in income tax rates,… an estimate … that casts doubt on Republicans’ ability to finance lower income-tax rates with base broadening….


The contribution of finance to rising inequality

by pdxblake

Business Insider provides an interesting chart from a NY Times blog of inequality state-by-state that reveals interesting trends across the US in inequality.

The purple states are those with the highest levels of inequality and as the colors become lighter, that represents lower levels of inequality.  There seem to be a few trends, for example, the high level of inequality across the South and generally in states that have large concentrations (NY, CT, IL) and those with large technology industry(MA and CA).

It is impossible to attribute causality to the high levels of unemployment without more analysis, but that’s not going to stop me from trying.  The high inequality in the financial states (those containing Wall Street, Greenwich and Chicago) may reflect the underlying trend over the past 30 years of an increasing financialization of the the economy, where financial companies generate a growing share of corporate profit (after tax).

The financial industry has become more deregulated during (particularly the last 30 years, and the profits after tax have risen in line).  There has also been a decline in the taxation on many profits from financial services (for example, by having more favorable tax rates for capital gains and dividends compared to ordinary income).  Financial companies also pay much more interest (and to be more leveraged) than non-financial companies.  Interest expense is deductible from income, so higher leverage benefits companies both from accentuating the profits and losses of the companies, but also by lowering taxable income of financial services companies.

Finance is also a relatively capital-intensive business (there are fewer people needed to generate its profits).  There were 7.7 million financial sector employees in July 2012, out of 133.2 million total non-farm employees (pdf), or 5.8% of total employees, yet finance generated nearly 50% of total profits.  States with large concentrations of finance (which to some degree includes MA and CA through the role of finance in venture capital that has financed the technology and biotech industries) therefore would likely have higher inequality than states that rely less on financial services industries.

That is not to say that these levels of inequality should necessarily lead to policies that stifle some areas of finance (I’m not saying it is time to try to undo the development of the internet, iPhones Google, etc).  Just that finance is doing quite well but doesn’t need any extra incentives in the form of lower tax rates on profits and favorable treatment of highly leveraged companies (through allowing the deduction of interest expenses).

Incentivizing leverage leads to more of it being used, which–all other things being equal–will increase the variation in profitability (larger swings to profit and loss).  Since 2008, it has been clear that the rewards in finance tend to be privatized and the losses are socialized.  Below is a graph that shows the annual percentage changes (continuously compounded) of financial profits or losses.

Because the 2008 crisis was so big, I had to stop the data in mid-2008 to make it viewable.  But it shows a distinct rise in the level of volatility in financial profits (look how many times the blue line gets above 60% and below -20% after about 1980 compared with before).  The costs of financial boom and bust (particularly involving institutions that are too big to fail) are large, and borne by taxpayers (well, last time we made a profit, but to took several years).  Profits accrue to the private financial institutions and are magnified by leverage.  This leads to even more outsized gains when things are doing well, which will–other things equal–lead to higher inequality.

And that leads me to the conclusion that while there have been a large amount of positive things in the past 30 years, and finance has contributed to making them happen, incentivizing financial institutions to take larger and larger risks by using greater amounts of leverage, while also giving favorable tax benefits to the profits makes very little sense and not only enhances the income inequality of the country, the times when things go wrong (and taxpayers have to step in) effectively acts as a subsidy to the financial industry.  With the relative positions between the Republican and Democratic parties on regulating finance more tightly and on shifts in the tax rates on higher income people, it is not surprising that a lot of the campaign money (particularly from the large financial institutions) has flowed towards Mitt Romney.  They benefit from the higher leverage that is encouraged by allowing interest expense to be tax deductible, and also pay a lower proportion of their income in taxes that will be used to step in when things go wrong.

I leave a discussion of why the South is more unequal to you.

Tax cuts for the rich don’t help the economy grow, but they do help inequality rise

by pdxblake

The Congressional Research Service tells us what we all pretty much new before: tax cuts for the wealthy are not that stimulative (ht Mark Thoma).  The report concludes:

“The evidence does not suggest necessarily a relationship between tax policy with regard to the top tax rates and the size of the economic pie, but there may be a relationship to how the economic pie is sliced,”

The relationship between economic growth and tax cuts relies upon strong ‘supply side’ effects.  That is, when you give the wealthy more money by cutting their tax cuts, they will take that money and invest in businesses to supply the economy with more goods.  However, when taxes on the wealthy are already at low rates and the economy is constrained not by lack of supply but by lack of demand for goods and services, the effect that is already small will decline, at the cost of higher long-term deficits.

The evidence that tax cuts for the wealthy benefit them (and not the rest of the country) is common sense: when you give people with the most wealth already more money, their share of after-tax income will rise relative to the rest of the economy.  The slanting of tax cuts for the wealthy will also affect the relative after-tax inequality of the US compared to other countries, and will limit the ability of government policy to reduce poverty.  Jared Bernstein at the Center on Budget and Policy Priorities posted this chart on his blog:

What this shows is the poverty levels of the countries before taxes and transfers (social programs to help the poor) for a bunch of countries.  The poverty level before taxes and transfers is relatively equal and the US is close to the average (26.4% poverty rate).  However, once the impact of tax policy and government social safety net programs is included, the picture changes dramatically.

The US has a much higher after-taxes and transfer poverty rate than the other countries–17.1% versus the average of 9.8%.  This comes from both less progressive taxation (relative to other countries the difference between the tax rates paid by the wealthy and the rate paid by the poor is lower in the US) and fewer social programs that reduce poverty (transfers).

If the government gives more tax cuts for the wealthy, the progressivity of the tax system will be reduced and the ability of the government to provide more generous social safety net programs will be reduced by higher deficits (and not the cyclical type of deficits the US is currently running which should decline once the economy begins to grow more rapidly).  Both of these effects will contribute to higher after-tax and transfer poverty rates and the US is already has much higher poverty rates after taxes and transfers than many other high-income countries.

Think about that the next time a Republican tells you we need to cut taxes on the wealthy rich job creators.

NY AG subpoenas private equity firms including Bain for tax dodging strategy (you can say it’s political, but only if you read the whole post)

by pdxblake

The NY Attorney General subpoenaed several private equity firms in July, including Bain Capital about their use of a loophole to lower the taxes paid on their management fee (distinct from their ‘performance fee’).  For a quick refresher on the management fee and performance fees, refer to a Business Insider post written shortly after Gawker published a load of leaked documents on Romney’s investments:

Private-equity firms, like other fund management firms, generally charge two kinds of fees on each fund:

  • Performance-based fees, which pay the firm ~20% of any gains
  • Management fees, which assess an annual ~2% fee on all invested capital

Both of these fees are standard professional fees, so they both should be taxed at ordinary income rates.

In one of the most outrageous loopholes in the tax code, however, the fund-management industry has bamboozled (or simply bribed) Congress into treating “performance-based” fees as capital gains rather than income. So, unlike lawyers, doctors, architects, mechanics, and hundreds of other service professionals, fund managers get the privilege of having their fees accrue tax-free in their funds.

The post–which I have to admit was rather prescient in light of the NY AG’s subpoenas–quotes a tax law professor who saw an illegal tax dodge in the Bain funds:

This trick involves treating not just “performance-based fees” but management fees as capital gains rather than ordinary income.


Bain also claimed capital gains treatment for its management fees. This allowed the funds (and Romney) to avoid paying ordinary income taxes on all of its fees, not just its performance fees.

How did Bain claim that its management fees were capital gains?

By “waiving” its management fees in some years in exchange for receiving a priority payment of “profit” in future years.

In other words, instead of taking a $20,000 cash payment for each $1 million under management in a particular year, Bain opted to take the $20,000 payment in a later year, as the first portion of any profit distributed from one of the fund’s investments.

The basic problem with the entire ‘carried interest’ loophole is that the money invested in the funds on which the performance fee is based is 1) not the investment managers; 2) not at risk of loss (at least for the investment manager); and 3) even if the performance fee did deserve capital gains treatment, it should have been taxed before it was used to generate a ‘capital gain’.

On point 3, if you make a capital gain by selling your house, then you bought your house with after-tax income (paying your mortgage, deducting from your income the amount of interest you paid on the mortgage).  When you sell it, you get to pay taxes on the gain you made at the capital gains tax rate (which for the moment is lower than on income) so that you are not paying taxes on the money you were already taxed on that you used to buy the house (the gain is the sale price – purchase price).

However, the ‘gain’ in the performance fee is just income.  There was no ‘capital’ that was invested to yield a profit, which is taxed as a capital gain (which again, for the moment, happens to be higher than the ordinary income tax rate).  Well, let me correct myself, there is capital, it is just not yours, you just manage it for other people.  So you have not invested your capital (money saved up, which you already paid taxes on), but you still want to treat the profit on it like a normal capital gain.  Hmm, interesting.

Returning back to the issue of the subpoena, trying to get capital gains tax treatment of management fees is even more egregious since the manager is not really putting the money (earlier period fee income) at risk of loss by granting a waiver and ‘investing’ it in the fund.  It is investing it in the funds with both 1) first priority from any future profit distributions; and 2) full knowledge of the investments in the fund,  knowledge of which ones are in black, and the power to sell the profitable investments to cash out the management fee in the future.

So, it shouldn’t be too surprising to see an investigation, and yes, you can bring on the “Schneiderman is doing this to help Obama win” argument.  You may be correct (I think it’s unlikely since Romney is relatively unconnected with Bain’s practice of trying to game the tax treatment of management fees, at least in the past 10+ years, or is he?).  However, it doesn’t win the argument about whether management fees should be taxed at the capital gains rate.

DeLong finds some fuzzy math in Martin Feldstein’s WSJ op-ed (and I found some more)

by pdxblake

Martin Feldstein provoked Brad DeLong’s ire with a Wall Street Journal op-ed that tries to show how Mitt Romney’s tax cut plan could lead to no increase in the deficit or the need to raise taxes on middle- and lower-income Americans, and takes issue with five points, including one where Feldstein makes a mathematical error by counting savings from removing tax deductions as if the current tax rates were in place, rather than Romney’s proposed rates.  DeLong rushes through the first four objections (which he gives Feldstein a pass on since the fifth is the most easiest and makes Feldstein’s point moot, since $152 billion > $168 billion is a false statement).  Here are a few of the four other items

First, Feldstein argues that Romney’s tax cuts cost $168 billion, once you add in the ‘dynamic scoring’, which is wonk-speak for magical supply side effects where tax cuts benefit the economy so as to raise GDP enough that the taxes on the additional GDP offsets some of the cost of the tax cuts.   The CBPP has a good summary of the arguments against using dynamic scoring in budget estimates which can best be summarized as the effects are highly uncertain and are likely to be small.  The love of conservatives for dynamic scoring is that, when fed in high estimates of the feedback from tax cuts to growth that are not well supported in empirical study (they are high than reality), they show that tax cuts have a more stimulative impact on economic growth than they actually do, and lead to the conclusion that tax cuts are much less costly than they actually are.

Second, Romney has not provided any specific deductions that he would propose eliminating and the Tax Policy Center report (pdf), which he criticized unfairly as being ‘biased’, makes an overwhelmingly friendly assumption that deductions on high-income could politically be eliminated (a very rosy assumption in favor of Romney’s plan).  By assuming this rosy political outcome, it effectively lowers the impact on the deficit by assuming more deductions will be removed for high-income people than can be credibly assumed.

Thirdly, Feldstein’s plan ‘moves the goalposts’ as DeLong points out by including in the amount of deductions those claimed by everyone with more than $100,000 (a much larger group than Obama’s focus for not extending the Bush tax cuts for only those people with incomes of $250,000).  This leads his estimate of total deductions at $636 billion to be much larger than any plausible scope for deductions to be eliminated since it includes the mortgage interest deduction for people earning between $100,000 and $250,000.

While one can argue the merits of the deduction of mortgage interest for this segment of earners (and for all earners), there is no way in hell that any politician would vote for a bill to do this any time in the near future (remember, it would have to pass the House whose members have to go try and get re-elected every 2 years).  The conservative Tax Foundation has data showing that of all tax returns filed, 6.8% of those are filed by people with incomes between $100,000 and $200,000, and include an average of almost $9,000 in deductions from the mortgage interest deduction.  With 150 million returns filed annually, the back-of-the-envelope amount of deductions that are being added into Feldstein’s number by moving the goal post just from the mortgage interest deduction is approximately $91 billion, or about one-seventh of the value of the deductions he thinks (with questionably support) could be eliminated.

The final straw for Brad DeLong was when Feldstein estimated the budgetary impact from eliminating $636 billion in deductions, where he used an average rate of 30%, which DeLong explains:

Taxpayers making more than $100K/year in AGI had marginal tax rates of 25%-35% in 2009–an average tax rate, Feldstein assumes, of 30%.

After Romney’s 1/5 reduction in tax rates they will have tax rates of 20%-28%–an average tax rate of 24%.

Multiplying not the wrong 30% but the true correct 24% marginal tax rate by the $636 billion in itemized deductions gets us not $191B but $152B.

$152B < $186B

DeLong makes a great point, but even giving a pass on the average tax rate being 30% (rather than what it would be, closer to 24%), and instead focusing on just moving the goalposts from $200k down to $100k (for the income levels where the deductions start to be eliminated) and just focusing on the impact of the mortgage interest deduction, we have Feldstein’s questionable ‘savings’ from eliminating deductions of $191 billion reduced by $27 billion ($91 billion in deductions * 30%), which puts Feldstein’s math wrong again because he is now saying:

$164B < $186B

And as DeLong pointed out, there are so many dodgy assumptions that get Feldstein to his original numbers that it is more and more ridiculous for anyone to defend the idea that Romney’s budget can either a) not increase the deficit, or b) not lead to increased taxes on people earning under $250k / $200k / $100k (pick your favorite).

UPDATE: Feldstein responds and starts to say, “While I still believe the assumptions that I used in my analysis…” before Brad DeLong interrupts and says “No! No! Ten thousand times no!  If the maximum marginal tax rate is 28%, you cannot cut $1 of itemized deductions and increase revenue by 30 cents. It is not possible. The assumption that you can is unbelievable. Nobody should believe it.”

Showing the impact of Obama and Romney’s tax plans (CHART)

by pdxblake

This is the clearest visual description of the difference between Romney and Obama’s tax plans.  Unlike most charts, this one from Naomi Robbins at Forbes (refining a chart from Ezra Klein) modifies his chart so that the horizontal axis so it is scaled correctly. What it shows is how narrowly Obama’s tax cuts affect the wealthy (the parts of the blue towards the right are very narrow meaning very few people are affected).  Romney’s plan gives a ton of tax cuts to the highest income people and the cost is borne across a large number of low income Americans.  I don’t think that’s fair, and this should be what the election is about, not selectively editing quotes about whether or not you did or did not build that.

Obama partial extension of Bush tax cuts gives a tax cut to 95% of the top 1%, GOP cries “socialism!”

by pdxblake

The types of people that Paul Krugman derides (rightly) as the Very Serious People are always bringing in ideas for deficit reduction and for “solving” the problem of the “fiscal cliff” that have one thing in common: they talk a big game about imposing shared sacrifice in the name of deficit reduction, but in fact call upon the wealthy for very little of the cuts.  The LA Times’ Michael Hiltzik describes:

“Yet there’s still reason for most Americans to fear the deal-making aimed at avoiding the fiscal cliff. For one thing, the debate seems increasingly to be driven by the wealthy, who can be trusted to protect their own prerogatives while declaring everyone else’s to be wasteful. “

Hiltzik digs up the statistics I didn’t have time to find from the Tax Policy Center (run by the Urban Institute and the Brookings Institution) about the extension of the Bush tax cuts excluding the points which only affect the very wealthy.  As I expected, even the “middle class” tax cut extensions primarily benefit those with the highest incomes because these tax cuts don’t apply only to those earning less than $250,000, they also benefit the wealthy’s first $250,000 in income.  Here’s how the numbers break down (taken straight from the Tax Policy Center report):

The key numbers is that, even though Obama’s proposal is supposed to amount to a tax increase on the wealthiest  Americans, it doesn’t do even that very well and amounts to a huge tax cut for the wealthiest.  Only 4.3% of the top 1% face a tax cut that averages just above $11,000 while the rest of the 1% who get a tax cut see their average tax cut of over $16,000).

Moving up to the richest of the rich, the 0.1% (i.e. those people with more income than 99.9% of all Americans), more of them face a tax rise, but still only 1 in 8.   The 7 out of the 8 highest one-tenth of one percent income earners get a massive tax cut, averaging nearly $68,000 per year.

This compares with a tax cut on the middle quintile (people around the middle of the income distribution, between the 40th and 60th percentile), who all get tax cuts, but only see $1,100 per year.

And yet even Obama’s proposal which is overwhelmingly tilted towards the wealthy is derided by Republicans as “Socialism!” as they cry out to protect the “job creators” (who apparently aren’t protected when 95% of the wealthiest 1% of Americans see a tax cut under Obama’s proposal, which gives you an idea of who the GOP sees as their natural base).


Republicans are holding middle-class tax cuts hostage to get high-end tax cuts extended

by pdxblake

Now that the Democrats have passed by 51-48 an extension of the Bush tax cuts, there is a clearly defined line for politicking the differences between the two parties’ positions.  Of course, the Senate bill is meaningless because it would have to be first introduced in and passed by the House, and if that ever happened, hell would freeze over the Republicans would not hold their filibuster fire that they direct towards anything Obama supports.

The economics of the two plans are clear though: the Senate bill continues the tax cuts for the middle and upper-middle classes (all the way up to income levels of $250,000).  The wealthy get the same tax cuts for the most part, but not the additional tax cuts that make the cost much higher with little economic benefit.  To benefit the economy as a whole the money would have to get invested, which is unlikely since there is plenty of capital already around and insufficient demand to justify much more new investment, or be spent, and the wealthy spend a smaller proportion of their income than people with lower incomes.  All it does is balloon the deficit further (which the Republicans sometimes like to pretend they care about, but actually don’t).

So, now we wait for the election to get any resolution on the automatic budget cuts in the sequester and the run up to the December 31st deadline for the entire Bush tax cuts to expire.  And, from where we sit now, Obama refuses to let the high-end Bush tax cuts be extended (rightly, in my view) and the Republicans say they will hurt the economy by allowing the parts of the tax cuts expire that have the most impact on consumer spending, at a time when the economy is weak.

Go here for more of our commentary on tax policy and the Bush tax cuts.