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Updated: 47 min 39 sec ago

Putting Kids Last at Government Schools

Wed, 08/19/2020 - 12:12pm

Way before we had a pandemic, I wasn’t a fan of the government school monopoly.

To paraphrase Winston Churchill, never have so many taxpayers paid so much money into a system that produced such mediocre results for so many people.

Now that we have a pandemic, the argument against government-run schools is even stronger. Simply stated the government monopoly is too politicized and too inflexible – and that means the the gap between government schools and private schools (and homeschooling) will be larger than ever.

Today, I want to show how the system is driven by bad ideology and bad incentives.

Let’s look at a recent announcement from the government schools where I live in Fairfax, VA. The bureaucrats don’t like when parents utilize private tutors because they would rather have all students fall behind than have some succeed.

Across the country, many parents are joining together to engage private tutors (who are often school teachers) to provide tutoring or home instruction for small groups of children. While there is no systematic way to track these private efforts, it’s clear that a number of “pandemic pods” or tutoring pods are being established in Fairfax County. …these instructional efforts are not supported by or in any way controlled by FCPS… While FCPS doesn’t and can’t control these private tutoring groups, we do have concerns that they may widen the gap in educational access and equity for all students.

Mike Gonzalez had the same reaction. He, too, was surprised that the bureaucrats would openly state their ideological desire for universal mediocrity.

Fairfax Co. Public Schools wants you to know it is not happy that any children are learning through pods. While FCPS “can’t control these private tutoring groups, we do have concerns that they may widen the gap in educational access and equity.”
https://t.co/SPxPgtf7qA

— Mike Gonzalez (@Gundisalvus) August 10, 2020

There are similar problems in other communities surrounding Washington, DC.

In his column for the Washington Examiner, Tim Carney explains how government school bureaucracies – including where he lives in Montgomery County, Maryland – care more about preserving the flow of tax dollars than educational success for kids.

Because public schools will be offering a vastly inferior service this year (remote-only learning), the allies of public schools and their teachers’ unions worry about parents pulling their children into private schools — and so they are trying to take away some of the private schools’ advantage. …after Gov. Larry Hogan struck down a county order barring private schools, one public school teacher wrote a public Facebook post nearly admitting as much: “MCPS parents… Please keep your kids enrolled in MCPS! Loss of funding will be devastating, not only this school year, but in the years to come, when we need to try to increase funding again.” …The public school superintendent in Falls Church City, a small, wealthy municipality just outside of D.C., wrote a similar note warning against “Pandemic Flight.” …Peter Noonan..warned parents that “disenrolling from FCCPS [will] have consequences. FCCPS receives funding from the local Government, the State Government, and the Federal Government based on the numbers of students we have enrolled. If there is an exodus of students from FCCPS, the funding of our schools will decrease.” Notice what’s missing in this letter? Any suggestion that your children will learn just fine through the public schools’ online learning system. …public school administrators know that they are offering an inferior product… Sadly, rather than wanting what’s best for their students, they ask parents to do what will bring more taxpayer money for their schools.

For what it’s worth, I also think teacher unions and school bureaucrats also don’t want parents to experience even a year of private schooling or homeschooling, lest they learn that there are better long-run options for their kids.

P.S. My criticism of the government school monopoly does not in any way imply that teachers are bad people (like all professions and groups, some will be good and some will be bad). It simply means they are in a bad system. Indeed, one of the benefits of school choice is that good teachers will flourish thanks to competition and innovation.

P.P.S. Yes, we have strong evidence from some states and localities in America that school choice produces better educational outcomes. But I always remind people that there’s also global evidence from SwedenChileCanada, and the Netherlands showing good results when competition replaces government education monopolies.

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Image credit: Ken Gallager | CC BY-SA 4.0.

The Make-Believe Postal Service Panic and the Tenth Theorem of Government

Tue, 08/18/2020 - 12:02pm

Politicians and interest groups periodically fan the flames of temporary panic to push for misguided policy. We’ve already seen three big examples this century.

  • The so-called PATRIOT Act was enacted in the feverish aftermath of 9-11, but many of its provisions simply added bureaucracy and gave government new/expanded powers unrelated to fighting terrorism.
  • The TARP bailout allegedly was needed to save us for financial collapse, but in reality was a substitute for a policy (FDIC resolution) that would have recapitalized the banking system without bailing out Wall Street.
  • Obama’s stimulus scheme had to be enacted to supposedly save the nation from another depression, but unemployment soared beyond administration projections and cronies got rich from boondoggles.

The same thing is now happening with the Postal Service, which ostensibly is on the verge of catastrophic collapse because of an expected increase in mail-in voting and sabotage by the Trump Administration.

The real story, though, is that bureaucracy has been losing money at a rapid pace for years and the only sensible solution is privatization. But that would upset the various postal unions and related interest groups, so they’ve created a make-believe crisis in hopes of getting more cash from taxpayers.

And this has nothing to do with Trump vs. Biden.

Let’s look at some rational voices on this topic, starting with this column by Charles Lane of the anti-Trump Washington Post.

Harder to account for is the progressive left’s idealization of the USPS, which began well before the uproar over new Postmaster General Louis DeJoy’s cost-cutting and its alleged impact on election mail. …when you look at what the agency actually does, a lot of it turns out to be a federally underwritten service for — profit-seeking businesses.Of the 142.6 billion pieces of mail of all kinds that the USPS handled in 2019, 53 percent was advertising material, a.k.a. junk mail, up from 48 percent in 2010. Junk mail makes up an even bigger share — 58 percent — of what individual households receive. …Companies pay a special rate, 19 cents apiece, to send these items (in bulk), as opposed to the 55 cents for a first-class stamp. …Some progressives are stuck in the pre-Internet age. Last week, Sen. Bernie Sanders (I-Vt.) said, apropos alleged mail delays: “I am not exaggerating when I say this is a life-and-death situation. The Post Office…delivers Social Security checks to seniors who rely on those benefits to survive.” He is exaggerating — a lot. Over 99 percent of all Social Security payments are sent by the more secure route of direct deposit; a 2013 law mandates it. …Crying “privatization” is the perennial scare tactic of progressives who oppose postal reform. That’s an odd one, too: Several European countries and Japan…have either fully or partially privatized their postal services. Actually, privatization is highly unlikely in the United States, given resistance from the two key lobbies — junk mailers and postal unions — that most influence Congress on this issue. …Something must be done to stem the Postal Service’s losses, which have totaled $83.1 billion since 2006, and to reduce its unfunded pension and health-care liabilities, which exceed $120 billion.

Here’s a twitter thread debunking some of the political hysteria about missing mailboxes.

Turns out the Washington Post uncovered the Great Mailbox Conspiracy ELEVEN YEARS AGO!

2009: “…half of the blue boxes in the Washington area have disappeared in the last nine years, and 200,000 nationwide have been plucked up in the last 20 years, leaving 175,000 total.” pic.twitter.com/oLYV8rbEYn

— Jeryl Bier (@JerylBier) August 16, 2020

And how about this column by Nick Gillespie of the anti-Trump Reason magazine.

By now you’ve probably heard that President Donald Trump and Postmaster General Louis DeJoy “are sabotaging democracy in plain sight” through a mix of nefarious ploys, ranging from removing “blue Post Office drop boxes” to scrapping mail-sorting machines to allegedly mandating a slowdown in delivering the mail. …The truth is far less incendiary… Here’s a little bit of math that should give voters succor. In 2016, about 140 million total votes were cast in the presidential election…with “nearly 24 percent…cast using by-mail absentee voting.” …Assume, for the sake of argument, that the same number of votes will be cast this year as in 2016. Even if all voters used the mail and posted their ballots on exactly the same day, that would comprise only 30 percent of the amount of mail the USPS says it processes every single day. So if the USPS screws up delivering votes in a timely and efficient manner this fall, it won’t be because of any sinister actions by the White House. It will be because of longstanding, well-documented managerial and cultural problems… For those who are interested in the post office’s chronically bad performance and “unsustainable” situation, the Government Accountability Office (GAO) has produced a long list of studies on where the problems come from and how they might be addressed. The short version is that Congress has blocked all sorts of serious reforms to an operation that has seen a 33 percent decline in mail volume since 2006.

And here’s another twitter thread that’s worth a look.

OK so everyone has seen the “viral” photo going around of the piles of mailboxes in Wisconsin being used as evidence that Trump is sabotaging USPS. Problem is, they have been there for years: Hartford Finishing Inc. powder coats and refurbishes the old mailboxes. (1/8) pic.twitter.com/HQpAprWxoK

— Gary He (@garyhe) August 17, 2020

Or what about this article by Jack Shafer from (probably anti-Trump) Politico.

The USPS really is hurting finanically, and really is worried about delivering ballots on time. It’s legitimate to worry about postal delays botching the vote, if a mass of votes are cast by mail just before Election Day. But don’t extrapolate from news accounts, USPS union protestations and candidate carping… the USPS has sent letters to 46 states expressing its doubts about delivering all the ballots in time to be counted. But, as the Washingtonn Post also mentioned in its story, those letters were in the works before Trump’s new postmaster general took office. …What about those vanishing USPS mail collection boxes? As it turns out, the USPS has been culling the boxes since 2000, when their numbers peaked and 365,000 of them stood sentinel on U.S. streets. Today, their numbers have dwindled to 142,000. Why has the USPS deleted them? Because the volume of first-class has nose-dived.

So what’s actually going on?

As I noted at the beginning of this column, we’re getting scammed. The folks who benefit from the current system want to create a sense of panic so they can get a big bailout for the Postal Service.

The Wall Street Journal (which isn’t anti-Trump, but understands how Washington works) opined accurately on what’s really happening.

Mrs. Pelosi is trying to put on a political show, starring Democrats as the saviors of the post office. She says she wants to pass a bill that “prohibits the Postal Service from implementing any changes to operations or level of service it had in place on January 1.” Also in the mix may be a $25 billion cash infusion. Then Chuck Schumer will demand that the Senate come back to town for the same vote. By the way the letter-carriers union endorsed Joe Biden on the weekend.

My modest contribution to this discussion is to unveil a Tenth Theorem of Government.

I’ll close with a prediction that politicians at some point in the future will manufacture a crisis (probably about deficits and debt) in order to impose a value-added tax.

P.S. Here are the nine previous Theorems of Government.

  • The “First Theorem” explains how Washington really operates.
  • The “Second Theorem” explains why it is so important to block the creation of new programs.
  • The “Third Theorem” explains why centralized programs inevitably waste money.
  • The “Fourth Theorem” explains that good policy can be good politics.
  • The “Fifth Theorem” explains how good ideas on paper become bad ideas in reality.
  • The “Sixth Theorem” explains an under-appreciated benefit of a flat tax.
  • The “Seventh Theorem” explains how bigger governments are less competent.
  • The “Eighth Theorem” explains the motives of those who focus on inequality.
  • The “Ninth Theorem of Government” explains how politics often trump principles.

The Truth about Income Mobility

Mon, 08/17/2020 - 12:50pm

In 2018, I shared a video from Professor Russ Roberts (a.k.a., @econtalker) on the economic status of the middle class, followed by a video last year on whether the rich are the only ones earning more income.

Today, we’ll look at his video on household income and mobility.

All of his videos are models of clarity, but nonetheless they require close attention because they are filled with so much useful information.

You’ll learn that some people manipulate numbers to paint a grim picture about economic mobility in America. But when you do honest apples-to-apples comparisons, you’ll see that capitalism is capable of delivering big benefits to ordinary people so long as it has enough breathing room to function.

In other words, we’re getting richer – as I wrote last year.

And, as I pointed out in an interview on CNBC, we should care about growth and opportunity instead of fretting whether some people get richer faster than other people get richer.

I’m writing on this topic today because there’s a new report from the Brookings Institution, authored by Stephen Rose, that looks at income trends. And it’s methodologically sound because it follows the same people over time, thus allowing the all-important apples-to-apples comparisons.

…the PSID panel data follow the experiences of the same respondents year after year. Even from one year to the next, many individuals’ incomes change significantly. This is particularly true at the tails of the distribution: nearly one-third of individuals in the bottom and top income quintiles are there temporarily because of an unexpected positive or negative event (Rose 1994). Multiyear incomes are therefore more equal than single-year incomes. …Piketty and Saez…argue that middle-class incomes have been stagnating. But their cross-sectional approach does not reflect individual experiences because they are comparing “similarly-situated people” and not looking at the experiences of the same individuals over time.

And what does Professor Rose find?

He points out that there are now a lot more “upper middle class” people in America (his data are adjusted for inflation, which is another way of ensuring apples-to-apples comparisons).

…the higher income classes expanded significantly during the first period. Between 1967 and 1981, the upper middle class tripled in size (from 6% to 18%) and the MMC grew by 3 percentage points (from 47% to 50%). Offsetting these gains were a corresponding shrinkage of the lower middle class (LMC) from 31% to 20% and the poor/near-poor (PNP) from 16% to 11%. In the later period (2002 to 2016), the changes were in the same direction, but more modest. The upper middle class (UMC) grew by 4 percentage points, the size of the MMC declined by 3 points, while the shares of the LMC and PNP were largely unchanged. In previous work, I argued that the differences between the UMC and those with lower incomes were the key driver of rising inequality.

Since Brookings is a left-of-center think tank, it’s not a surprise that Rose has a somewhat negative interpretation (“rising inequality”) of this data.

But he’s actually giving us good news.

Robert Samuelson, in his column for the Washington Post, wrote about Professor Rose’s new study and put together a table based on his data.

And I’ve augmented the table with some arrows to call attention to what’s happened in the 50 years between 1967 and 2016. The bottom line that America now has fewer lower-income and middle-income people and a lot more upper-income people.

Perhaps it is true that we have more inequality today than we did in 1967, but only very twisted people (such as those who work for the IMF) would want to erase all the gains we’ve enjoyed since that time.

To be sure, all income groups could do even better with pro-growth policies such as tax reform and spending restraint. And we also could adopt policies that are especially beneficial for the less fortunate, such as school choice and licensing reform.

Sadly, the politicians who rant and rave about inequality are more interested in punishing the rich rather than helping the poor.

P.S. Margaret Thatcher debunked the left’s view of inequality in her farewell remarks to Parliament.

P.P.S. With apologies to Jonathan Swift, here’s David Azerrad’s “modest proposal” to end inequality.

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Image credit: Vinicius Altava | Pexels License.

The Sensible Choice Solution to the School Reopening Controversy

Sat, 08/15/2020 - 12:37pm

One month ago, I wrote that expanded school choice might be a silver lining to the dark cloud of corornavirus.

This issue is getting more heated, as this Reason video explains.

When I’ve written in the past about the issue of school choice, I’ve focused on the superior educational outcomes of private schools (and homeschooling as well) compared to the subpar performance of government schools.

Let’s revisit the topic, looking specifically at the debate over whether schools should reopen.

  • Some people argue that children will suffer long-term harm because of diminished educational outcomes if schools are closed.
  • Others argue that there may be additional infections if schools are opened, risking the lives of children or members of their families.

At the risk of sounding like a mealy-mouthed politician, both sides are right.

Simply stated, there are potential downsides regardless of which option is selected.

And it’s quite likely that the right approach for some families will be the wrong approach for other families.

This is a very powerful argument for the kind of decentralized decision-making that is only possible with school choice.

  • Some parents may want a traditional in-a-classroom experience for their children.
  • Some parents may want a blended in-person/online approach for their kids.
  • Some parents may want education for their kids to be entirely online.
  • Some parents may want to choose homeschooling for their children.
  • Some parents may want to experiment with new approaches such as pod teaching.

And the only way to satisfy these disparate desires is to break the government’s monopoly on education.

Let’s look at some recent analysis.

Writing for National Review, Cathy Ruse and Tony Perkins explain why we need alternatives to a one-size-fits-all government monopoly.

…the great American entrepreneurial spirit is awakening as parents are forced to rethink education for their children. And that is to the benefit of children and the nation. …There is no better time to make a change than right now, when public education is in chaos. Parent resource groups are forming to help families make an exit strategy and find the best education option for their children. Today, there are more options than ever. …Homeschooling continues to be a growing trend… “Hybrid homeschooling” is a new option, where children are homeschooled part of the week and learn in a more traditional school setting with other students for the rest. The most exciting new parent solution is the “pandemic pod,” a return to where families in one neighborhood or social circle hire a teacher to instruct their small group of children. …The last piece of the puzzle to set families truly free to make the best education decisions for their children is for states to set free public-education funds. …Imagine the possibilities if the primary educators of children — their parents — were given the freedom to spend that money to acquire the best education for their child. ..Let’s rethink, not rotely reopen. If there ever was a time when parent power could defeat the power and monopoly of the education elites, that time is now. Let freedom ring! 

J.D. Tuccille discussed the options, including homeschooling, in a column for Reason.

Chicago Public Schools became the latest large school district to opt for online-only lessons in the fall. …it leaves a lot of Chicago families unhappy and—like their counterparts around the country—heading for the exits, in search of options that better suit their needs now and in the future. …That leaves even many families favoring online classes as dissatisfied as those preferring in-person learning—and not just in Chicago. Across the country, there has been a surge in interest in traditional alternatives such as private schools as well as homeschooling, microschools (which essentially reimagine one-room schools for the modern world), and learning pods (in which families pool kids and resources). …the lines are blurry among the various categories of DIY education. But why shouldn’t they be blurry? Families aren’t interested in imposing rigid models on their kids; they’re trying to educate their children and adopting whatever tools and techniques get the job done. …Now, “23 percent of families who had children attending traditional public schools say they currently plan to send their children to another type of school when the lockdowns are over,” according to some admittedly unscientific polling… “Notably, 15 percent of respondents said they would choose to homeschool their children when schools reopen.”

As you might expect, the unions representing teachers from government schools have a much different perspective.

As the Wall Street Journal recently explained in an editorial, they’re using the crisis as an excuse to demand more money.

…teachers unions seem to think it’s…an opportunity…to squeeze more money from taxpayers and put their private and public charter school competition out of business. …an alliance of teachers unions and progressive groups sponsored what they called a “national day of resistance” around the country listing their demands before returning to the classroom. They include…canceling rents and mortgages, a moratorium on evictions/foreclosures, providing direct cash assistance… Moratorium on new charter or voucher programs and standardized testing…federal money to support the reopening funded by taxing billionaires and Wall Street” …If there’s a silver lining here, it’s that Americans are getting a closer look at the true, self-interested character of today’s teachers unions. …The proper political response should be to give taxpayer dollars to parents to decide where and how to educate their children. If parents want to use the money for private schools that are open, or for new forms of home instruction, they should have that right.

By the way, it’s not just that teacher unions want more money.

They also deliver an inferior product.

And a politicized product as well. Read this thread to be horrified about what is being “taught” to children trapped in government schools.

1/
This is a screenshot of people saying 2+2=5. You read that right…2+2=5.

Among them are teachers, educators, and professors who plan on teaching this stuff to your children. So let’s talk about what’s going on here, why they’re doing this, and how we can stop it.

A thread: pic.twitter.com/3CY2IcsahY

— Wokal Distance (@wokal_distance) August 4, 2020

Let’s close with a very appropriate cartoon.

P.S. School choice doesn’t automatically mean every child will be an educational success, but evidence from SwedenChileCanada, and the Netherlands shows good results when competition replaces government education monopolies.

P.P.S. Getting rid of the Department of Education would be a good idea, but the battle for school choice is largely won and lost on the state and local level.

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Image credit: Gage Skidmore | CC BY-SA 2.0.

Anti-Keynesian Growth after World War II

Fri, 08/14/2020 - 12:24pm

Last week, I shared some data showing how the economy enjoyed a strong recovery from recession in the early 1920s when President Warren Harding cut government spending.

(And these were genuine cuts, not the nonsense we get from today’s politicians, who claim they’ve cut spending simply because the budget increases by 5 percent rather than 7 percent.)

What happened nearly 100 years ago is very relevant today since we still have advocates of Keynesian economics who claim that more spending (especially debt-financed spending) is a recipe for more growth.

To show why this view is misguided, let’s now look at what happened in the 1940s after World War II came to an end.

In a column for today’s Wall Street Journal, Professor Richard Vedder explains that the Keynesians predicted economic disaster because of big reductions in government spending.

…many Americans assumed the end of the war would mean a resumption of the Depression, which was cut off by the World War II military buildup. In the middle of the fighting, America’s leading Keynesian economist, Alvin Hansen of Harvard, said: “When the war is over, the government cannot just disband the Army, close down munitions factories, stop building ships, and remove economic controls.” …When the sudden end of combat became apparent in late August 1945, economist Everett Hagen predicted that the unemployment rate in the first quarter of 1946 would be 14.8%.

So what actually happened?

Vedder points out that the Keynesian predictions of massive unemployment were wildly inaccurate.

Millions of military personnel did become jobless within months and defense spending plummeted, putting more out of work. In June 1946 federal employment was almost precisely 10 million less than a year earlier. Yet the sharp rise in overall unemployment didn’t occur. The total unemployment rate for 1946 was 3.9%… Perhaps most interesting for today, all this occurred as the U.S. moved from an extremely expansionary fiscal policy—with budget deficits equal to almost 25% of gross domestic product in 1944 (the equivalent of more than $5 trillion today)—to an extremely contractionary one. The U.S. by 1947 was running a budget surplus exceeding 5% of output—the equivalent of more than $1 trillion today. …This was the complete reverse of the expectation of the newly dominant Keynesian economists.

In the following chart, you can see the numbers from the Office of Management and Budget’s Historical Tables (Table 1.2), which show that fiscal policy between 1945 and 1948 was very contractionary, at least as defined by the Keynesians.

There definitely were huge spending cuts (the real kind, not the fake kind) during those years, and big deficits also became big surpluses.

Professor Vedder’s column explained that this anti-Keynesian policy didn’t produce mass unemployment.

But what about economic growth?

Well, you’ll see in the chart below the data from the Bureau of Economic Analysis for the 1945-48 period. There was a recession in 1946, which could be interpreted as evidence for Keynesianism.

But then look what happened in the next couple of years. There were more budget cuts, deficits became surpluses, and the economy enjoyed a strong rebound.

According to Keynesian theory, these two charts can’t exist. There can’t be an economic recovery when spending and deficits are falling.

Yet that’s exactly what happened after World War II (just as it happened under Harding, as Thomas Sowell observed).

Maybe, just maybe, Keynesianism is simply wrong. Maybe it’s nothing more than the economic version of a perpetual motion machine?

P.S. It’s also worth noting that huge increases in spending and debt under Hoover and Roosevelt didn’t produce good results in the 1930s.

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Image credit: National Portrait Gallery | CC BY-NC-ND 3.0.

A Primer on the Laffer Curve

Thu, 08/13/2020 - 12:44pm

Last week, I gave a presentation on the Laffer Curve to a seminar organized by the New Economic School in the nation of Georgia.

A major goal was to help students understand that you can’t figure out how changes in tax rates affect tax revenues without also figuring out how changes in tax rates affect taxable income.

As you might expect, I showed the students a visual depiction of the Laffer Curve, explaining that the government won’t collect any revenue if the tax rate is zero (the left point of the horizontal axis), but also pointing out that the government won’t collect any revenue if tax rates are 100 percent (the right point on the horizontal axis).

The curve between those two points shows how much tax is collected at various tax rates.

The upward-sloping part of the curve shows the “region of increasing revenue” (i.e., where higher tax rates produce more revenue) and the downward-sloping part of the curve shows the “region of declining revenue” (i.e., where higher tax rates produce less revenue).

I noted in my remarks that this is not a controversial concept.

Indeed, I’d wager that every economist in the world will agree.

Just in case you think I’m exaggerating, you can see in this video that even Paul Krugman agrees that there is a Laffer Curve.

Needless to say, this doesn’t mean that we agree on the shape of the Laffer Curve.

Even more important, we presumably don’t agree on the ideal point on the Laffer Curve.

I’m guessing he would want to be at the revenue-maximizing point, whereas I explained in the presentation that it’s much better to at the growth-maximizing point.

To show why this is an important distinction, I specifically cited research from two economists (one from the University of Chicago and one from the Federal Reserve) in hopes of getting students to understand that higher tax rates will destroy a lot of private income for every dollar of additional revenue that politicians will collect.

If you look at the nearby image, you’ll see that’s especially true for taxes on “capital” since households have much more control over the timing, level, and composition of business and investment income.

Maybe I’m just a wild-eyed libertarian, but I don’t think it’s a good idea to destroy lots of private income just so politicians get a bit of extra revenue to spend.

This does not mean, by the way, that the Laffer Curve is a panacea, or some sort of free lunch.

I should have shown the students this one-minute video clip of me pointing out that it’s only in rare circumstances that a tax cut generates enough additional growth (and therefore enough additional taxable income) to be self-financing.

To be sure, self-financing tax cuts do exist.

In the presentation, I shared the IRS data showing that the federal government collected fives times as much money from the rich after President Reagan reduced the top tax rate from 70 percent to 28 percent.

And I also shared the OECD data showing that industrialized nations are collecting more revenue from income taxes today, as a share of economic output, than they were back in 1980 when top tax rates on personal and corporate income were much higher.

And I also could have cited interesting results from CanadaDenmarkHungaryIrelandItalyPortugalRussiaFrance, and the United Kingdom.

I’ll close by recycling my three-part video series from 2008 on the Laffer Curve (assuming you’re not already tired of my voice after the 22-minute presentation at the start of today’s column).

The first video discusses the theory.

The second video looks at the evidence.

And the third video shines a spotlight on the Joint Committee on Taxation’s primitive methodology for producing revenue estimates.

The good news is that the Joint Committee on Taxation has been dragged kicking and screaming in the right direction since 2008, so the present process for estimating the revenue impact of change in tax policy is somewhat more accurate.

P.S. Here’s my response to Matt Yglesias’ supposed debunking of the Laffer Curve.

P.P.S. I used to think my friends on the left could be persuaded since they presumably don’t want tax rates to be so high that revenues decline. But it seems many of them actually are motivated by a desire to punish success rather than a desire to maximize revenue for government.

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Image credit: Gage Skidmore | CC BY-SA 2.0.

The Economic Damage of Wealth Taxation

Wed, 08/12/2020 - 12:40pm

Speculating about tax policy in 2021, with Washington potentially being controlling by Joe Biden, Chuck Schumer, and Nancy Pelosi, there are four points to consider.

  1. The bad news is that Joe Biden has endorsed a wide range of punitive tax increases.
  2. The good news is that Joe Biden has not endorsed a wealth tax, which is one of the most damaging ways – on a per-dollar raised basis – for Washington to collect more revenue.
  3. The worse news is that the additional spending desired by Democrats is much greater than Biden’s proposed tax increases, which means there will be significant pressures for additional sources of money.
  4. The worst news is that the class-warfare mentality on the left means the additional tax increases will target successful entrepreneursinvestorsinnovators, and business owners – which means a wealth tax is a very real threat.

Let’s consider what would happen if this odious example of double taxation was imposed in the United States.

Two scholars from Rice University, John Diamond and George Zodrow, produced a study for CF&P on the economic impact of a wealth tax.

They based their analysis on the plan proposed by Senator Elizabeth Warren, which is probably the most realistic option since Biden (assuming he wins the election) presumably won’t choose the more radical plan proposed by Senator Bernie Sanders.

They have a sophisticated model of the U.S. economy. Here’s their simplified description of how a wealth tax would harm incentives for productive behavior.

The most direct effect operates through the reduction in wealth of the affected taxpayers, including the reduction in accumulated wealth over time. Although such a reduction in wealth is, for at least some proponents of the wealth tax, a desirable result, the associated reduction in investment and thus in the capital stock over time will have deleterious effects, reducing labor productivity and thus wage income as well as economic output. …A wealth tax would also affect saving by changing the relative prices of current and future consumption. In the standard life-cycle model of household saving, a wealth tax effectively increases the price of future consumption by lowering the after-tax return to saving, creating a tax bias favoring current consumption and thus reducing saving. … we should note that the apparently low tax rates under the typical wealth tax are misleading if they are compared to income tax rates imposed on capital income, and the capital income tax rates that are analogous to wealth tax rates are often in excess of 100 percent. …For example, with a 1 percent wealth tax and a Treasury bond earning 2 percent, the effective income tax rate associated with the wealth tax is 50 percent; with a 2 percent tax rate, the effective income tax rate increases to 100 percent.

And here are the empirical findings from the report.

We compare the macroeconomic effects of the policy change to the values that would have occurred in the absence of any changes — that is, under a current law long run scenario… The macroeconomic effects of the wealth tax are shown in Table 1. Because the wealth tax reduces the after-tax return to saving and investment and increases the cost of capital to firms, it reduces saving and investment and, over time, reduces the capital stock. Investment declines initially by 13.6 percent…and declines by 4.7 percent in the long run. The total capital stock declines gradually to a level 3.5 percent lower ten years after enactment and 3.7 percent lower in the long run… The smaller capital stock results in decreased labor productivity… The demand for labor falls as the capital stock declines, and the supply of labor falls as households receive larger transfer payments financed by the wealth tax revenues… Hours worked decrease initially by 1.1 percent and decline by 1.5 percent in the long run. …the initial decline in hours worked of 1.1 percent would be equivalent to a decline in employment of approximately 1.8 million jobs initially. The declines in the capital stock and labor supply imply that GDP declines as well, by 2.2 percent 5 years after enactment and by 2.7 percent in the long run.

Here’s the table mentioned in the above excerpt. At the risk of understatement, these are not favorable results.

Other detailed studies on wealth taxation also find very negative results.

The Tax Foundation’s study, authored by Huaqun Li and Karl Smith, also is worth perusing. For purposes of today’s analysis, I’ll simply share one of the tables from the report, which echoes the point about how “low” rates of wealth taxation actually result in very high tax rates on saving and investment.

The American Action Forum also released a study.

Authored by Douglas Holtz-Eakin and Gordon Gray, it’s filled with helpful information. The part that deserves the most attention is this table showing how a wealth tax on the rich results in lost wages for everyone else.

Yes, the rich definitely lose out because their net wealth decreases.

But presumably the rest of us are more concerned about the fact that lower levels of saving and investment reduce labor income for ordinary people.

The bottom line is that wealth taxes are very misguided, assuming the goal is a prosperous and competitive America.

P.S. One obvious effect of wealth taxation, which is mentioned in the study from the Center for Freedom and Prosperity, is that some rich people will become tax expatriates and move to jurisdictions (not just places such as MonacoBermuda, or the Cayman Islands, but any of the other 200-plus nations don’t tax wealth) where politicians don’t engage in class warfare.

CF&P Foundation Paper Finds Proposed Wealth Tax Would Mean Loss of 1.8 Million Jobs

Wed, 08/12/2020 - 5:09am

For Immediate Release
Wednesday, August 12, 2020
202-285-0244
www.freedomandprosperity.org

CF&P Foundation Paper Finds Proposed Wealth Tax Would Mean Loss of 1.8 Million Jobs

(Washington, D.C., Wednesday, August 12, 2020) The Center for Freedom & Prosperity (CF&P) Foundation today published a new paper titled, “The Economic Effects of Wealth Taxes.” Authored by John Diamond and George Zodrow of Rice University, the paper considers the significant economic damage that would occur if lawmakers adopted a wealth tax of between 2 percent-6 percent. Such a plan, modelled after the proposal from Senator Elizabeth Warren, is likely to be part of next year’s post-election tax agenda.

Link to the paper: http://freedomandprosperity.org/2020/publications/the-economic-effects-of-wealth-taxes/

PDF: http://www.freedomandprosperity.org/files/White%20Paper/Diamond-Zodrow_Economic_Effects_of_Wealth_Taxes.pdf

Key findings from the paper:

A 2 percent annual tax on household wealth above $50 million and a 6 percent tax on household wealth over $1 billion would have the following effect on economic outcomes:

  • Long-run GDP decline of roughly 2.7 percent (relative to a steady state with no wealth tax) due to a decline in the capital stock of roughly 3.7 percent;
  • An immediate loss in hours worked of 1.1 percent, equating to approximately 1.8 million jobs, and a long-run loss in hours worked of 1.5 percent;
  • Initial decline in average annual household real wage income of about $2,500;
  • Explosive welfare state growth as transfers relative to GDP (excluding SS) increase by 70.1 percent;
  • Per-household wealth held by the top 0.25 falls by $3.7 million, and from lower-middle to upper-middle households, declines in lifetime wealth range from $440 to $49,660.
  • The lowest three lifetime income deciles are projected to be the beneficiaries of more redistribution spending, so they wouldn’t be net losers (other than increased dependency on government).

CF&P Chairman Dan Mitchell commented, “A wealth tax would shrink GDP, reduce annual household incomes and result in lost wages and American jobs. It would be very bad news for our economy and for families in all economic tiers.”

About the Center for Freedom and Prosperity Foundation

The Center for Freedom and Prosperity (CF&P) Foundation is a non-profit organization created in October of 2000 to advance market liberalization. The CF&P Foundation seeks to promote economic prosperity by educating the American people and elected representatives using original research and outreach.

For additional comments:
Andrew Quinlan can be reached at 202-285-0244, [email protected]

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Image credit: Pictures of Money | CC BY 2.0.

The Economic Effects of Wealth Taxes

Wed, 08/12/2020 - 4:45am
The Economic Effects of Wealth Taxes

[PDF Version]

August 2020

John W. Diamond and George R. Zodrow, Tax Policy Advisers LLC

Executive Summary

In this paper, we estimate the economic effects of the wealth tax proposed by Senator Warren using a computable general equilibrium model of the U.S. economy under the assumption that all revenues are used to increase income transfers (excluding Social Security payments) that accrue primarily to lower income groups. Our simulation of the Warren wealth tax estimates in the long run GDP falls by roughly 2.7 percent, as a result of decline in the capital stock of roughly 3.7 percent and in total hours worked of 1.5 percent, and aggregate consumption falls by 1.4 percent. Initially hours worked decline by 1.1 percent in a full employment economy; if instead labor hours worked per individual were held constant, this would be roughly equivalent to a loss of approximately 1.8 million jobs. Real wages decrease initially by 1.4 percent, but increase by 0.2 percent five years after enactment and by 1.3 percent in the long run. Together, the changes in real wages and the decline in hours worked imply that annual household real wage income on average across all wealth cohorts fall by $2,491 initially and by $1,129 five years after the reform. Five years after the reform, household real wage income falls by $4,487 for the lowest lifetime income group, by roughly $561 for the median household, and is unchanged for the top decile. In the long run, transfers relative to GDP increase by 70.1 percent, with most of the increase in transfers going to the bottom third of lifetime earners, whose average per-household transfer increases by $6,905. Per-household  wealth held by the top lifetime income group (the top 0.25 percent) falls by 6.3 percent ($3.7 million), and per-household wealth of the fourth through ninth income deciles declines by 0.9 percent (roughly $440) to 4.2 percent (roughly $49,660), while the per-household wealth of the bottom three income deciles increases by roughly 19.0 percent ($100) for the lowest income decile, 10.7 percent (roughly $500) for the second lowest decile, and 1.8 percent (roughly $350) for the third lowest decile.  

 

I. Introduction

A wealth tax is an individual level tax imposed on all or most forms of net wealth (assets less liabilities) typically above a fairly large exemption amount.  Although the United States currently does not have a broad-based wealth tax, Senator Bernie Sanders and Senator Elizabeth Warren each proposed a version of a wealth tax in the recent Democratic presidential campaign. In this paper, we begin by discussing the basic features of wealth taxation, the administrative concerns raised by the implementation of a new wealth tax, and its economic effects.[1]  We then turn to a description of the computable general equilibrium model we use to analyze the economic effects of a wealth tax in this study, followed by a description of our simulation results. A final section summarizes the results and suggests directions for future research.

II. The Structure of a Wealth Tax

A wealth tax is imposed on an annual basis and its base is net wealth, that is, the taxpayer’s total assets less total liabilities, including assets and liabilities held abroad.[2] In principle, all assets should be included in the wealth tax base at market values, such as stocks and bonds including those held in mutual funds, privately held businesses, housing and other real estate, liquid assets such as money market funds and savings deposits, and consumer durables.  In practice, many assets are exempted from taxation on either administrative grounds (e.g., consumer durables) or on political grounds. Loans should be subtracted from the base, but limits on the deductibility of loans are appropriate to the extent that some assets are not included in the wealth tax base. Wealth taxes are typically assessed only on wealth in excess of a significant exemption amount, both to simplify administration and compliance and to limit taxation to high-wealth taxpayers on equity grounds. The base is then subject to taxation under the wealth tax rate schedule, which may specify a single or “flat” rate or may involve a progressive tax rate structure.

The wealth tax proposed by Senator Warren is an example of a tax with a relatively simple progressive rate structure, as her plan would impose a 2 percent annual tax on household wealth in excess of $50 million and a 6 percent tax (up from a 3 percent tax rate in her initial proposal) on household wealth in excess of $1 billion. The Sanders wealth tax proposal is more complex. For married couples, it would impose a tax of 1 percent on households with wealth in excess of $32 million and increase in seven one percentage point increments to a top rate of 8 percent for households with net wealth in excess of $10 billion.[3] Both proposals assume a broad wealth tax base. In this paper, we model the economic effects of the Warren proposal; however, some preliminary results suggest that the economic effects of the two plans would be roughly similar.

Interestingly, the proposed top rates under these two proposals (6 percent and 8 percent) are quite high in comparison to other wealth taxes around the world – at least in the relatively few countries that utilize such taxes. Bunn (2019) notes that of the 36 countries in the OECD, only three (Switzerland, Spain, and Norway) currently have relatively broad-based wealth taxes, down from a high of 12 countries in 1996.[4]  Specifically, Norway imposes a wealth tax at 0.15 percent at the national level plus 0.70 percent at the municipality level for a total tax rate of 0.85 percent, Spain imposes a progressive wealth tax with rates that vary from 0.2 percent to 2.5 percent but that can be adjusted by its autonomous regions (with Madrid eliminating the tax entirely), and Switzerland has wealth tax rates that vary across its 26 cantons, ranging from 0.3 percent to 1.0 percent. Brülhart et al. (2017) note that the Swiss wealth tax is imposed on the upper middle class as well as the wealthiest households, given its relatively low exemption that was roughly equivalent to $107,000 in U.S. dollars in 2011.

As discussed by the Organisation for Economic Co-operation and Development (OECD) (2018), the countries that have eliminated their wealth taxes have done so for a variety of reasons. One overarching trend cited by OECD is a general movement toward lowering tax rates on high-income earners and on capital income; for example, the average top personal income tax rate in OECD countries declined from 65.7 percent to 43.3 percent in 2016, and the average statutory corporate income tax rate declined from 47 percent in 1981 to 24 percent in 2017. More specifically, OECD notes three primary reasons cited by countries for eliminating their wealth taxes. First, governments in these countries were concerned about the efficiency costs associated with wealth taxes, especially those related to capital flight in an era of increased capital mobility and increased access of wealthy taxpayers to tax havens.[5] Second, in practice net wealth taxes often failed to achieve their redistributive goals, primarily due to narrowly-defined tax bases coupled with pervasive tax avoidance and evasion which resulted in relatively low revenues, on the order of 0.2 to 1.0 percent of GDP.[6] Third, these countries were concerned about high administrative and compliance costs, especially when compared to these relatively low revenues.[7] In addition, wealth tax revenues in OECD countries have declined over time or at best remained constant, despite increasing levels of wealth since the 1970s.  Kopczuk (2013) notes that the relatively low revenues obtained from wealth taxes has made their elimination less problematic from a political perspective. Finally, as discussed below, the fact that relatively low wealth tax rates are equivalent to relatively high capital income tax rates has dissuaded some countries from using wealth taxes. For example, Boadway and Pestieau (2019) note that German courts held that the combined tax burden under the German income and wealth taxes could be no more than 50 percent of taxable income, and the wealth tax was ultimately held to be unconstitutional due to its confiscatory nature.

Another critical issue is the breadth of the base of a wealth tax. A broad base is desirable on both efficiency grounds so that the tax does not bias investment toward assets that receive preferential wealth tax treatment, and on equity grounds so that the tax does not provide differential treatment of individuals who have the same amount of wealth but choose to hold it in different forms. However, as under the income tax, a broad base may be difficult to achieve under a U.S. wealth tax, as political factors could easily result in exemptions or preferential treatment for wealth held in the forms of closely held businesses, farm assets, housing (partly on the grounds that housing is already subject to wealth taxation in the form of local property taxes), pension assets, collectibles such as fine art and antiques, and myriad other assets.

The experience with wealth taxation in Europe is not encouraging, with many exemptions such as those listed above, coupled with full deductibility of all loans in calculating net wealth which further reduces the tax base (Brumby and Keen, 2018; OECD, 2018). Saez and Zucman (2019) provide a counter argument: because the U.S. wealth tax would apply only to net wealth in excess of $50 million, preferential treatment of assets would be politically unpopular as it would benefit only highly wealthy individuals. This argument, however, clearly discounts the political power of such wealthy individuals – which, at least in some circles, provides one of the main arguments in support of a tax on large accumulations of wealth. Moreover, as noted above, creating a wealth tax bias favoring certain assets implies differential effective tax rates across assets which in turn creates resource misallocation and causes economic inefficiencies, a problem that has arisen in the context of European wealth taxes (OECD, 2018).

III. Administrative Concerns with a Wealth Tax

Much of the debate regarding the feasibility of a wealth tax centers on whether it can be administered effectively. Perhaps the most critical issue is valuation – under a wealth tax the market value of all assets subject to tax would have to be determined annually. Assets traded on national exchanges would be easy to value, as would holdings of cash. But experience with the estate and gift tax suggests that other assets, especially closely-held businesses, intangible assets, and collectibles such as fine art and antiques, are difficult to value and tend to be significantly under-valued; in addition, experience with the property tax suggests that accurate valuation may be problematical with real estate, including both residential and non-residential properties. Valuation problems would not be trivial – Batchelder and Kamin (2019) estimate that publicly traded assets account for only one-fifth of the taxable holdings of the top one percent of wealth holders. Valuing assets held abroad is also likely to be quite difficult. A second issue is evasion – taxpayers would have an incentive to hide assets, both domestic and foreign, and locating these assets would in many cases be quite difficult. Note that poor enforcement of a wealth tax creates its own economic distortions, as taxpayers are inefficiently encouraged to invest in assets that tend to be undervalued or hidden from the tax authorities. Finally, rules would have to be devised for the taxation of wealth held in trusts and family foundations.

The effectiveness of a wealth tax in the United States would depend on successful enforcement. Saez and Zucman (2019c) recommend increased reporting requirements for financial assets, valuing businesses using simple rules of thumb based on income or the book value of assets, and valuing artwork at its insured value. Additional resources for the aggressive enforcement by the IRS would be required, although such expenditures could be financed with some of the revenue from the wealth tax. The incremental increase in enforcement resources could be significant, as auditing the financial affairs of the very wealthy is highly complex; currently, the IRS processes about 4,000 estate and gift tax returns annually while collecting relatively little revenue. By comparison, roughly 75,000 returns would have to be processed under the Warren plan, and the analogous figure under the more sweeping Sanders plan would be 180,000 households. Moreover, these returns would have to be processed in an environment in which the taxpayers would have sizable resources to contest valuations, challenge legal interpretations, dispute other IRS claims, etc.

Finally, a wealth tax could encourage emigration and the renouncing of U.S. citizenship by the wealthy in order to avoid the wealth tax, which would be facilitated by the fact that most other OECD countries currently do not tax wealth. Although emigration has been problematical under several European wealth taxes, it seems less likely to be an issue in the much larger and more geographically isolated United States. In addition, both the Sanders and Warren proposals recommend an exit tax to discourage such tax-induced migration, which in principle could be applied retroactively to individuals who migrated while the tax was being discussed and enacted. Enforcement of these provisions, however, might also be difficult.

Ultimately, the key issue is the fraction of the wealth tax base that would be lost to undervaluation, other forms of tax avoidance, and tax evasion. Saez and Zucman (2019b) argue that the empirical evidence suggests that a 1 percent wealth tax would reduce reported wealth by 8 percent and then assume that a 2 percent tax would result in 15 percent reduction in reported wealth. Summers and Sarin (2019) suggest that this estimate is highly optimistic, seriously underestimating tax avoidance, evasion, and the exemptions that are likely to characterize a realistic wealth tax in the United States.[8] By comparison, the authors of the Penn-Wharton Budget Model (PWBM) (2019) analysis of the Warren wealth tax proposal review the empirical evidence and conclude that it implies a tax semi-elasticity of reported wealth of -13, that is, a one percent increase in the wealth tax rate is associated with a reduction in reported wealth of 13 percent, so that a flat rate 2 percent tax would reduce taxable wealth by 26 percent. In our analysis, we generally rely on the PWBM estimated wealth tax semi-elasticity. Note, however, that all of the existing empirical estimates are for relatively low rate taxes, and may not apply for taxes at rates as high as 2 and 3 percent — not to mention the 6 percent top rate envisioned under the Warren proposal or the 8 percent top rate under the Sanders plan. Indeed, the taxable income elasticity literature suggests that the sensitivity of taxpayers increases as tax rates increase, and also with income which provides the resources and often the flexibility to more effectively avoid or evade the tax. Moreover, Brülhart et al. (2017) find that the taxable wealth elasticity substantially exceeds the taxable income elasticity. Thus, avoidance and evasion are likely to create serious problems under a wealth tax, the magnitudes of which are difficult to estimate, especially for high wealth tax rates that are outside the boundaries of existing experience with the tax.

 IV. Economic Effects of a Wealth Tax A. Effects on Saving and Investment

A primary concern about a wealth tax is its effect on saving and investment. The most direct effect operates through the reduction in wealth of the affected taxpayers, including the reduction in accumulated wealth over time. Although such a reduction in wealth is, for at least some proponents of the wealth tax, a desirable result, the associated reduction in investment and thus in the capital stock over time will have deleterious effects, reducing labor productivity and thus wage income as well as economic output. This effect would to some extent be ameliorated by increased foreign investment in the United States (which would be accompanied by an increase in the trade deficit through the balance of payments); for example, Viard (2019) notes that the central estimate utilized by the Congressional Budget Office that 43 percent of reductions in domestic saving are offset by increased investment flows from abroad, with the range of estimates varying from 29 percent to 61 percent. The analogous figure in our model is 43 percent, very similar to the 40 percent figure used by PVBM (2019). A second offsetting effect would arise if wealth tax revenues were used for public saving or investment, e.g., in the form of reductions in the deficit and national debt, investment in public infrastructure, or investment in human capital accumulation. By comparison, this offsetting effect would not arise with expenditures on public consumption. Viard (2019, p.8) suggests that “very little of the revenue might be devoted to those purposes [public saving or investment]” and might instead be used to finance transfer programs; indeed, both the Warren and Sanders plans indicate that one of the primary ways their wealth tax revenues would be used would be to finance a new “Medicare for All” program. Our analysis follows the latter approach in assuming that wealth tax revenues are used solely to finance increases in transfer payments. Note, however, that the simulated macroeconomic effects of the wealth tax would be less negative if the revenues were instead used to finance reductions in the national debt or other public investments.

A wealth tax would also affect saving by changing the relative prices of current and future consumption. In the standard life-cycle model of household saving, a wealth tax effectively increases the price of future consumption by lowering the after-tax return to saving, creating a tax bias favoring current consumption and thus reducing saving. The magnitude of this response would depend on the sensitivity of the consumption of high-wealth individuals to such changes in relative prices, as well as the effective tax rate on saving, taking into account the potential for tax avoidance and evasion, which would reduce the effective tax rate and thus dampen the saving response. An offsetting effect arises, however, if some saving of high-wealth individuals is motivated by a desire to leave a bequest, defined broadly to include bequests to children and other relatives as well as charitable contributions. Such motives are sometimes modeled as implying a “target bequest,” that is, a bequest or a gift of a fixed magnitude determined by the taxable household.[9]  In this case, by both reducing wealth and reducing the after-tax return to remaining wealth, a wealth tax actually forces additional saving, since additional wealth accumulation is required to achieve the target bequest.

Our model includes both saving motives, as households are life-cycle savers but also have a fixed target bequest. The latter ensures that savings responses to changes in after-tax returns are muted, and thus addresses the long-standing criticism that savings responses in life-cycle models are unreasonably large (for example, see Ballard (2002) and Gravelle (2002)).

However, in our view, the standard life-cycle model with a target bequest does not capture well the likely responses of high-wealth households at the very top of the lifetime income distribution to the imposition of a wealth tax for two reasons. The first is that it seems unlikely that these households would dramatically curtail their consumption in order to finance a fixed target bequest. Indeed, the opposite result seems more likely: very high-wealth households might instead roughly maintain their pre-tax levels of consumption and thus their existing standards of living and instead reduce the target bequest by the amount of wealth tax paid. Such a result would be broadly consistent with empirical evidence suggesting that the wealth elasticity of consumption is relatively low, and that the consumption spending of high-wealth households is much less sensitive to changes in income and wealth than that of low-wealth households (see, for example, Carroll, et al., 2017).  Accordingly, in our analysis, we assume that in the aggregate, the target bequest is reduced by the amount of wealth tax revenue raised, so that the effects of the wealth tax on saving are limited to changes in after-tax rates of return and other general equilibrium effects.

Second, in the standard life-cycle model, a reduction in wealth will result in a reduction in demand for leisure (assuming that leisure is a normal good) and result in an increase in labor supply. Again, such a result seems unlikely for the very wealthy, whose labor supply is likely to be largely independent of the variations in wealth due to the wealth tax. Accordingly, we assume that the labor supply of the very wealthy households subject to the wealth tax is not affected by the tax, an assumption that is generally consistent with empirical evidence suggesting that income effects on labor supply are relatively small (McClelland and Mok, 2012). This is only true for the top 0.25 percent of households and relaxing this assumption has virtually no effect on aggregate estimates.

As noted above, another issue is that a wealth tax may distort the allocation of investment into assets for which enforcement is relatively poor or avoidance and evasion are relatively easy, which is likely to have a negative economic impact. For example, if tax avoidance, including under-valuation or tax evasion, is easier for collectibles or foreign investments, investments in such assets may increase at the expense of investments in the domestic private capital stock, reducing labor productivity and wages.  Note that our model does not capture these differential effects as all assets are taxed uniformly – although the effective tax rate is reduced by avoidance and evasion – and thus may understate the negative effects of a wealth tax on the domestic private capital stock and wages.

Finally, we should note that the apparently low tax rates under the typical wealth tax are misleading if they are compared to income tax rates imposed on capital income, and the capital income tax rates that are analogous to wealth tax rates are often in excess of 100 percent. To see this, note that a wealth tax is imposed each year on the stock of wealth (at some specific date), rather than on the flow of the income from that stock of wealth. As a result, a relatively low wealth tax rate is equivalent to a much higher capital income tax rate. For example, with a 1 percent wealth tax and a Treasury bond earning 2 percent, the effective income tax rate associated with the wealth tax is 50 percent; with a 2 percent tax rate, the effective income tax rate increases to 100 percent. In addition, as stressed by Mitchell (2019), these calculations do not take into account the taxation of interest income under the federal  income tax, which adds a second level of taxation at a top individual rate of 37 percent plus a net investment income tax of 3.8 percent, or taxation at the state level in those states that tax capital income under their personal income taxes.[10]

Moreover, Melly and Viard (2020) stress that the relatively high effective income tax rates obtained using the risk-free return on an asset such as a U.S. Treasury bill are also the relevant effective income tax rates for riskier investments that include a risk premium. The rationale underlying this argument is that in equilibrium the ex ante after-tax returns to safe investments should be equal to the ex ante after-tax returns to risky investments, and this can occur only if the tax applies solely to the safe return component of the total risky return.[11]

B. Distributional Effects of the Wealth Tax

A wealth tax with a large exemption would necessarily be highly progressive as it would directly affect only households with wealth in excess of the exemption – $50 million in the case of the Warren proposal – and thus apply only to very wealthy households.[12] Saez and Zucman (2019b) estimated that the Warren proposal, which would apply tax to households with wealth in excess of $50 million, would apply to 75,000 households or approximately 0.06 percent of all households, who hold approximately 10 percent of the total net wealth held by U.S. households, which they estimate to be $94 trillion in 2019. This estimate falls squarely in the middle of the range of four estimates of total net wealth of $86 trillion to $101 trillion (in 2016) cited by Holtzblatt (2019). Saez and Zucman estimate that a $50 million exemption would exempt slightly over 90 percent of this wealth, leaving a tax base of $9.3 trillion. A flat rate 2 percent wealth tax, ignoring any tax avoidance or evasion, would thus raise about $187 billion. They also estimate that a 1 percent surtax on wealth in excess of $1 billion – which characterized Senator Warren’s initial proposal – would raise an additional $25 billion from the 900 families at the top of the wealth distribution.

By comparison, Saez and Zucman (2019a) estimate that the Sanders proposal, which applies tax to households with wealth in excess of $32 million (for couples) would apply to 180,000 households or 0.15 percent of all households. They estimate the Sanders plan would raise $335 billion in 2019 under the assumption of a tax avoidance and evasion rate of 16 percent. However, the assumption that the avoidance and evasion rate would be the same under a wealth tax with rates as high as 8 percent as it would be under rates of 2 and 3 percent under the original Warren plan is implausible. On the other hand, with the tax semi-elasticity of -13 used by the PWBM authors, the wealth tax base of the highest wealth households would vanish entirely at a rate of 8 percent, an equally implausible result.  The general point is that it is impossible to predict how much avoidance and evasion would occur under such wealth tax rates, given the lack of empirical evidence on these high-rate elasticities, attributable to the fact that no country has ever tried to impose a wealth tax at anything approaching such rates.

Since under either proposal these households would bear most of the burden of a wealth tax, it would be highly progressive. A final assessment, however, would of course depend on the general equilibrium effects of the tax, including an analysis of how the revenues were spent.

V. The Diamond-Zodrow Model

This section provides a brief description of the model used in this analysis; for more details, see Zodrow and Diamond (2013) and Diamond and Zodrow (2015), and for the most recent parameter values used in the model, see Diamond and Zodrow (2020). The Diamond-Zodrow (DZ) model is a dynamic, overlapping generations, computable general equilibrium (CGE) model of the U.S. economy that focuses on the macroeconomic, distributional, and transitional effects of tax reforms. The model is thus well suited to simulating in considerable detail the economic effects of the implementation of the wealth taxes described above.

The DZ model is a micro-based general equilibrium model in which households act to maximize utility over their lifetimes, and firms act to maximize profits or firm value, with behavioral responses dictated by parameter values taken from the literature; these responses include changes in consumption, labor supply, and bequest behavior by households, as well as changes in the time path of investment by firms that take into account the costs of adjusting their capital stocks. Households and firms are characterized by perfect foresight. By construction, the model tracks the responses to a tax policy change every year after its enactment and converges to a steady-state long-run equilibrium characterized by a constant growth rate. As a result, the model tracks both the short-run and long-run responses to a tax policy change.

The overlapping generations structure of the model enables us to track the effects of policy reforms across generations and across income groups within each generation, rather than simply tracking the effects of reforms in terms of broad aggregate variables, and to analyze reforms like a wealth tax that affect only specific income groups. Specifically, each generation alive at any point in time includes 12 income groups that have differing but fixed lifetime wage profiles (we do not model human capital accumulation). Households are grouped by lifetime income deciles in each generation, with the tenth decile split into the top 0.25 percent (group 12) the next 0.75 percent (group 11), and the remaining 9 percent (group 10). In the case of the Warren wealth tax plan analyzed in this paper, the $50 million exemption implies that the tax affects only a small subset of the population, specifically, households with lifetime income in approximately the top 0.12 percent, all of whom are in the top lifetime income group.

Implementation of the reform implies that these households are subject to the two-rate progressive wealth tax that characterizes the Warren plan; the reform is not anticipated. As noted above, a key factor in the analysis is the fraction of the wealth tax base that goes unreported due to tax avoidance and evasion. The PWBM (2019) approach in assuming a wealth tax semi-elasticity of -13 implies a 26 percent avoidance/evasion rate with a 2 percent wealth tax, and a 78 percent avoidance/evasion rate with a 6 percent wealth tax. However, since the 6 percent rate is far outside the range observed empirically and is thus quite uncertain, and a 78 percent avoidance/evasion rate is extremely high, we simply assume that the average avoidance/evasion rate is 30 percent. It is also worth noting that our model does not capture the efficiency costs associated with tax avoidance/evasion behavior.

The model includes considerable detail on business taxation, including separate tax treatment of corporate and pass-through entities, separate tax treatment of owner-occupied and rental housing, and separate tax treatment of new and old capital. The model includes explicit calculation of asset values before and after the enactment of a reform, which enter into the base of the wealth tax. We also model the progressive taxation of labor income for households at different income levels, capture differential taxation of different types of capital income (although we do not model differential capital income taxes across income groups), and model government expenditures, including government transfers and a pay-as-you-go Social Security system.

The model includes four consumer/producer sectors, characterized by profit-maximizing firms and competitive markets. The goods produced by these four sectors are: (1) a composite good C produced by the “corporate” sector, which includes all business subject to the corporate income tax; (2) a second composite good N produced by the “noncorporate” sector that encompasses all pass-through entities including S corporations, partnerships, LLCs, LLPs, and sole proprietorships; (3) an owner-occupied housing good H; and (4) a rental housing good R.

The model includes a simplified treatment of international capital flows and international trade. The allocation of mobile capital is determined by relative interest rates at home and abroad, and the reduction in investment due to the introduction of a wealth tax in the United States leads to capital inflows from abroad. Trade is assumed to satisfy a standard balance-of-payments constraint.

On the consumption side, each household has an “economic life” of 55 years, with 45 post-education working years and a fixed 10-year retirement, and makes its consumption and labor supply choices to maximize lifetime welfare subject to a lifetime budget constraint that includes personal income and other taxes as well as a fixed “target” bequest. As discussed above, households in the top lifetime income group are assumed to have fixed labor supply and to reduce their target bequest by the amount of the wealth tax. Given this model structure, there are 55 overlapping generations at each point in time in the model, and each generation includes the 12 lifetime income groups described above.

The government purchases fixed amounts of the composite goods at market prices, makes transfer payments, and pays interest on the national debt. It finances these expenditures with revenues from the corporate income tax, a progressive labor income tax, and flat-rate taxes on capital income. The model does not include public infrastructure.

All markets are assumed to be in equilibrium in all periods. The economy must begin and end in a steady-state equilibrium, with all of the key macroeconomic variables growing at the exogenous growth rate, which equals the sum of the exogenous population and productivity growth rates. Note that this is a critical assumption in that it implies that the imposition of a wealth tax cannot change the rate of economic growth in the model, which is exogenously specified.  Hansson (2010) examines wealth taxes in 20 OECD countries between 1980 and 1999 and estimates that a 1 percentage point increase in the wealth tax rate reduces the economic growth rate by between 0.02 and 0.04 percentage points. Thus, a wealth tax rate in the range of 2 to 6 percent as proposed under the Warren plan could potentially have significantly more negative medium and long terms effects than those simulated in this paper.

VI. Wealth Tax Simulation Results

In this section we describe the results of simulating the effects of the Warren wealth tax within the context of our computable general equilibrium model. As discussed above, the tax is imposed at a 2 percent tax on wealth in excess of $50 million, coupled with a 4 percent surtax on wealth in excess of $1 billion. We compare the macroeconomic effects of the policy change to the values that would have occurred in the absence of any changes — that is, under a current law long run scenario, which includes the permanent features of the Tax Cuts and Jobs Act enacted in 2017, including the corporate income tax rate cut to 21 percent, but does not include provisions like expensing and the personal income tax rate cuts that are currently scheduled to be phased out.

The wealth tax raises revenue equal to 1.1 percent of GDP in the first year of enactment and 1.35 percent of GDP in the long run, and is collected from households who are in the top 0.1 percent of the lifetime income distribution. The macroeconomic effects of the wealth tax are shown in Table 1. Because the wealth tax reduces the after-tax return to saving and investment and increases the cost of capital to firms, it reduces saving and investment and, over time, reduces the capital stock. Investment declines initially by 13.6 percent, then rebounds quickly, and declines by 4.7 percent in the long run. The total capital stock declines gradually to a level 3.5 percent lower ten years after enactment and 3.7 percent lower in the long run; the capital stock declines less than domestic investment because of an inflow of foreign capital in response to an increase in relative returns to capital, as described above. The smaller capital stock results in decreased labor productivity and an eventual decline in nominal wages, although price changes imply that real wages, which decrease initially by 1.4 percent, increase by 0.2 percent after ten years, fluctuate around that level, and ultimately increase by 1.3 percent in the long run. The demand for labor falls as the capital stock declines, and the supply of labor falls as households receive larger transfer payments financed by the wealth tax revenues which result in income effects that increase the demand for leisure and thus reduce labor supply. Hours worked decrease initially by 1.1 percent and decline by 1.5 percent in the long run. Recall that our model assumes full employment so that this decline reflects a voluntary reduction in hours worked, holding the labor force constant, in response to wealth-tax-induced changes in prices and incomes. However, if instead labor hours worked per individual were held constant, the initial decline in hours worked of 1.1 percent would be equivalent to a decline in employment of approximately 1.8 million jobs initially. The declines in the capital stock and labor supply imply that GDP declines as well, by 2.2 percent 5 years after enactment and by 2.7 percent in the long run. Consumption also declines, but by less than GDP since the declines in investment are disproportionately large and the declines in the capital stock occur gradually over time. Indeed, consumption increases initially by 4.4 percent, but then declines gradually, to a decrease of 0.7 percent ten years after reform and 1.4 percent in the long run. Similar declines in consumption are observed in the four sectors, although there is also a shift from owner-occupied housing to rental housing due to the increase in relative housing demands by lower-income individuals, who consume a disproportionate share of rental housing.

Transfers increase as the revenues from the wealth tax are used to increase government transfers (other than Social Security) in proportion to existing government transfers. Transfers relative to GDP increase by 54.8 percent initially (from a ratio of 4.1 to 6.3), by 60.1 percent ten years after reform, and by 70.8 percent in the long run. These increases are concentrated in the lower lifetime income groups, as 20 percent of the increase in transfers relative to GDP goes to the lowest income group (the bottom decile), 15 percent to the second lowest lifetime income group (the second lowest decile), and 13 percent to the third lowest lifetime income group (the third decile). This of course reflects a reduction in the wealth of the top lifetime income group, which experiences a reduction in net wealth of roughly 6.3 percent. The wealth of the fourth through ninth income deciles falls by 0.9 percent to 4.2 percent, while the wealth of the lowest three income deciles increases by roughly 19.0 percent for the lowest decile, 10.7 percent for the second lowest decile, and 1.8 percent for the third lowest decile.  Based on data from the Survey of Current Finances for 2016 and the long run change in wealth from the simulation, the changes in wealth in terms of today’s dollars and wealth holdings implies that the wealth per household of the highest income decile falls by roughly $3.7 million, and per household wealth of the fourth through ninth income deciles declines by roughly $440 to $49,660, while the per household wealth of the bottom three income deciles increases by roughly $100 for the lowest income decile, $500 for the second lowest decile, and $350 for the third lowest decile.

Table 1

Macroeconomic Effects of the Warren Wealth Tax

(Tax Rates of 2% and 6%, Revenue Finances Increased Transfers)

(Percentage changes in variables, relative to steady state with no wealth tax)

 

Variable           % Change in Year: 2020 2024 2029 2039 2069 LR GDP 0.4 -2.2 -2.5 -2.7 -2.6 -2.7 Total Consumption 4.4 0.2 -0.7 -1.3 -1.3 -1.4       Corporate Good 4.2 0.3 -0.6 -1.3 -1.2 -1.4       Noncorporate Good 4.2 0.3 -0.6 -1.3 -1.2 -1.4       Rental Housing 6.2 2.0 1.9 2.1 2.6 3.2       Owner–Occupied Housing 4.6 -0.6 -1.6 -2.3 -2.5 -2.8 Total Investment -13.6 -8.7 -6.8 -5.4 -4.8 -4.7 Total Capital Stock 0.0 -2.3 -3.5 -4.2 -3.7 -3.7 Real Wage -1.5 0.2 0.6 1.1 0.8 1.3 Total Employment (hours worked) -1.1 -1.3 -1.3 -1.3 -1.4 -1.5 Transfers (non-SS) / GDP 54.8 65.1 60.1 59.1 66.5 70.8 VII. Conclusion

Recent proposals for the introduction of a wealth tax, especially those put forth by U.S. Senators Elizabeth Warren and Bernie Sanders, have garnered considerable attention. Proponents of a wealth tax stress that in addition to raising revenue, the wealth tax has the advantage of reducing income and wealth disparities. Opponents stress that implementing a wealth tax would face formidable administrative and compliance problems and would have negative effects on saving and investment – problems that have resulted in many OECD countries dropping the tax, although three nations still utilize the tax. Of special concern are the relatively high tax rates under the two proposals – with top rates of 6-8 percent – which are significantly above those utilized in other countries.

In this paper, we focus on estimating the economic effects of the wealth tax proposed by Senator Warren using a computable general equilibrium model of the U.S. economy under the assumption that all revenues are used to finance increase in income transfer that accrue primarily to lower income groups. In particular, we provide an estimate of the trade-offs involved in imposing such a plan. For example, in the long run, transfers relative to GDP increase by roughly 70.1 percent (from a ratio of 4.1 to 6.9), with 48 percent of the increase in transfers going to the bottom 3 income groups, while GDP falls by roughly 2.7 percent, as a result of declines in the capital stock of roughly 3.7 percent and in hours worked of 1.5 percent, and aggregate consumption falls by 1.4 percent.  Wealth held by the top lifetime income group falls by 6.3 percent. Different observers will of course have very different views as to the desirability of making these tradeoffs, but our analysis hopefully sheds some light on the debate by providing an estimate of their magnitudes.

We conclude with a few caveats. In our view, dynamic, overlapping generations computable general equilibrium models of the type used in this analysis are one of the best tools available to analyze the economic effects of tax policy changes such as the wealth tax analyzed in this study; in particular, they provide a rich structure based on fundamental economic theory that captures many of the complex and interacting effects of potential tax reforms. Nevertheless, it is clear that the estimated effects of the wealth tax presented in this report reflect the results of a particular simulation within the context of a specific computable general equilibrium dynamic economic model. For example, as noted above, the model used in this analysis does not allow for the imposition of the wealth tax to change the rate of economic growth (although it does allow for changes in GDP relative to the steady state level).  If a wealth tax reduced the long run rate of economic growth, as suggested in the empirical analysis by Hansson (2010) cited above, a wealth tax rate in the range of 2 to 6 percent as proposed under the Warren plan could potentially have significantly more negative medium and long terms effects than described in this paper. On the other hand, our analysis assumes that wealth tax revenues are used solely to finance increases in transfer payments and assumes the very wealthy reduce their bequests in response to the wealth tax; the simulated macroeconomic effects of the wealth tax would be less negative if the revenues were instead used to finance reductions in the national debt or other public investments or if we assumed the very wealthy reduced consumption rather than their bequests.  More generally, the results of any study that attempts to model the effects of significant tax reforms in today’s highly complex and internationally integrated economy are at best suggestive, and this report is no exception. Such results depend on the details of the reform proposed and its model representation as well as a wide variety of structural assumptions in the model and the specific model parameters utilized in simulating the model. An analysis of the sensitivity of our results to variations in model structure, model assumptions, and parameter values as well as alternative wealth taxes is the subject of ongoing research.

Acknowledgements

This report was prepared with the financial support of the Center for Freedom and Prosperity (CF&P) Foundation.  The opinions expressed in this paper are those of the authors and should not be construed as reflecting the views of CF&P Foundation or any entity with which the authors are affiliated, including Rice University and the Baker Institute for Public Policy.

This study used the Diamond-Zodrow model, a dynamic computable general equilibrium model copyrighted by Tax Policy Advisers, LLC, in which the authors have an ownership interest. The terms of this arrangement have been reviewed and approved by Rice University in accordance with its conflict of interest policies.

[1]  In this paper, we draw on numerous recent articles that have examined the issues surrounding wealth taxation, including especially Viard (2019), as well as Holtzblatt (2019), and Li and Smith (2020).

[2]  An annual wealth tax should thus be distinguished from the estate and gift tax, which is a one-time tax imposed on the transfer of assets.

[3]  The tax thresholds for married couples under the Sanders plan are $32 million (1 percent), $50 million (2 percent), $250 million (3 percent), $500 million (4 percent), $1 billion (5 percent), $2.5 billion (6 percent), $5 billion (7 percent), and $10 billion (8 percent). These thresholds would be halved for single taxpayers.

[4]  In addition, Belgium imposes a tax on financial securities at a flat rate of 0.15 percent, Italy imposes a tax on foreign wealth, and the Netherlands imposes a presumptive income tax on wealth in lieu of taxing capital gains under its income tax. These taxes differ considerably from the broad-based wealth taxes under discussion in the United States.

[5] For example, in 2018 France replaced its wealth tax with a property tax on high-value real estate as part of a set of measures designed to reduce the taxation of relatively mobile capital income, with the government citing the need to attract foreign investment as a primary rationale; see “Speech by Bruno LeMaire, French Ministry of the Economy and Finance,” https://eaccny.com/news/chapternews/speech-by-bruno-la-maire-french-minister-of-the-economy-and-finance/.

[6]  For example, Sweden repealed its wealth tax in 2007 due to concerns about widespread evasion (Henrekson and Du Rietz, 2014) and emigration of high-wealth individuals (Edwards, 2019).

[7]  Rosalsky (2019) notes that the wealth tax in Austria was eliminated in large part due to the high cost of administering and enforcing the tax (https://www.npr.org/sections/money/2019/02/26/698057356/if-a-wealth-tax-is-such-a-good-idea-why-did-europe-kill-theirs).

[8]  Summers and Sarin (2019) argue that experience with the estate and gift tax suggests that far more wealth – on the order of 60 percent – would escape taxation; their revenue estimate for the Warren proposal is roughly $25 billion, in comparison to the Saez-Zucman (2019b) estimate of $212 billion. Saez and Zucman (2019d) argue that the Summers-Sarin estimate is far too low because it assumes that the exemptions and weak enforcement under the estate and gift tax would apply to the wealth tax. Note that the Saez-Zucman estimate implies that revenues would be roughly 1 percent of GDP – only the Swiss tax raises revenue on this scale although it imposes the tax on a much broader base including many upper middle class households, while wealth taxes raise much less in Norway (0.4 percent) and in Spain (0.2 percent) (Viard, 2019).

[9]  For example, see Fullerton and Rogers (1993). Other bequest motives may also be operative, including altruism toward one’s heirs, a “joy of giving” motive typically modeled by treating the bequest simply as another consumption good, or a “strategic bequest” motive, under which parents attempt to alter the behavior of their children by altering the promised bequest.

[10]  Recognizing this relatively high tax burden, Spain limits the combined income and wealth tax burden to 60 percent of taxable income.

[11]  Our model does not consider risk and uncertainty explicitly, although it does include an equity premium. On a related point, Kopczuk (2019) notes that a wealth tax may encourage risk-taking more than the alternative of capital income taxation because the taxation of wealth effectively allows full deductibility of losses, which is often difficult to achieve under capital income taxation. On the other hand, he also argues that wealth taxation tends to shift the tax burden from economic rents to safe returns, which is undesirable on efficiency grounds.

[12]  Note, however, that shifting of the wealth tax might reduce wages as described above, thus reducing somewhat the progressivity of the tax.

 

References

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Batchelder, Lily, and David Kamin, 2019. “Taxing the Rich: Issues and Options.” Working paper. New York University, New York, NY.

Boadway, Robin, and Pierre Pestieau, 2019. “Over the Top: Why an Annual Wealth Tax for Canada is Unnecessary.” Fiscal and Tax Policy Commentary No. 546. C. D. Howe Institute, Toronto, Canada.

Brülhart, Marius, Jonathan Gruber, Matthias Krapf, and Kurt Schmidheiny, 2017. “The Elasticity of Taxable Wealth: Evidence from Switzerland.”  Working Paper, University of Lausanne, Lausanne, Switzerland.

Brumby, James, and Michael Keen, 2018. “Insights and Analysis on Economics & Finance.” IMF Blog. International Monetary Fund, Washington, DC, https://blogs.imf.org/2018/02/13/game-changers-and-whistle-blowers-taxing-wealth/.

Bunn, Daniel, 2019. “What the U.S. Can Learn from the Adoption (and Repeal) of Wealth Taxes in the OECD.” Tax Foundation, Washington, DC, https://taxfoundation.org/wealth-tax-repeal-wealth-taxes-in-europe/.

Carroll, Christopher, Jiri Slacalek, Kiichi Tokuoka, and Matthew N. White, 2017. “The Distribution of Wealth and the Marginal Propensity to Consume.” Quantitative Economics 8 (3), 977-1020.

Diamond, John W., and George R. Zodrow, 2013. “Promoting Growth, Maintaining Progressivity, and Dealing with the Fiscal Crisis: CGE Simulations of a Temporary VAT Used for Debt Reduction.” Public Finance Review 41 (6), 852–884.

Diamond, John W., and George R. Zodrow, 2015. “Modeling U.S. and Foreign Multinationals in a Dynamic OLG-CGE Model.” Working paper. Rice University, Houston, TX.

Edwards, Chris, 2019. “Taxing Wealth and Capital Income.” Tax and Budget Bulletin No. 85. Cato Institute, Washington DC.

Fullerton, Don, and Diane L. Rogers, 1993. Who Bears the Lifetime Tax Burden? Brookings Institution Press, Washington, DC.

Gravelle, Jane G., 2002. “Behavioral Responses to a Consumption Tax.” In Zodrow, George R., and Peter Mieskowski (eds.), United States Tax Reform in the 21st Century, 25–54. Cambridge University Press, Cambridge, UK.

Hansson, Asa, 2010.  “Is the Wealth Tax Harmful to Economic Growth?” World Tax Journal  2 (1).

Henrekson, Magnus, and Gunnar Du Rietz, 2014. “The Rise and Fall of Swedish Wealth Taxation.” Nordic Tax Journal 1 (1), 9-35.

Holtzblatt, Janet, 2019. “Should Wealth Be Taxed?” Tax Policy Center, Washington, DC, https://www.taxpolicycenter.org/sites/default/files/holtzblatt_ppt.pdf.

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Kopczuk, Wojciech, 2019. “Comment on ‘Progressive Wealth Taxation’ by Saez and Zucman.” Brookings Papers on Economic Activity, Conference Draft, September 5-6.

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Image credit: Pictures of Money | CC BY 2.0.

A Video Primer on Austrian Economics

Tue, 08/11/2020 - 12:08pm

I went to George Mason University for my Ph.D. specifically because of my interest in both “public choice” and “Austrian theory.”

The former deals with analyzing how politicians, bureaucrats, and voters really behave (as opposed to the naive view you may have learned in a civics class), and the latter refers to a particular type of economic analysis that was developed by scholars (mostly based in Vienna) in the late 1800s and early 1900s.

I occasionally put in a plug for Austrian economics, largely because it has a lot to offer when analyzing business cycles, monetary policy, and entrepreneurship (it is generally similar to other market-friendly schools of thought when looking at other issues, such as public finance, trade, and regulation).

But I’ve never done a column explaining Austrian economics. It’s time to rectify that oversight thanks to a 7-part video series narrated by Professor Steve Horwitz.

Part I discusses the marginal revolution (which supplanted the labor theory of value) and notes that Austrians emphasize subjective value.

Analyzing behavior “on the margin” is important for good economics. It’s why, for instance, that we should focus primarily on marginal tax rates rather than average tax rates.

In Part II, Steve discusses how Ludwig von Mises showed back in 1920 that genuine socialism (rather than Nordic-style redistributionism, which didn’t even exist back then) was not feasible in part because governments have no rational way of setting prices and sensibly allocating resources.

If you want an amusing version of what you just watched, check out this video I shared last year.

In Part III, Steve elaborates on the role of knowledge, citing the important work of Friedrich Hayek on the importance of decentralization, prices, and private property.

One of the implications of this work is that central planning is not feasible.

In Part IV, Steve discusses Israel Kirzner’s work on entrepreneurship, which Austrian scholars point out is the source of innovation.

Part V is Steve’s explanation of how money evolved via spontaneous order.

The above video focuses on the origin of metallic money. It’s also worth noting that paper money was developed by the private sector.

In Part VI, Steve discusses the Austrian theory of business cycles, which focuses on how monetary policy can cause distortions that lead to booms and busts. And a key insight is that the false booms make busts inevitable.

Another insight from the above video is that the best response to a downturn is to do nothing, even though that’s not a popular answer for politicians – particularly compared to the Keynesian prescription of more spending.

In the final video, Part VII, Steve explains the Austrian view of marginal utility.

Here’s a bonus video featuring Tyler Cowen’s analysis of the Austrian theory of business cycles (the topic Steve covered in Part VI)

P.S. I shared a longer video on the Austrian theory of the business cycle back in 2013.

P.P.S. And no discussion of Austrian economics is complete without sharing Part I and Part II of the Hayek vs-Keynes rap contest.

No Unconditional Handouts to the States

Tue, 08/11/2020 - 3:54am

Originally published by Inside Sources on August 10, 2020.

The biggest sticking point in negotiations between the White House, Senate Republicans and House Democrats over the next COVID-19 relief bill is the treatment of the CARES Act’s recently expired $600 in added weekly unemployment benefits.

But added unemployment benefits are not the only point of contention and — in the long run — the question of financial aid to the states is likely to prove the most consequential.

The sides are far apart on the question of aid to the states. In their bill, Democrats provided $1 trillion, roughly the entire amount that Republicans proposed in new spending, just for state, local and tribal governments.

Republicans proposed no new funds for states but offered more flexibility for use of funds leftover from the $150 billion allocated in the CARES Act. A new report from the U.S. Treasury Department’s Office of Inspector General shows that only about 25 percent have yet been spent.

State and local governments are taking on considerable responsibility in the fight against COVID-19, and for good reason, as they are closest to the problem and best positioned to quickly respond as conditions change.

It is thus understandable that Congress would consider some measure of financial support to state and local governments as part of the national effort to address the virus. But how states are permitted to spend any potential relief dollars is just as important to get right as the amount of aid they end up receiving.

Long before the arrival of COVID-19, many states were in dire straits financially.

Some, like New Jersey, Illinois and Massachusetts have taken on hundreds of billions of dollars in debt to finance large governments, while others make the hard decisions that lead to responsible and balanced budgets.

Some, like Wyoming, Alaska, California and North Dakota, even planned ahead and now have sizable “rainy-day” funds they can draw upon to fill budget gaps due to declining tax revenues during the pandemic.

And whereas some states responded to expected declines in tax revenue with furloughs and other spending cuts, Illinois continued its irresponsible ways by passing a budget with $2.4 billion more in spending than the previous year.

Is it right that the most responsible states should have to shoulder the added costs of supporting those that refuse to get their fiscal houses in order? Doing so would amount to a reward for failing to act responsibly.

Employee compensation accounts for half of all state and local spending, making unfunded pension liabilities a large part of the story when it comes to state financial mismanagement.

For decades, governments have failed to fully fund the often generous pension benefits for their employees, kicking the can down the road for future taxpayers to deal with. Unfunded liabilities of state pension plans now total roughly $5 trillion, according to U.S. Pension Tracker.

This is a problem that requires significant reforms. A condition free bailout of the states that allows governments to allocate federal dollars toward closing fiscal gaps caused by excessive spending — such as through state employee pension programs — would only serve to sap the political will necessary to make reform a reality.

To avoid this problem, Congress should scrutinize state requests for aid and provide only those funds necessary to help them address COVID-related challenges.

Or if being more generous is a necessary compromise, then funds should be conditioned on the adoption of fiscally responsible reforms that put pension programs on the path to sustainability, or that encourage the use of rainy-day funds to better prepare for the next crisis.

Will America Learn from Japan’s Fiscal Decline?

Mon, 08/10/2020 - 12:58pm

Compared to most of the world, Japan is a rich country. But it’s important to understand that Japan became rich when the burden of government was very small and there was no welfare state.

Indeed, as recently as 1970, Japan’s fiscal policy was rated by Economic Freedom of the World as being better than what exists today in Hong Kong.

Unfortunately, the country has since moved in the wrong direction. Back in 2016, I shared the “most depressing chart about Japan” because it showed that the overall tax burden doubled in just 45 years.

As you might expect, that rising tax burden was accompanied by a rising burden of government spending (fueled in part by enactment of a value-added tax).

And that has not been a good combination for the Japanese economy, as Douglas Carr explains in an article for National Review.

From 1993 to 2019, the U.S. averaged 2.6 percent growth, …far ahead of Japan’s meager 0.9 percent. …What happened? Big government happened… Japanese government spending was just 17.5 percent of the country’s GDP in 1960 but has grown, as illustrated below, to 38.8 percent of GDP today. …the island nation’s growth never recovered. The theory that government spending boosts long-term growth has failed… What government spending does is crowd out investment.

Amen. Japan has become a parody of Keynesian spending.

Here’s a chart from Mr. Carr’s article, which could be entitled “the other most depressing chart about Japan.”

As you can see, the burden of government spending began to climb about 1970 and is now represents a bigger drag on their economy than what we’re enduring in the United States.

Unfortunately, the United States is soon going to follow Japan in that wrong direction according to fiscal projections from the Congressional Budget Office.

Carr warns that bigger government in America won’t work any better than big government in Japan.

Rather than a problem confined to the other side of the world, Japan’s death spiral is a pointed warning to the U.S. The U.S. and Japanese economies are on the same trajectory; Japan is simply further along the big-government, low-growth path. …The United States is at risk of entering a Japanese death spiral.

Here’s another chart from the article showing the inverse relationship between government spending and economic growth.

Moreover, the U.S. numbers may be even worse because of coronavirus-related spending and whatever new handouts that might be created after the election.

The negative relationship of government spending with growth and investment holds with adjustments for cyclical influences such as using ten-year averages or the Congressional Budget Office’s estimates of cyclically adjusted U.S. government spending. CBO data highlight how close the U.S. is to a Japanese-style death spiral. …Of course, CBO’s recent forecast was prepared before the coronavirus shock and does not incorporate spending by a new Democratic government, so this dismal outlook is likely to worsen.

So what’s the solution? Can the United States avoid a Greek-style future?

The author explains how America can be saved.

Boosting growth means restraining government. Restraining government means reengineering entitlements… Economically, it shouldn’t be too difficult to do better. We have an insolvent, low-return government-retirement program along with an insolvent retiree-health program — part of a Rube Goldberg health-care system.

He’s right. To avoid stagnation and decline, we desperately need spending restraint and genuine entitlement reform in the United States.

Sadly, Trump is on the wrong side on that issue and Biden wants to add fuel to the fire by making the programs even bigger.

P.S. Here’s another depressing chart about Japan.

P.P.S. Unsurprisingly, the OECD and IMF have been cheerleading for Japan’s fiscal decline.

P.P.P.S. Japan’s government may win the prize for the strangest regulation and the prize for the most useless government giveaway.

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Image credit: victorpalmer | Pixabay License.

Being Libertarian

Sun, 08/09/2020 - 12:33pm

Back in 2018, I shared five images that capture what it means to be libertarian.

Let’s do the same thing today, except we’ll first start with a video that is interesting overall, but has some specific insights about libertarians from 5:45-7:20.

Now let’s look at our five new images.

We’ll start with the all-important point that there’s a big difference between wanting good things and thinking that government is the way to achieve good things.

Our second contribution shows the libertarian claim that they are the philosophical descendants of America’s Founders (even Alexander Hamilton).

Our third contribution is from Reddit’s libertarian page and it captures the movement’s laissez-faire spirit.

Next we have another reminder that government was the most dangerous entity in the 20th century (and presumably in all history).

Last but not least, here’s a powerful set of images that underscores the giant difference between legality and morality.

P.S. There’s another interesting video on Jonathan Haidt’s analysis of libertarians at the end of this column. And you can read more of his analysis here.

P.P.S. You can learn more about libertarian self-identification here and here.

Evidence from Italy: Less Regulation = More Jobs and Higher Earnings

Sat, 08/08/2020 - 12:26pm

There are all sorts of regulations, some of which affect the entire economy and some of which target certain sectors. Moreover, regulations vary widely since – depending on the example – they may tell people and business what to do, how to do it, when to do it, and who to do it with.

This is why it’s probably best to think of government red tape as an obstacle course that increases the difficulty of engaging in commerce.

An expensive obstacle course.

Some new research published by Italy’s central bank gives us an opportunity to understand the consequences of red tape.

The study, authored by Lucia Rizzica, Giacomo Roma, and Gabriele Rovigatti, looked at a real-world example of product market regulation (PMR) governing retail hours in Italy.

In this paper we focus on how the regulation of shops opening hours affects the relevant market size and structure. This dimension of PMR has traditionally been a controversial issue in the policy debate, as it involves social, political, economic, and even religious considerations. …we tackle these questions empirically and estimate the effects of full deregulation in shop opening hours on the level and composition of employment and on the number of shops and their size distribution…we focus on Italy and build a novel dataset of Italian municipalities 2007-2016, including their regulatory status, and exploit the variation provided by the staggered implementation at the municipal level of a deregulation reform enacted from1998 onwards.

Here’s a visual from the study, showing the variation over time in the number of municipalities with no regulation, medium regulation, and heavy regulation.

The good news is that Italy actually got rid of rules dictating when stores could be open and this gave the economists an opportunity to measure what happened.

Our estimates show that, in the context of a general contraction of the retail sector and of the economy as a whole, deregulating shops opening hours helped lowering the decrease in both the number of workers and establishments, with an estimated positive impact of about 3% and 2%, respectively. …On top of it, individual-based estimates show that the sector’s labor force structure changed towards a higher prevalence of employees over self-employed, together with a general increase in the number of hours worked and earnings of employees, especially of those with permanent contracts. Our results are robust to a number of checks… In Table 2 we present our baseline results. In columns (1)-(2) we report the estimates of the liberalization effect on the number of workers, and in columns (3)-(4) those on the number of plants in each municipality. …the resulting estimated effect of liberalization in the newly liberalized municipalities is a 3.4% increase in the number of individuals working in the wholesale and retail sector, and a 2.1% increase in the number of shops. …Finally, we show that the reform also had a positive effect on the activity of complementary services, such as restaurants and financial services and, overall, on total employment in affected areas.

For wonky readers, here’s the table mentioned in the above excerpt.

So what’s the bottom line?

…from a policy perspective, our results provide support to the idea that a more flexible regulation of the business environment boosts economic growth… We find no evidence that this leads to a worsening of employment conditions, on the contrary permanent dependent workers enjoyed an increase in their earnings.

It’s great to see that deregulation produced more jobs and higher earnings.

But one thing that we don’t find in the study, unfortunately, is any estimate of how deregulation also benefited consumers thanks to lower prices and greater convenience.

In other words, eliminating or reducing red tape is a win-win situation for just about everybody (with the only exception being the cronyists who gain undeserved advantages because of regulation).

P.S. While I’m glad that Italy got rid of rules limiting retail hours, the country – as measured by the World Bank – still has a lot of needless red tape.

OECD Research Acknowledges Big Benefits from Federalism

Fri, 08/07/2020 - 12:10pm

Largely because of my support for jurisdictional competition, I’m a big fan of federalism.

Simply stated, our liberties are better protected when there’s decentralization since politicians are less like to over-tax and over-spend when they know potential victims of plunder have the option of moving across a border.

Indeed, I cited some academic research back in 2012 which showed that there as less economy-weakening redistribution in nations with genuine federalism (see, for instance, how Vermont politicians were forced to backtrack when they try to impose government-run healthcare).

Now let’s look at some additional scholarly evidence. A study published by the OECD, authored by Hansjörg Blöchliger, Balázs Égert and Kaja Fredriksen, investigates the impact of federalism on outcomes in developed nations.

Here are the key findings from the abstract.

This paper presents empirical research on the potential effects of fiscal decentralisation on a set of outcomes such as GDP, productivity, public investment and school performance. The results can be summarised as follows: decentralisation, as measured by revenue or spending shares, is positively associated with GDP per capita levels. The impact seems to be stronger for revenue decentralisation than for spending decentralisation. Decentralisation is strongly and positively associated with educational outcomes as measured by international student assessments (PISA). While educational functions can be delegated either to sub-central governments (SCG) or to schools, the results suggest that both strategies appear to be equally beneficial for educational performance. Finally, investment in physical and – especially – human capital as a share of general government spending is significantly higher in more decentralised countries.

Here’s some detail from the body of the paper about the pro-growth impact of decentralization (especially when sub-national governments are responsible for raising their own funds).

Across countries, sub-central fiscal power, as measured by revenue or spending shares, is positively associated with economic activity. Doubling sub-central tax or spending shares (e.g. increasing the ratio of sub-central to general government tax revenue from 6 to 12%) is associated with a GDP per capita increase of around 3%. …Revenue decentralisation appears to be more strongly related with income gains than spending decentralisation. This empirical finding may reflect that “true” fiscal autonomy is better captured by the sub-central revenue share, as a large part of sub-central spending may be mandated or regulated by central government. … the estimated relationship never becomes negative and is not hump-shaped, i.e. “more decentralisation always tends to be better”.

The part of “more decentralisation always tends to be better” is a good result.

But it’s also a sad result since the United States has moved in the wrong direction in recent decades.

Though we’re still less centralized than most nations, as you can see from this chart from the OECD study.

Kudos to Canada and Switzerland for leading the world in federalism.

Here are some additional details from the study. I’m especially interested to see that the authors acknowledge how jurisdictional competition helps to explain why nations with federalism perform better.

Decentralised fiscal frameworks can raise TFP through an increase in the efficiency and productivity of the public sector… Public sector productivity is influenced by competition between SCGs and inter-jurisdictional mobility. Most SCGs aim at attracting and retaining mobile production factors, in order to promote investment and economic activity. They can do so by using fiscal policy, among other instruments. Since firms are choosing their location based on where they expect the highest returns on investment, and since returns depend (partly) on public inputs, SCGs have an incentive to raise the productivity of their public sector. SCGs may also try to improve the relationship between taxation and public service levels, by lowering taxes… The more decentralised a country, the stronger these competitive forces could be. Competition and inter-jurisdictional mobility could be weakened by large intergovernmental transfer systems, in particular fiscal equalisation.

As a aside, it’s rather ironic that that the professional economists at the OECD produce rigorous studies (here’s another one) showing the benefits of jurisdictional competition while the political appointees push for anti-growth policies such as tax harmonization.

Let’s close by looking at the study’s estimates of how nations would enjoy more prosperity by shifting in the direction of decentralization.

…an assessment of what a country might gain in terms of higher GDP if it moved to the benchmark of the most decentralised country. To be more specific, the gains were calculated for each federal country if it moved tax decentralisation to the level of Canada, and for each unitary country if it moved tax decentralisation to the level of Sweden (Figure 6). Further decentralisation could potentially be associated with an average increase of GDP of around 1% to 2% for federal countries and 3% to 4% for unitary countries, with values for more centralised countries being larger.

Here’s the accompanying chart.

Since the U.S. still has some federalism, our gain isn’t very large, but nations such as Austria, Belgium, Slovakia, Ireland, Luxembourg, and the United Kingdom could get big boosts.

P.S. I didn’t focus on the findings about better educational outcomes in decentralized nations. But I can’t resist pointing out that this is an additional reason to abolish the Department of Education.

P.P.S. Here’s a video discussing how Switzerland benefits from federalism.

P.P.P.S. And here’s what scholars from the Austrian school of economics wrote about federalism.

Warren Harding’s Anti-Keynesian Solution to a Deep Economic Downturn

Thu, 08/06/2020 - 12:58pm

We did not get good policy during the economic crisis of the 1930s. Indeed, it’s quite likely that bad decisions by Herbert Hoover and Franklin Roosevelt deepened and lengthened the Great Depression.

Likewise, George Bush and Barack Obama had the wrong responses (the TARP bailout and the faux stimulus) to the economic downturn of 2008-09.

But people in government don’t always make mistakes. If we go back nearly 100 years ago, we find that Warren Harding oversaw a very rapid recovery from the deep recession that occurred at the end of Woodrow Wilson’s disastrous presidency.

In a column for the Foundation for Economic Education, Robert Murphy has a very helpful tutorial on what happened.

…the U.S. experience during the 1920–1921 depression—one that the reader has probably never heard of—is almost a laboratory experiment …the government and Fed did the exact opposite of what the experts now recommend. We have just about the closest thing to a controlled experiment in macroeconomics that one could desire. To repeat, it’s not that the government boosted the budget at a slower rate, or that the Fed provided a tad less liquidity. On the contrary, the government slashed its budget tremendously… If the Keynesians are right about the Great Depression, then the depression of 1920–1921 should have been far worse. …the 1920–1921 depression was painful. The unemployment rate peaked at 11.7 percent in 1921. But it had dropped to 6.7 percent by the following year and was down to 2.4 percent by 1923. …the 1920–1921 depression “purged the rottenness out of the system” and provided a solid framework for sustainable growth. …The free market works. Even in the face of massive shocks requiring large structural adjustments, the best thing the government can do is cut its own budget and return more resources to the private sector.

Writing for National Review, David Harsanyi points out that there are many reasons why Warren Harding should be celebrated over Woodrow Wilson.

Wilson was one of the most despicable characters in 20th-century American politics: a national embarrassment. The Virginian didn’t merely hold racist “views;” he re-segregated the federal civil service. He didn’t merely involve the United States in a disastrous war in Europe after promising not to do so; he threw political opponents and anti-war activists into prison. Wilson, the first president to show open contempt for the Constitution and the Founding, was a vainglorious man unworthy of honor. Fortunately, we have the perfect replacement for Wilson: Warren Harding, the most underappreciated president in American history… Harding, unlike Wilson — and most of today’s political class, for that matter — didn’t believe politics should play an outsized role in the everyday lives of citizens. …Where Wilson had expanded the federal government in historic ways, creating massive new agencies such as the War Industries Board, Harding’s shortened term did not include any big new bureaucracies… Wilson left the country in a terrible recession; Harding turned it around, becoming the last president to end a downturn by cutting taxes, and slashing spending and regulations. Harding cut spending from $6.3 billion in 1920 to $3.3 billion by 1923.

Walter Block, in an article for the Mises Institute, explains that what happened almost 100 years ago can provide a good road map if President Trump wishes to restore prosperity today (especially when compared to the disastrous policies of Hoover and Roosevelt).

…let us look back a bit at some economic history regarding recessions and depressions… The depression in 1921 was short lived—maybe not a V, but at least a very narrow U. …Happily, during the 1921 depression, the government of President Warren G. Harding did not intervene…and the entire episode was over not in a matter of weeks (the V) or years (a fattish U), but months (a narrow U). The Great Depression, which stretched from 1929–41 (a morbidly obese U) stemmed from identical causes. …But Presidents Herbert Hoover and Franklin D. Roosevelt “fixed” this by propping up heavy industries whose extent was overblown by the previous artificially lowered interest rates, in an early “too big to fail” paroxysm. The Smoot-Hawley Tariff added insult to injury, and put the kibosh on any early recovery. …I now predict the sharpest of Vs, but if and only if, all other things being equal, the Trump administration cleaves to market principles. …So, Mr. President, embrace the free enterprise system, attain a V, a very narrow and sharp one, and the prognostication for November will be significantly boosted.

Professor Block’s analysis is very sound…except for the part where he speculates that Trump will do the right thing and copy Harding.

Given Trump’s awful track record on spending, it would be more accurate to speculate that I’ll be playing in the outfield for the Yankees when they win this year’s World Series.

Suffice to say, though, that it would be great to find another Warren Harding. Here’s a chart based on OMB data showing that he actually cut spending (and we’re looking at genuine spending cuts, not the make-believe spending cuts that happen in DC when politicians boost the budget by less than previously planned).

According to fans of Keynesian economics, these spending cuts should have tanked the economy, but instead we got a boom.

P.S. By the way, something similar happened after World War II.

P.P.S. Back in 2012, I shared some insightful analysis from Thomas Sowell about Harding’s economic policy.

P.P.P.S. Harding also lowered tax rates.

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Image credit: National Photo Company Collection, Library of Congress | Public Domain.

The Case Against the Public Option

Wed, 08/05/2020 - 12:53pm

Even though Joe Biden has embraced a very left-wing agenda, I suspect many of the items on his wish list are designed to placate Bernie-type activists who have considerable influence in the Democratic Party.

As such, I don’t think Biden will push “Medicare for All” if he’s elected. But I fear he may support a “public option” that is less radical but still misguided.

The strongest argument in the video is that a government-created competitor to private insurance companies will be much more expensive than politicians are promising.

This is what always happens with government programs (see MedicareMedicaid, and Obamacare) because politicians have a never-ending incentive to buy votes with other people’s money. And it will happen with any new program.

But I think the video overlooks an argument that would be even more politically effective, which is the fact that a public option would slowly but surely begin to strangle employer-based health insurance.

Simply stated, vote-buying politicians will deliberately under-price the cost of the public option. And the presence of a subsidized and under-priced government health plan will make employer-based policies less attractive over time – especially since the subsidies almost certainly will expand.

However, people generally like their employer-based health plans and presumably will be skeptical of any plan that threatens that system (and it’s probably safe to assume that health insurance companies will have an incentive to educate people about that likely outcome).

By the way, it’s not my intention to defend the employer-based system, which largely exists because of a foolish loophole in the tax code. As far as I’m concerned, that system is a convoluted and inefficient mess that has contributed to the health care system’s third-party payer crisis.

What we need is a restoration of free markets in health care.

But with the public option, the best-case scenario is that many people over time will get pushed from the top line of this image to the bottom line.

And that’s also the worst-case scenario since no problems will be fixed, but overall costs will be even higher thanks to greater government involvement.

For what it’s worth, some advocates of the public option claim it can actually save money by lowering reimbursement rates to doctors and hospitals. That could happen in theory, but exploding costs for MedicareMedicaid, and Obamacare show that it doesn’t happen in reality.

The bottom line is that more government intervention in health care won’t solve the problems caused by existing levels of government intervention in health care (a tragic example of Mitchell’s Law). Which is why I fear that the public option ultimately would be a slow-motion version of Medicare for All.

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Image credit: Pictures of Money | CC BY 2.0.

Subsidized Unemployment and Societal Capital

Tue, 08/04/2020 - 12:28pm

In early June, I pontificated about the upside-down incentives that are created when government pays people more to be idle than they could get by working.

This is a real-world concern because the crowd in Washington earlier this year approved a $600-per-week bonus for people getting unemployment benefits.

And that resulted in many people getting far more from benefits than they could get from employment. In some cases, even twice as much.

Anyhow, that bonus expired at the end of July, which has triggered a debate on whether to renew the policy.

In her Washington Post column, Catherine Rampell argues that super-charged benefits don’t discourage employment.

State benefits, on average, cover about 40 percent of the typical worker’s lost wages…  Given the extraordinary economic crisis, federal lawmakers wanted to “top up” state benefits so that workers would get close to 100 percent of their lost wages. …So Congress passed a $600 weekly supplement because it seemed about the right amount to make the average worker whole. …a majority of unemployed workers received more in benefits than they earned in their most recent paychecks. …this prompted concerns that the benefits themselves might slow down the recovery, discouraging people from returning to work because being on the dole was too darn comfortable. …five…recent studies…concluded the…$600 federal supplement does not appear to have depressed job growth. …Yes, at some point, …fears about work disincentives may materialize, as the economy recovers and job opportunities become more plentiful. We’re nowhere near that point now.

The Wall Street Journal also opined on this topic, specifically debunking one of the studies cited by Ms. Rampell.

Most Americans understand intuitively that if people make more money by not working, fewer people will work. Then there are politicians and economists who want to pass out more money while claiming that disincentives to work are irrelevant. …a study by Yale economists…purportedly finds the $600 federal enhancement to jobless benefits hasn’t affected the incentive to work. …Yet the study excluded part-time workers and those who hadn’t been working at a business in their sample last year. In other words, the study focused on workers with more loyalty to their employers. …Notably, states with more generous unemployment benefits for low-wage workers generally have had larger declines in labor-force participation. In Kentucky the lowest-paid 25% of unemployed workers on average have made 216% of what they did working. The state’s labor-force participation has declined 4.8 percentage points since February. …If you subsidize not working, you get less work.

In this Rampell vs. WSJ debate, I’m more sympathetic to the latter.

When the big fight over extended unemployment benefits during the Obama years was finally resolved, it showed that people are significantly more likely to find jobs when they’re no longer getting paid for not working.

This doesn’t mean that it will be easy (especially in an environment where there is still uncertainty about the coronavirus), or that we shouldn’t have sympathy for people facing pressure to find jobs after losing their previous positions.

But if we want prosperity and rising living standards, there’s really no alternative.

I’ll close with another excerpt from Ms. Rampell’s column. She cites an economist who found that some people went back to work even though they received less money than they were getting from the government.

Evercore ISI economist, Ernie Tedeschi, …observed that in June, around 70 percent of unemployment recipients who resumed working had been receiving more from benefits than their prior wage — yet nonetheless returned to work.

This is largely good news since it shows that America still enjoys a high degree of societal capital (work ethic, desire to earn rather than get handouts, etc).

But this underscores why we shouldn’t erode that valuable form of capital by making people feel like chumps for doing the right thing (a point I emphasized earlier this year when criticizing Elizabeth Warren’s dependency agenda).

Otherwise we wind up with the real-world version of this satirical Wizard-of-Id cartoon.

P.S. Speaking of satire, Nancy Pelosi actually argued that paying people not to work was a form of stimulus.

P.P.S. Here are a couple of anecdotes, one from Ohio and one from Michigan, about the perverse impact of excessive unemployment benefits during the last downturn.

P.P.P.S. If you want more academic literature on the relationship between government benefits and joblessness, click here and here.

P.P.P.P.S. Last but not least, prominent economists on the left (including Paul Krugman) actually agree the unemployment benefits encourage joblessness.

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Image credit: Steven Depolo | CC BY 2.0.

Greece Needs to Expand its Experiment with Supply-Side Economics

Mon, 08/03/2020 - 12:35pm

There’s a reason that Greece is almost synonymous with bad economic policy. The country has endured some terrible prime ministers, most recently Alexis Tsipras of the far-left Syriza Party.

Andreas Papandreou, however, wins the prize for doing the most damage. He dramatically expanded the burden of government spending in the 1980s (the opposite of what Reagan and Thatcher were doing that decade), thus setting the stage for Greece’s eventual fiscal collapse.

But Greek economic policy isn’t a total disaster.

Policy makers in Athens are trying a bit of supply-side tax policy, at least for a limited group of people.

The U.K.-based Times has a report on Greece’s campaign to lure foreigners with low tax rates.

“The logic is very simple: we want pensioners to relocate here,” Athina Kalyva, the Greek head of tax policy at the finance ministry, said. “We have a beautiful country, a very good climate, so why not?” “We hope that pensioners benefiting from this attractive rate will spend most of their time in Greece,” Ms Kalyva told the Observer. Ultimately, the aim is to expand the country’s tax base, she added. “That would mean investing a bit — renting or buying a home.” …The proposal goes further than other countries, however, with the flat tax rate in Greece to apply to other sources of revenue as well as pensions, according to the draft law. “The 7 per cent flat rate will apply to whatever income a person might have, be that rents or dividends as well as pensions,” said Alex Patelis, chief economic adviser to Kyriakos Mitsotakis, the prime minister. “As a reformist government, we have to try to tick all the boxes to boost the economy and change growth models.”

Here are excerpts from a Reuters report.

Greece will offer financial incentives to encourage wealthy individuals to move their tax residence to the country, part of a package of tax relief measures… Greece’s conservative government is keen to attract investments to boost the recovering economy’s growth prospects. …The so-called “non-dom” programme will offer qualified wealthy investors who opt to shift their tax residence to the country a flat tax of 100,000 euros ($110,710) on global incomes earned outside Greece annually. “The tax incentive will run for a duration of up to 15 years and will include the benefit of no inheritance tax for assets outside Greece,” a senior government official told Reuters. One of the requirements to qualify will be residing in Greece for at least 183 days per year and making an investment of at least 500,000 euros within three years. …Investments of 3 million euros will reduce the flat tax to just 25,000 euros. There will also be a grandfathering clause protecting investors from policy changes by future governments.

By the way, Greece isn’t simply offering a flat-rate tax to wealthy foreigners. It’s offering them a flat-amount tax.

In other words, because they simply pay a predetermined amount, their actual tax rate (at least for non-Greek income) shrinks as their income goes up.

And since tax rates matter, this policy is luring well-to-do foreigners to Greece.

That’s good news. I’m a big fan of cross-border tax migration, both inside countries and between countries. And I’ve specifically applauded “citizenship by investment” programs that offer favorable tax rates to foreigners who bring much-needed investment to countries wanting more growth.

But I want politicians to understand that if low tax rates are good for newcomers, those low rates also would be good for locals.

But here’s the bad news. Fiscal policy in Greece is terrible (ranked #158 for “size of government” out of 162 nations according to the latest edition of Economic Freedom of the World).

What’s especially depressing is that Greece’s score has actually declined ever since the fiscal crisis began about 10 years ago.

In other words, the country got in trouble because of too much government, and politicians responded by actually making fiscal policy worse (aided and abetted by the fiscal pyromaniacs at the IMF).

And the bottom line is that it’s impossible to have overall low tax rates with a bloated public sector – a lesson that applies in other nations, including the United States.

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Image credit: Pedro Szekely | CC BY-SA 2.0.

Why Elon Musk’s EV Credits Need to Go

Fri, 07/31/2020 - 12:21pm

Originally published by RealClearEnergy on July 30, 2020.

Over the last week, the media has reported that Elon Musk’s Tesla is making money hand over fist. In reality, however, like Musk’s aerospace company SpaceX, Tesla is using fists – the government’s – to take money from the taxpayers.

To avoid going into the red, Tesla leverages government mandates requiring the production of electric cars to mulct other car companies that don’t make EVs – or enough of them – into buying “credits” from Elon in lieu of doing so.

Essentially, other car companies must choose between diverting capital into unprofitable electric cars or diverting money into Elon Musk’s pockets.

It’s cheaper and easier to do the latter than to expend the even larger sums it would take to design, tool, and manufacture their own electric cars, which they’d then have to try to sell without losing money again. Their dealers don’t want cars they can’t get enough people to buy to make it worthwhile – even with the incentive of thousands of dollars of other people’s money (tax credits) thrown in as part of the deal. It looks bad to have what amounts to electrified Azteks just sitting there, collecting dust and taking up valuable floor space that could be used to display cars that people want to buy – and do – without being paid off to buy them.

No one wants to be the automotive Goodwill store.

One analyst notes that Tesla’s reported profits “are more than accounted for by $1 billion in regulatory credits sold to other carmakers during the 12 months (up to) June.” (italics mine). But these credits would never have been bought absent the government mandate. According to Morningstar’s David Whiston, “Tesla had a pre-tax loss of $278 million excluding $428 million regulatory credit revenue.” This is how Tesla makes – or rather, takes – its money. But that’s not how it’s reported.

The analyst went on to state that Tesla “… is only able to earn this income because rivals haven’t gotten their act together yet on building enough electric vehicles and have to buy credits to satisfy emissions regulators.”

Gotten their act together?

EV apologists makes it sound like a car company only wanting to build what people are willing to buy at a price that makes it worth making is a disreputable thing. And that’s the problem with electric cars – they are not worth it for most manufacturers; at least presently. If they were, the government would not need to impose production quotas. There are no production quotas for iPhones – and Apple doesn’t need to get the government to strong-arm Samsung to buy “credits” from them in order to stay in business. But car companies that make what people want to buy – and what is profitable to sell – are shamed for not viewing the government as their customer like Tesla does.

Tesla “earns” this money in the same way as the IRS. The difference is that Tesla is a privately-owned company using the same offer-you-can’t-refuse methods. Elon Musk is on track to pocket another couple of billion for this very reason, something only possible because of his silent partner, the government. It’s easy making money when you can simply take it.

But as the aforementioned analyst also notes, “this good fortune won’t last forever” – because, eventually, the other car companies will “get their act together” – meaning, they’ll cave into the regulatory pressure and build the required number of electric cars. Perhaps nothing but electric cars – as VW has publicly said it will do by 2025, after being practically crucified by the government for selling millions of 50 MPG (at only about $22,000) diesel-powered cars that people jostled in line to buy. Which they can no longer buy – because the government outlawed them.

At any rate, once VW builds nothing but electric cars, they will no longer have to pay Elon to build electric cars. However, someone will still have to pay for all these government mandated EVs, which are currently impossible to sell for a profit without someone else taking a loss. Nissan, for example, has been bled for “selling” its Leaf electric car. It frequently only leaves the showroom floor when its new owner’s receive tax credits to the tune of several thousand dollars, and the window stickers of all the other cars on the floor increase to offset the loss.

The only reason Nissan builds the Leaf at all is to meet the regulatory requirements. It would probably be cheaper – and easier – to line Elon’s pockets, as GM, Toyota and other car companies have been doing. But it will get a lot more expensive for everyone when all you’re able to buy is an electric car, and it’s no longer possible to use the government to make someone else pay for it.

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Image credit: Maurizio Pesce | CC BY 2.0.

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