Scott Sumner  

Better than expected, but will it survive?

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Touchy-Feely Bull in a China S... The Value of the Reformation: ...

Just a quick reaction now, but I'll have much more to say later. This is based on a brief news article, not a detailed reading of the proposed tax bill.

1. There is more tax reform than I expected. I've argued we need tax reform more than tax cuts.

2. The bill would eliminate the AMT and radically reduce the share of people who itemize. These two tax provisions are incredibly wasteful--almost perfect examples of what economists mean by a "deadweight loss". If we can't reform the tax system it would be a major failure of our political system. I'm thrilled to see them being targeted.

3. My taxes would probably rise, as the plan hits dual income upper middle class people, especially those in high tax states like California. However I strongly support tax changes that would raise my taxes, as long as they make the tax system more efficient. You should too!

4. They will also phase out the inheritance tax, but I expect the Dems to add that back in when they retake power. In contrast I believe the changes described in point #2 might endure, if they pass Congress (a huge if).

5. The cut in the corporate rate was inevitable, even if the Democrats had won the election. It is a worldwide trend and thus it was inevitable that we'd feel the need to catch up for international "competitiveness" reasons. (Yes, "competitiveness" is a meaningless term, but it matters to policymakers.)

In a perfect world we would have simply eliminated the various loopholes for mortgage deductions and state and local taxes. But this proposal is cleverly designed to come pretty close, and would allow them to be totally eliminated in a future reform. Again, if it survives.

Also, in a perfect world the reform would have been closer to revenue neutral and more progressive. Perhaps including a dramatic increase in payroll taxes for the rich to make up for lost revenue. Wage taxes are identical to consumption taxes, they are easy to collect, and they are easy to make progressive.

My dream tax system has three parts, a progressive VAT (exempting the first $X of consumption), a steeply progressive payroll tax, and a progressive property tax. (The current property tax is regressive.) If people work for a company, then all the income they get from that company would be treated as labor income. This would prevent people from incorporating their business to avoid (higher) wage taxes.

When I say "steeply progressive payroll tax" I mean a subsidy for low wage workers, and relatively high rates for high wage workers. My dream system has no personal or corporate income tax, and no inheritance tax, but would still be quite progressive.

I believe the switch to a network/information economy makes the need for tax progressivity greater than in the old commodity economy, where people's productivity was based more on how hard they worked. At the same time, I believe the current obsession with "inequality" is way overdone. America's middle class is doing fine.

PS. I forgot to mention one other useful tax---a carbon tax.


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CATEGORIES: Tax Reform , Taxation




COMMENTS (29 to date)
Floccina writes:

On progressive property tax:

Florida has what they call a homestead exemption which appears to make property tax look progressive but in a competitive pretty free to build market like mine in north Florida, it ends up taxing renters much more than owners and since renters tend to be poorer, it ruins the progressiveness.

IVV writes:

"3. My taxes would probably rise, as the plan hits dual income upper middle class people, especially those in high tax states like California. However I strongly support tax changes that would raise my taxes, as long as they make the tax system more efficient. You should too!"

Ah, the dual income upper middle class! Wonderful purchasing power, very little political clout! A perfect fuel to feed the nation's fires of government! Come, let us bask in their glow!

(Now if only they'd stop taxing expats like the rest of the world...)

Lewis writes:

What does a progressive property tax look like? It seems that such reforms wind up being a way for people to take a massive windfall, and they end up raising prices for younger families and workers, who often have more income than wealthy retirees, and renters. If by "progressive" you mean " based on the value of the property" then there is a weird incentive to own five little pieces of property instead of one big one, or enter into ownership-like arrangements with someone who's getting the break. In California, Prop 13 has introduced very bizarre incentives for local government, who seek out hotels and retail while trying to quash any new housing. See the fight in Brisbane, CA underway.

I think you should qualify your statement than the payroll tax is equivalent to a consumption tax. It would be in a steady state. But during the enactment there would be a difference, since people have already accumulated a great deal of wealth in our current regime. So adding a consumption tax would tax retirees but a payroll tax would not. Thus, raising $x in revenue from a payroll tax would require relatively higher taxes on current workers.

Steve F writes:

I have a hard time seeing how any tax system other than flat would not result in lots of distortions.

TAA writes:

Scott - have you given your views on the reduced pass through rate?

Like you, I'm positively surprised by what I've seen, but have a hard time rationalizing this aspect of the plan.

Ben writes:

I don't understand the obsession of the GOP for scrapping inheritance tax.

It's politically toxic, with Twitter basically universally highlighting it as unfair and makes the plan look like it's just for the rich and it's certain to be reinstated by the Dems in a few years (and possibly before full repeal anyway).

It's pointless, they should spend their political capital somewhere else, but I suppose it must be what donors are asking for.

Marine Recon writes:

We don't need tax reform - we need to repeal the 16th Amendment (Income Tax) and replace it with just two taxes.

1. Real Estate Tax - based on square-feet of owned and developed land (above/below ground) - voted on once every four (4) years by the registered voters of all states at a rate divisible by three (3) and not less than $0.90/sqft and not more than $9.90/sqft, the amounts to be equally distributed to federal, state, and local governments and to be disbursed on a monthly basis by the state of origin

2. Sales tax. Voted on every 2 years by each state's registered voters and to be an amount divisible by three (3) and not to be less than $0.03 but no more than $0.15 the amounts to be equally distributed to federal, state, and local governments and to be disbursed on a monthly basis by the state of origin

If this is too simple and too sparse, then I suggest that government has grown too sophisticated and too large for our own good.

Thomas Sewell writes:

@Ben,

The inheritance tax is one of the worst taxes for many reasons:
1. Fairness: It's taxing wealth which has already had taxes paid on it, solely because someone died.
2. It's easy to avoid if you plan ahead and hire accountants/lawyers to do things like move your assets using gifts, foundations, etc... Almost everyone does that, so it raises very little money and what little money it does raise tends to be from a small number of people who die unexpectedly (Your parents just died in a car accident, here's the tax bill!) or fail to plan, making it feel even more unfair.
3. As a result of #2, there is a lot of economic dead-weight loss as money is spent paying accountants/lawyers to do legal tax avoidance rather than on something useful or productive or wealth building for society.
4. It hits small businesses/family farms, i.e. not easily divisible entities, the worst. Just when the owner dies, the government then comes and tells their kids, BTW, you can't actually continue your parent's business/farm legacy as-is, you're going to have to sell it (without even being able to time the sale very well and only after complying with a bunch of court bureaucracy) in order to pay the taxes. That makes many of the victims sympathetic.

What do you see as the good points of the inheritance tax as currently implemented? Some theoretical philosophy of children not getting to benefit from their parent's hard work? Most parents who choose to build wealth instead of squandering it in their lifetime aren't going to share that philosophy and in practicality, it doesn't actually have that effect. In reality, it appears to just be a method of additionally (by definition, their parent just died, remember) punishing the children of some subset of the wealthy whose parents weren't fully prepared to die because they didn't pay lawyers and accountants enough.

Matthew Waters writes:

Hrm, progressive property tax sounds vaguely like Piketty's wealth tax. Just thought I would point that out.

The thing I *really* wish this tax system would get rid of is:

1. Employer health insurance deductibility.
2. Step-up in capital gains basis on death.

Even more than mortgage interest deduction, these lead to very wasteful distortions. I'm fine with getting rid of estate tax at this point if it comes with eliminating basis step-up.

Mark Bahner writes:
However I strongly support tax changes that would raise my taxes, as long as they make the tax system more efficient. You should too!

Yes, I also strongly support tax changes that would raise your taxes, as long as they make the tax system more efficient. ;-)

Matthew Waters writes:

Thomas Sewell,

The estate tax offsets a huge benefit from step up in capital gains basis.

For most billionaires, they have some extremely large capital gain which they haven't sold. Gates, Buffett, Kochs, etc. have stocks which have appreciated thousands of times over.

If they sold that stock while they were alive, then they have to pay capital gains. If their heirs inherit the stock, then they don't have to pay capital gains.

The reasoning was that the old, pre-death basis could be very hard to figure out. IMO, this is less true now. But with the step-up in basis, the estate tax at least offsets that by taxing gross inheritance, regardless of basis.

In any case, the small business/family farms thing is basically a complete myth. The estate tax starts at $5.5M wealth. In practice, the mythical small business worth $6M would owe $200k in tax (40% of amount above $5.5M). A business worth $6M will have access to that amount of money, or can make an installment plan which is written into the law. It's not "breaking the business up."

What's your definition of a small business which would be broken up? A business valued at $50M? Your viewpoint has to be extremely skewed to feel sorry for heirs of a $50M estate. However the heirs figure out how to pay $18M in taxes, they still inherit $32M at the end of the day.

The deadweight loss and tax attorney arguments are true of *any* tax. As Milton Friedman said, to spend is to tax. In the end, any estate tax you don't have is a tax ultimately paid somewhere else.

In utilitarian terms, the marginal dollar brings less utility to heirs of large estates. It just does. Any dollar you don't tax from those estates has to be taxed somewhere else or has to be a dollar of spending cut.

Scott Sumner writes:

Lewis, Think about the property tax in NYC, where billionaires in penthouse apartments pay a property tax rate far lower than the rate paid by working class people. Under my system it would be the opposite, they would pay a higher rate.

TAA, I'll study that issue and get back to you.

Ben, See my reply to Matthew.

Matthew, You said:

"Hrm, progressive property tax sounds vaguely like Piketty's wealth tax. Just thought I would point that out."

Except it is not anything like that tax.

I agree that the tax system should be progressive, because a dollar is worth less to a rich person than a poor person. But the estate tax is a horrible way to do that, for all sorts of reasons. There's a reason why countries like Sweden have abolished their estate taxes; they are unfair and distortionary.

Your comment about whether we should feel sorry for businesses hit by the estate tax misses the point. On economic grounds I don't feel sorry for anyone in America. Even our poor people are relatively rich compared to the rest of the world. The issues are fairness and efficiency, not whether we feel sorry for people.

I don't want to tax a thrifty guy who leaves his wealth to his children at a far higher rate that a rich guy who spends all his wealth on an orgy of wine, women and song. But that's just me, others may have a different value system.

By all means tax the rich, just don't do it with an estate tax.

Matthew Waters writes:

Well, I did say I would be ok with abolishing the estate tax if it also eliminated the step-up in basis for capital gains. If efficiency is the main issue, then old people do hold on to assets they would otherwise sell.

I support the estate tax in the current system if there is no step-up in basis. The argument went that the original basis could be very difficult or impossible to find out. If that's true, then tax estates on a gross basis.

Also, it's worth pointing out how the Waltons actually did get around the estate tax with trusts. When Democrats have proposed rules to disallow these trusts, they were always defeated.

There are a lot of bad faith arguments about how the rich avoid taxes. Tax cutters will say "the rich will just hire lawyers to avoid them," but then the proposals to close the loopholes are voted down.

Link

Jonathan Paulson writes:
Wage taxes are identical to consumption taxes
Why is this true? My personal consumption is much lower than my wages. I guess the argument is that all wage income is eventually realized as consumption? (or passed on to heirs, which seems to spoil the argument)
BC writes:

What is the reason for progressive taxation if we already have means-tested benefits, or vice-versa? If the goal is to have the simplest possible system with the least distortion, then why wouldn't we choose either progressive taxation or means-tested benefits, but not both, depending on which was simpler and less distortive?

ZC writes:

@Scott Sumner

"Perhaps including a dramatic increase in payroll taxes for the rich to make up for lost revenue." If they're truly rich (not just high-earned income, which is what I presume you mean), then they'll just stop working (at the margin) or alter how their income is classified (cap gains, distributions, etc. shifting earned income to passive).

"I agree that the tax system should be progressive, because a dollar is worth less to a rich person than a poor person." That's a presumption that's unsupported by reality. Venture out into 'poor' America and you'll see that many of them don't value dollars much at all, contributing to their persistent generational poverty. It makes for nice economic theory in a textbook, but doesn't always hold true in reality.

The tax bill, as proposed, is a typical legislative boondoggle that doesn't have a chance of passing in it's current form. What will emerge will be crafted by special interests and filled with loopholes and handouts that will serve to increase the length, complexity, and distortive effects of the tax code, not make it more efficient.

Alan Goldhammer writes:

Very nice analysis. One question that I have is the economic impact on home building if the current proposal survives intact. Clearly the special interest groups (home builders, realtors, and probably banks issuing mortgages) have already come out against the mortgage interest deduction and SALT provisions. Home building is a key economic contributor though subject to 'bubble' effects. It will be interesting to see if anyone has done an economic impact analysis on this sector.

Chappy writes:

Well, if by "more reform than expected" you assumed none, then I can understand. Coherent reform is another story. Your impression of item #2 and the AMT is seriously undermined by the fact that practically nothing was done on mortgage interest. My wife, a tax lawyer, ran our taxes based on the plan and we'd come out $500 ahead based on removing the AMT. I agree the AMT is stupid, but it also doesn't make sense if the underlying reason for it is not also addressed.

Anyway, I guess, as an economist, being impressed with a couple provisions of the bill is fine, but this bill is incoherent as tax policy and politically dead-on-arrival. (Of course it would have been more DOA if it were coherent).

paulbern writes:

You write, 'My taxes would probably rise, as the plan hits dual income upper middle class people'

My guess is (though I may be off) that your household income puts you into the top 20% of the US income distribution, easily. In which case, you are not middle-class, sorry. That's one of the biggest delusions around.

Sean writes:

I agree with you on a lot of things.

But I can't see why SALT deductions are inefficient. If you view your personal life as a small business then they are basically a cost of doing business. If you work in tech you have to live in San Francisco. Should we tax a tech worker more than a farmer?

Also I view housing as an investment. Shouldn't the costs of the investment be deductible.

I think upping the standard deduction is silly. It makes sense to have it exists since most people have some salt deductions but at low levels there not worth calculating so just give them a small standard deduction.

Chappy writes:
My dream tax system has three parts, a progressive VAT (exempting the first $X of consumption), a steeply progressive payroll tax, and a progressive property tax. (The current property tax is regressive.) If people work for a company, then all the income they get from that company would be treated as labor income. This would prevent people from incorporating their business to avoid (higher) wage taxes.

As an economist, I think this makes a lot of sense. On the other hand, you're going to regret your statement about the bill having lots of "reform" when you figure out the pass-through income reduction is just going to lead to owners characterizing wage income as pass-through income.

Duane Oyen writes:

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Thaomas writes:
My taxes would probably rise, as the plan hits dual income upper middle class people, especially those in high tax states like California. However I strongly support tax changes that would raise my taxes, as long as they make the tax system more efficient. You should too!

I would agree (although I'd curb the mortgage interest tax subsidy through a partial credit rather than a capped deduction and see no rationale for the reducing the state tax deduction -- what's the dead weight loss there?) if the system were not becoming less fair by shifting after tax income to high income tax payers and heirs.

Duane Oyen writes:

I am fine with all of this till the thoughtless comment about Pigou taxes, that is, the carbon tax.

I agree theoretically about carbon taxes and Pigou in general- but the elites who so easily promote them ignore the fact that these are quite regressive. The guys who need to drive 1974 Pontiacs to their jobs blowing leaves are quite sensitive to such costs, as are the whole industries that employ lots of people provided that there is lots of cheap energy available. And, even on the right, the big proponents of carbon taxes (e.g., Irwin Stelzer, Greg Mankiw, George Shulze) tend to see them as a sop to the rich global warming alarmists.

Find a way to tax carbon that does not hurt the lower classes, and we can buy in. Otherwise, the upper-middle class "greens", however pale the green or macroeconomically virtuous, should, to put it gently, find a different approach.

Billy Kaubashine writes:

The lowest possible rate with the fewest possible decision-distorting deductions (loopholes) applied as broadly as possible (so every voter has some skin in the game) should be the goal.
The real problem is that for the majority of American voters, there is no incentive to reject any government spending proposal because most voters don't pay for government programs.
When candidates make stupid promises, they know that the majority of voters will reap the benefit without sharing any of the cost.
We fought a revolution against taxation without representation. We now have representation without taxation.

David Friedman writes:

The argument for a carbon tax assumes that we know the externality from CO2. Increases will have both positive and negative effects, the size of both is quite uncertain, with the result that we not only do not know the size of the externality, we do not know its sign. Lots of people are sure they do, but that's because they know what result they want to get and make judgement calls accordingly.

That is the same claim I made, in print, 45 years ago in response to what was then the orthodox view of the effects of population increase--that they would be something between very bad and catastrophic. Events since then are consistent with what I wrote, inconsistent with what everyone else, with the notable exception of Julian Simon, claimed.

Jim Scott writes:

You misspeak a little when you describe the federal estate tax as an inheritance tax. It's an estate tax, levied on the estate of a deceased individual. Inheritance taxes are levied on the inheritors. Some states have estate taxes, some have inheritance taxes, and New Jersey and Maryland have both. The trend on the state level is to eliminate or reduce estate and inheritance taxes, sometimes by raising exemption amounts. As recently as five or six years ago, New York's estate tax exemption amount was only $500,000 (which was taxed at 3.06% or 5%, graduated to 16% if you were over, depending on which expert you consult). Now it is, as best I can figure (please consult your tax advisor), $5.25 million. However, if you're five percent over, you owe tax of $430,050. In other words, as in the example from the NY Society of CPAs, there's a $430,050 tax on the additional $236,500 in your estate.

https://www.nolo.com/legal-encyclopedia/new-york-estate-tax.html

David Manheim writes:
a progressive VAT (exempting the first $X of consumption)

Is there any implementable way to do this?

If you're putting a refundable tax credit on everyone's taxes and charging VAT on all purchases, it's just saying "progressive income tax" again. Otherwise, you're asking people to track their spending for the VAT exemption...?

Mark Bahner writes:
The argument for a carbon tax assumes that we know the externality from CO2.Increases will have both positive and negative effects, the size of both is quite uncertain, with the result that we not only do not know the size of the externality, we do not know its sign.

Yes, that's why it's better to tax fossil fuels by taxing emissions of particulate matter, sulfur dioxide, and nitrogen dioxide.

Not that we particularly need to do that, either. Coal is dying. Natural gas and oil will also be dead in the southern part of the U.S. in a decade or two...killed by photovoltaics backed up by electric vehicle batteries. It is easy to imagine the U.S. emitting less than one-fourth of its current CO2 and methane emissions by the middle of this century.

Finally, any politically feasible CO2 tax in the U.S. will have no measureable impact on global temperatures.

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