Inconsistency of the Day

A thought occurred to me while I read this Wall Street Journal opinion piece that explains that taxes are high on American corporations. This is despite an earlier GOA report that showed a 12.6% effective tax rate.

It turns out there were two problems with that report. First, it had a small sample size. It was based on one year, 2010. That year saw heavy write-downs (i.e. tax deductions) from the financial crisis, so it was an anomaly. Second, it didn’t include taxes paid to foreign countries.

Another study, with a longer period or 2004 through 2010, showed the total tax rate exceeded 35%.

The thought that occurred to me was this: I wonder how those who tell us that ‘corporations are not people’ feel about corporate taxes. 

My guess is that they don’t want corporations to have a voice in the political arena, but they want to tax the heck out them, which I find inconsistent.

They should realize that corporations are made up of people. Shareholders and employees are people.

While I sort of agree that corporations in the political arena are usually out to use government’s power against us, I think the proper place to fix this is by reducing the power government has, rather than trying to keep the 16 year-old-girl away from the proverbial bad-boy.

I also think that the proper place to tax corporations is at the individual level. Taxing corporations just reduces the transparency of the taxes government is imposing on individuals.

Thoughts on taxes II

In my first Thoughts on taxes post, I listed reasons why I prefer a simple and broad tax system.

In this post, I will elaborate on the first reason I listed for preferring a simple tax code:

  •  No matter the complexity of the income tax system, government collects about the same percent of the overall economy’s income (GDP) in taxes.

Since World War II, our country has had a fairly wide variation in complexity and rates in its income tax code. Yet, the chart on this page shows individual income taxes collections have stayed in a relatively narrow range between 8% and 10% of GDP.

Politicians often say they want to raise tax rates to increase tax collections. This chart suggests that rates — at least for the various tax codes since about 1950 — don’t have significant effects on government’s take of the economy as a percent of GDP.

So, making moderate changes to get more (or less) revenue doesn’t seem to work.

This doesn’t seem to be widely known and is rarely brought up when discussing tax rate proposals.

It also doesn’t seem intuitive. It’s fair to ask, how could it be that tax rate changes don’t seem to have much effect on the total percent of income collected in taxes?

Great question. I’m not sure I know the full answer, but a key part of it is that the complexity of the tax code itself.

Different types and amounts of income are taxed at different rates and we all have choices that allow us at least some flexibility on how much taxes we pay. We’ll tend to favor the types and amount of income that we feel are a good deal on an after-tax basis.

If the tax rate for dividend income, for example, is lower than the tax rate on capital gains (both are investment income) — then it’s worth our while to favor dividends over capital gains. Investment advisers will encourage us to switch investment strategies to invest in companies that pay dividends to help us minimize our tax bill. Management teams will respond by distributing more money back to owners through dividends than share repurchases.

Consider the recent example where Great Britain raised the tax rate to 50% on those making more than a million pounds. The number of folks reporting more than a million pounds dropped in one year from 16,000 to 6,000 and taxes collected from this group declined from 13.4 billion to 6.5 billion pounds.

The article states:

It is thought that many of the highest earners moved abroad or reduced their taxable incomes to avoid paying the new levy.

So, while the tax rate went up, the amount of income exposed to this tax rate when down meaning the weighted average tax rate in England probably didn’t change that much.

There are other decisions we can make that change our tax rates. How much you donate to charity, how big of a mortgage you decide to get, deciding not to sell a stock because you won’t make enough after taxes on the gain, how much you decide to save in tax deferred retirement accounts and how much you decide to contribute to your HSA or cafeteria plan are some of the more common decisions that have clear tax implications.

Raise tax rates on folks like Warren Buffett, a vocal tax increase advocate, and he’ll just donate more to charity to lower his tax rate.

Where does the Laffer Curve bend?

Laffer Curve

What is t*?

Thomas Sowell says that when tax rates are raised on high-income individuals, they respond to incentives by arranging their financial affairs differently to minimize those taxes.

Folks, like blogger Megan McArdle, lecture/patronize opponents of tax increases that current marginal tax rates are not near the bend in the Laffer Curve (the point where increasing tax rates would reduce revenue).

This is from Mark Perry’s blog, Carpe Diem:

The U.K. government is learning about the economic lesson that “if you tax something, you get less of it.”  Following an increase in the top marginal income tax rate to 50%, tax revenues from high-income taxpayers are falling, and are not going up, as the Treasury somehow expected by ignoring the economic lesson that “people respond to incentives.” A U.K. Treasury official explained the disappointing drop in tax revenues by saying it “was partly due to highly-paid individuals arranging their affairs to avoid paying the 50% rate.”  Duh.

Does the Laffer Curve exist?

Commenting on this post, Speedmaster writes:

The Laffer curve is very real. You can argue shape differences, and where we might be on it. But I don’t think a sane person can deny it exists.

Speedmaster writes more the subject here.  It’s worth a read.  And here’s more from a February post with Arthur Laffer himself explaining the curve.  From that post Laffer explains what causes the bend in the curve:

Changing tax rates changed behavior, and changed behavior affected tax revenues. Reagan understood that lowering tax rates led to static revenue losses. But he also understood that lowering tax rates also increased taxable income, whether by increasing output or by causing less use of tax shelters and less tax cheating.

I’m always entertained by folks who downplay the Laffer Curve and claim that changing tax rates won’t change behavior “that much” (or enough to make tax rate changes counterproductive).

I find this to be a good example of revealed preferences.  Sometimes how we say we will behave and how we actually behave are different.

This difference isn’t caused by dishonesty.   It’s caused by not having a full appreciation of all the factors that will influence our behavior and decisions in the moment.

An example from mass transit might help illustrate.  I once read about a market research study for area considering building light rail for mass transit.  They asked residents if they would be willing to ride the train. 

Of course, they answered. It sounded like a great idea.  Trains are cool.  They can save time and money, right?

After they built the train, many fewer people actually used the train than the market research predicted.  Why, they asked?

It turns out they hadn’t considered all the factors when they answered the market research.  Sure, trains are cool and all, but my car gives me maximum flexibility in my schedule.  If I miss the 5:20 train, for example, I’m stuck until the 6:20 train, when I could have made it home faster if I just drove.

They also say things like they neglected to consider how much time it would take to get to and from the stations.  After they arrived at their destination, they still had to walk a ways or take a bus to get them where they were going and it was just a hassle.

In the end, they just didn’t realize how good they had it with their individual cars.  It turns out there were good reasons why roads and vehicles put most trolley cars and passenger trains out-of-business about 90 years ago.  It’s just that we forgot those reasons.

Same with tax rates.  It’s easy to say that raising marginal tax rates by 5% won’t change our behavior, for example, because we just can’t imagine that it will.  It seems insignificant.

But, when we’re actually faced with it, we do change our behavior in some marginal situations that we didn’t think about when we considered it from a distance.

But, when rates go up, we end up looking a little harder for those deductions and credits to help get back some of that tax money.  We put a little more money into our 401k or maybe buy a rental property.

We turn down that job offer that has a little higher pay and more responsibility because we do the math and realize that the after-tax bump in pay just isn’t high enough to compensate for the added headache.

Progressive tax rates II

I appreciate the comments to my previous post.  They all provide good reasons why progressive tax rates may not be as fair of a way to tax as it first appears.

As dave points out, it’s inefficient to pay for a mediator to administer the system because the mediator takes his cut too.  That could be the economic rent that gets wasted in setting the rates, the cost of running the IRS and all the expense taxpayers and businesses go through to file tax returns.

W.E. Heasley suggests asking why they desire a more level income distribution?  Actual results of such schemes do not have a good track record.

thebigdog suggests considering that progressive tax rates shrinks the pie for everyone, which could hurt the very people with lower income that progressive tax rate supporters are trying to help.

With further correspondence with commenter, DG Lesvic on Cafe Hayek, he pointed me to this good passage on his website (from a section titled The Forbidden Theory of Redistribution):

At the line between rich and poor, but one penny of income separates them.  So, when it is taken from the rich and given to the poor, their stations are reversed.  The rich become poor and the poor rich, which attracts manpower from the occupations of the one to those of the other.  To restore the manpower allocations it preferred, the market must bid the net wages of the formerly higher paid occupations back up and of the formerly lower paid back down.  But, anticipating increasing rates of redistribution, and compensating not just for the current but for the greater anticipated rates, the market must bid the net wages of the formerly higher paid to even higher levels and of the formerly lower paid to even lower levels than before, for differentials even greater than before.

Let’s remember the original two sentences supporting a progressive tax rate:

Someone who makes $10,000, pays 10% to the government only has $9,000 left.  Someone who makes $1 million pays 50% still has $500 thousand left — a lot more even though they pay a higher rate.

Here’s my feeble attempt at a response.

You assume that wage rates do not change with tax rates.  What if someone who makes $10,000 earns less because the market accounts for their lower tax rate while someone who makes $1 million earns more to compensate for their higher tax rate?

You don’t think that’s possible?

All else equal, would you prefer a job that pays $50,000 and a 20% tax rate ($40,000 after tax) or one that pays $60,000 with a 40% tax rate ($36,000 after-tax)?  My guess is that you would take the lower paying job with the lower tax rate because the after-tax income is greater.

And when you think of it, why would wages be different than any other good or service?  You may spend more on a car if you did not have to pay sales tax.  Tax rates matter.

While progressive tax rates appear to be a fair way to tax, please consider that may only be an illusion.

If it were an illusion, would you still favor a progressive tax rate?

Progressive tax rates

A few weeks ago a family member explained the simple and appealing logic of progressive tax rates — or tax rates that get progressively higher on higher incomes.

Someone who makes $10,000, pays 10% to the government only has $9,000 left.  Someone who makes $1 million pays 50% still has $500 thousand left — a lot more even though they pay a higher rate.

I’m looking for a simple and appealing argument against it.  I don’t think I’ve found it yet.  But I think some good reasons against it are in the following sources.

In St. Augustine Anticipates H.L. Mencken and Walter Williams, Don Boudreaux quotes from St. Augustine’s City of God.  The quote equates the use of force to take from folks via the state with robbery.

I explained another good reason in my post, The political power machine.  Giving government officials the power to set different tax rates for different people doesn’t do much except give those in government the power to extract economic rent.

But both of those arguments may not be necessary if F.A. Hayek is correct.  In the comment section of Don Boudreaux’s post, commenter DG Lesvic quotes from Hayek’s The Constitution of Liberty (p. 306).  Hayek claims the only argument needed against government redistribution is the economic argument that redistribution increases inequality.  All other social, political and moral arguments leaves the door open for the economic argument that it decreases inequality.

Hayek might be onto something.  Folks seeing progressive taxes as a means of decreasing income inequality may be why the simple logic that my family member articulated is so appealing.

If Hayek is correct, then we need to know how redistribution increases inequality and be able to articulate that in a way that is as intuitive and simple as the two sentences from my family member.

Does anyone have any ideas on how to do that?