Tackling Taxes

With the pending debt crisis, the issue of taxes has become a much discussed issue. The biggest backlash in the debate seems to have been spurred by Warren Buffet, who says the ultra-rich should be paying more. A New York Post op-ed says that this is misguided:

Left unsaid is that much of that is taxed at 35 percent (via the corporate income tax) before he even gets his hands on it. So in effect, he’s paying taxes twice (that is, when his companies actually pay, anyway).

Counting both taxes, his effective rate would really be well north of 40 percent for a big chunk of his income.

In addition, Obama has propagated rhetoric against Corporate Jet Owners:
This, according to Republicans, has spurred a class warfare about who pays what taxes. The Daily Show pretty much explains it best:

The Daily Show - World of Class Warfare - The Poor's Free Ride Is Over
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This dialogue of shifting the burden of taxes from the rich to the poor has been a common thread from the Republican candidates. Fact of the matter is that the people who aren't paying taxes are amongst the poorest in our country. They live from pay check to pay check and can't afford to pay taxes without threatening their already low standard of living. Quite simply, it's a type of tactical rhetoric to enrage the contingency they're appealing to who tend to hate taxes and hate paying them. To these people, everyone should share the burden if there is a burden at all. Here's what Michelle Bachmann had to say:

"Part of the problem is today, only 53 percent pay any federal income tax at all; 47 percent pay nothing," said Bachmann. "We need to broaden the base so that everybody pays something, even if it's a dollar. Everyone should pay something, because we all benefit."

It's not just her saying this. Jon Huntsman is also in the we need more people paying taxes boat (8:11). I agree with Huntsman as saying we need people to have a stake in our spending. If you aren't paying taxes, what do you care how the government is spending those funds?

The problem though is that people are looking at it from a budgetary stand point. Taxing the poor shouldn't be seen as the way to increase tax revenues. It should be used more to make sure people have a shake in the government's spending. It should be to keep the government accountable.

But as I said before, these are the poorest of the poor:

Consider: Of those households that do not owe income taxes, about a third earn $10,000 a year and a slightly smaller share earn between $10,000 and $20,000. More than three-fourths earn $30,000 or less.

In addition, the notion that these households pay no taxes is flat-out wrong. They pay — leaving aside state and local sales, income and property taxes — federal gasoline and other excise taxes and, most significantly, payroll taxes on every dollar they earn. These taxes are regressive. Everyone pays the same share, regardless of income, so they hit the poor hardest, and they counterbalance the progressivity of the income tax code.

Let's not worry about taxes from a who pays stand point then. Let's worry about taxes from the stand point of the budget. Raising tax revenues is necessary in times where the budget is a concern. Deciding the budget isn't as simple as cutting spending and increasing taxes though. It is important to also consider the effect that these changes will have on the economy.

The economy is struggling.

We need policies that encourage economic growth. Let's start with Obama's plan to raise taxes and see if it would positively affect the economy. We'll look at the UK for evidence. The UK raised the top tax bracket to 50% for the wealthiest:

The new rate will affect the 300,000 highest earners in the UK, out of the 29 million people who pay income tax.
It will be levied on taxable incomes greater than £150,000 a year and aims to raise an extra £2.4bn by next year.

This is, in effect, similar to what Obama wants to do in taxing those making $250,000 or more. So did it work?

The most likely explanation is that higher income tax receipts partially represent the new 50p rate kicking in and rasing revenue. How else to explain the figures? Receipts are up way in advance of earnings or employment growth.

So it has worked in raising revenues. The big question then becomes has it helped the economy? It seems not:

"We always said that recovering from the deepest recession that we've had for many decades, with the largest budget deficit that we've seen for a very long time was going to be choppy and I think probably the waters have been choppier than anyone expected. We've seen big headwinds in the global economy, rising oil prices, rising commodity prices. All those things have an impact on the British economy."

Those same variables would seemingly have the same effect on the US economy. Raising revenues won't be worth it if you have events like this going on:

A solution that also addresses the economy would be the best case scenario. So what other options are there? Michelle Bachmann has proposed that we cut taxes:

Representative Michele Bachmann promised Saturday that as president she would turn things around within one economic quarter, in part by cutting corporate taxes and eliminating capital gains and inheritance taxes. Painting President Obama as doggedly antibusiness, Mrs. Bachmann asked, “Why in the world wouldn’t we do what we know works to create jobs in this country?”

Why would we want to cut taxes when we need to raise revenues? This doesn't seem intuitive does it? Well, a lot of companies have a lot of cash on their balance sheets, but they aren't using it:

Tax policy is driving much of this trend. For multinational corporations, cash earned abroad cannot easily be remitted to the United States. If it is paid back to the United States, it is subject to a dividend tax that can rise to as much as 35 percent. Companies are loath to pay this tax because while they can offset it with taxes paid abroad, the companies still end up paying a relatively high tax rate.

However, lower taxes won't solve the problem completely:

Five companies alone — Pfizer, Merck, Hewlett-Packard, Johnson & Johnson and I.B.M. — repatriated $88 billion, But the repatriation did not result in increased investment. Instead, companies largely repatriated the money and used their current United States holdings to pay out dividends or engage in share repurchases. This was contrary to what Congress had intended.

While the cash was not used for investment, this does not mean it did not have an overall positive effect on the American economy: shareholders went on to spend this cash. The study’s authors acknowledged this, stating that “presumably these shareholders either reinvested these funds or used them for consumption, thereby having indirect effects on firm investment, employment or spending.”

How can this be fixed?

A permanent tax reduction would not only cut taxes but actually raise revenue, allowing for Republicans to vote for it. And it should be a holiday without restrictions — trying to force companies to invest the money rather than pay dividends is a useless exercise that will create only more bureaucracy.

Even if the money were largely spent on buybacks and dividends and a large portion were kept abroad, it would still be reasonable to expect $300 billion to $600 billion to be repatriated. This money would flow into the economy, making the dividend tax cut a stimulus package that Democrats could support.

Lowering taxes isn't the complete solution, but there are ways to combat corporate loopholes and encourage the return of that money into the United States. Tax-friendly areas have been known to do well, as was chronicled in the WSJ documenting the success of the Swiss region Zug:

Developed nations from Japan to America are desperate for growth, but this tiny lake-filled Swiss canton is wrestling with a different problem: too much of it.

Zug's history of rock-bottom tax rates, for individuals and corporations alike, has brought it an A-list of multinational businesses. Luxury shops abound, government coffers are flush, and there are so many jobs that employers sometimes have a hard time finding people to fill them.

Zug provides an example where lower taxes has helped grow the economy and grow tax revenues. This is because as the economy has grown, there's been more wealth to kick back to the government. The government are getting lower percentages of incomes, but those incomes are growing because of the burgeoning economy.

We've actually seen this work in the United States before, when Reagan cut outrageous taxes leftover from the Carter administration. While this didn't rejuvenate the economy immediately, it helped the economy regain momentum through the 1990s, while the Clinton administration operated at a budget surplus.

Government officials need to take a hard look at this. The debt crisis is clearly an important issue. The solution, however, must make long-term sense. To me, this means that the government should encourage economic growth to raise in the future tax revenues. The shortfall from lowering taxes can be done by cutting spending.

The answer to our problems is addition by subtraction. The economy needs a boost. This is the way to do it.

The Budget Debate

There has been a general societal movement towards greater savings in the post-financial crisis period. Households and firms are saving more than they used to due to the weakened economy. Government has been faced with the choice of stimulating economic growth or confronting the budget deficit. To date, it has tried to spur the economy through low interest rates and increased spending. However, now, the big issue has become the budget deficit. Legislation to cut spending on both the local and national stage has been met with scrutiny and protests. The alternative to cutting spending would be to increase revenues through revised taxation. Republicans and Democrats disagree on this issue fundamentally, which has spurred the debate. Both sides have preached rhetoric attacking the American people’s fears about the job market. The problem with these two issues, cutting the budget deficit and creating jobs, is that may conflict with one another. Cutting spending directly addresses budgetary issues, but may hinder a recovering economy. Attempting to stimulate the economy and increase tax revenue through tax code revision might not address either issue. Cutting spending seems like the best way to tackle the budget deficit, but it is important to keep in mind what is being cut such that economic recovery is not negatively affected.

To understand why the GOP is so concerned with the budget deficit, it is important to understand the underlying economics. While it may seem counterintuitive to say it could have a negative impact on output, government spending can be bad when the government is increasing the national debt. First, increased government spending through increases in output and money demand increases the overall domestic interest rate, which can have a negative impact on consumption, investment, and net exports. Secondly, increasing the national debt through the deficit increases the size of interest payments on that debt. Recently, we have seen countries like Greece and Ireland seek bailouts because of the amount of debt they faced due to mounting debts. The GOP seeks to avoid that sort of situation by reducing government spending. It might be more important to decide what to cut rather than to unleash an all out assault on spending.

Wisconsin has come under the public eye both because of their attempts to pass legislation to cut spending as well as the heated reaction the legislation has received from unions. The key part of the legislation, which Republicans are having trouble passing because the Democrats have boycotted the vote, seeks to increase cost sharing of healthcare and pensions between government and government employees. These savings to government from increasing cost sharing would potentially save 5,500 state jobs and 5,000 local jobs. Private companies have already employed this type of cost sharing plan, so it makes sense for government to do this as well, particularly in Wisconsin where public employees enjoy higher salaries than their private counterparts. Why should government both provide better salaries and full benefits when private employers are not facing the same costs? It is not an efficient use of government funds to provide more than what the market dictates. While the pending issue is the limitation of collective bargaining, the spending cuts in this bill are in line with how government should target spending cuts. Government should try to make its spending more efficient while not hurting jobs.

The Wisconsin legislation gives us insight on the debate between Republicans and Democrats on the national level. After the House passed a $61 billion cut in government spending, Republican House Speaker, John Boehner, said, “we will not stop here in our efforts to cut spending, not when we’re broke and Washington’s spending binge is making it harder to create jobs.” In response, House democratic leader, Nancy Pelosi, disagrees “the Republican spending bill destroys jobs and their reaction is, ‘so be it.’” The key here is to understand what spending is being cut. In Wisconsin, they want to make spending cuts through cost sharing, taking measures similar to private enterprise and saving government jobs. The concern from Democrats is that spending cuts will slash program funding instituted to create jobs. Whoever is right in this regard is dependent on what the spending cuts actually intend to cut. The Democrats seem more intent on tackling the jobs issue than the budget problem.

The Democrats do not seem to have a definitive response to the budget issue, but certain actions that the Democrats are preaching could both help stimulate the economy and indirectly address the budget issue. In his State of the Union speech, Obama preached the need to revise corporate tax code, particularly in closing loopholes. The US corporate tax rate of 35 percent is amongst the highest in the world, but some companies pay much less than that. Obama hopes to simplify the code to lowering the rate, but making sure all companies pay the same rate. He believes this can be done without increasing the deficit. While it might not stimulate investment from these companies, it would resolve a key issue concerning these companies.

Many companies are currently cash rich, but are choosing to issue debt. Much of this money is overseas, so to bring this cash over, these corporations would be subject to the corporate tax. Since interest rates are low, companies are issuing cheap debt rather than bringing over foreign earnings. Companies would rather use foreign earnings to invest in lower yielding foreign assets, borrow money, or even not invest in a potentially profitable project in the US with foreign earnings all because of the tax rate. This is hurting investment in the US and taking away jobs. Whether a lower corporate tax rate would stimulate corporations to bring their foreign earnings into the US remains to be seen, but it is clear that the current corporate rate is discouraging companies from bringing over foreign earnings. This could have significant implications on tax revenues.

The financial crisis and the recession have caused a notable decline in tax revenues. Tax revenues are down nearly $400 billion since 2007, and corporate tax income is down $175 billion over the same period. This is not due a change in the tax code because President Obama has maintained the tax status quo, recently extending the Bush tax cuts. The big difference, however, is that the unemployment rate has risen significantly, meaning less people have jobs, and therefore, there is less income to be taxed. They also had less money to consume, hurting companies’ revenues and their incomes that they could be taxed upon. If simplifying the corporate tax code can spur investment in the US and create jobs, it would help reverse this trend. Unfortunately, there is no definitive effect from taking such measures. Changing the tax code does not mean that companies will invest, thus creating jobs and increasing tax revenues. It does not tackle the deficit problem head on like cutting spending.

Both Republicans and Democrats will debate this issue because they think they know what is best for the country. While the budget deficit is of significant concern, it is further complicated by the recession and the need to create new jobs. Cutting spending is complicated because it can save jobs by making government spending more efficient, but it can also cut programs that would create new jobs. However, it guarantees to tackle the issue head on. Hoping that spending and changing the corporate tax rate will stimulate job growth and tax revenues is not a certainty. In deciding a compromise, Democrats and Republicans must decide what measures will have the most positive impact on the economy.

Our Majesty The Budget

How old is the Queen nowadays?

The New Budget...

...same as the old budget

Here's Obama's plan to reduce the deficit:

The president spelled out plans to offset spending by more than $1.2 trillion over 10 years, partly through a freeze on many domestic programs and by imposing more than $800 billion in higher taxes and fees on households earning more than $250,000, on banks that benefited from the financial industry bailout and by repealing tax breaks for the oil, gas and coal industries.

There are some interesting quotes from various critics in that article.