Tag: Public finance

The Laffer Curve Strike Britain

Who knew?

The Treasury received £10.35 billion in income tax payments from those paying by self-assessment last month, a drop of £509 million compared with January 2011. Most other taxes produced higher revenues over the same period.

Senior sources said that the first official figures indicated that there had been “manoeuvring” by well-off Britons to avoid the new higher rate. The figures will add to pressure on the Coalition to drop the levy amid fears it is forcing entrepreneurs to relocate abroad.

The self-assessment returns from January, when most income tax is paid by the better-off, have been eagerly awaited by the Treasury and government ministers as they provide the first evidence of the success, or failure, of the 50p rate. It is the first year following the introduction of the 50p rate which had been expected to boost tax revenues from self-assessment by more than £1billion.

It’s called the Laffer Curve, gentlemen. You can raise taxes on the rich only up to a certain point, at which point tax avoidance begins to eat into revenues. Where that point is a subject of debate (no economist worth his salt would claim the turnover in revenue does not exist). It’s difficult to compare American and British rates since the effective rate is different, owing to differences in loopholes, deductions, etc. But clearly, Cameron has gone too far.

(Note the poll, which shows overwhelming opposition to the 50% rate. Granted, it’s the Telegraph — the paper of the people who think Britain is run by another country. And every right wing blog has been linking the story. Still … damn.)

You can’t balance budgets entirely off the rich, not even in Britain. Revenues are part of the equation. But in the end, you need a broad tax base and spending restraint.

The President Punks Us … Again

Here’s the thing: the President’s budget proposal is effectively DOA. Even if the Republicans didn’t control the House, his Senate has refused to propose a budget in three years. So there is no chance today’s proposal will come anywhere close to passing.

Given that, why doesn’t he propose something bold? Why does’t he put out Simpson-Bowles? Why doesn’t he say, “Hey, you want the budget balanced? Here’s what it’s going to take.” and put out a proposal with big tax hikes and even bigger spending cuts. He’s had two plans — Simpson-Bowles and the Ryan Plan — but out in front of him. And he responds with this?

President Obama on Monday unveiled a $3.8 trillion spending plan that seeks to pump billions of dollars into the economy while raising taxes on the rich to tame a soaring national debt now projected to grow significantly faster than previously forecast.

The president’s outlook for debt reduction has slid markedly since September, when Obama told Congress that his proposals would hold annual deficits well under $600 billion after next year and permit the debt held by outside investors to rise to $17.7 trillion by 2021, or 73 percent of the overall economy.

The new 10-year blueprint shows annual deficits exceeding $600 billion every year except 2018. And the portion of the debt held by outside investors would grow to $18.7 trillion by 2021, or 76.5 percent of the economy — a full $1 trillion higher.

Administration officials said about half the increase is due to policy changes, with the other half driven by gloomier economic projections that tend to depress tax collections, increase government spending and drive deficits up. Job growth has proved stronger than expected since the budget was prepared, they said, adding that the picture would look brighter today.

To see how accurate their past budget projections have been, Veronique de Rugy looked at the 2010 budget proposal. It projected a $500 billion deficit in FY 2013, about half of what we will actually have.

Now to be fair, the budget proposal keeps overall spending nearly frozen at $3.8 trillion. However, this is part of the problem. The Stimulus bumped up the baseline and we are still well ahead of it. I said at the time that the true cost of the stimulus would be more like $4.5 trillion over the next decade (a $300 billion one-year increase times ten years with the usual spending growth). And rather than cut stimulus bullshit, Obama’s spending cuts, such as they are, are coming from things like NASA, which did not get stimulus spending but is losing any Mars exploration to pay for things like Solyndra.

The President proposes to tax dividends as ordinary income. While I think this should be paired with an overall rate cut, I’m not opposed to this in principle. Since we lowered the capital gains and dividend rates in the 1990’s, we’ve had two investment bubble and little economic growth. I recently talked to an engineering professor who confided that his best students were going into finance instead of … engineering. I think it’s a fair argument that the low tax rates on investments had the side effect of keeping tax rates low for high-stakes financial gambling (that we subsequently bailed out) while leaving them high on people actually working and making. When Wall Street bankers pay a third of the tax rate of business owners, something is wrong.

BUT. But … you don’t start tax reform with the objective of taxing Mitt Romney or Warren Buffet more. The appropriate thing to do here is scrap the entire system and rebuild it from scratch in a way that minimizes the deadweight loss of the revenue our government needs to operate. It is possible, as Reagan showed, to increase overall tax revenues while decreasing the impact on the economy.

But that would require courage. And Obama’s budget basically punts on all the big issues. Stimulus spending? Maintained. Green energy? Increased. Medicare? Untouched. Social Security? Ha!

This is a joke. We should treat it as such. The first serious budget proposal will come out of the House. That’s when we should pay attention.

The Canadian Model

To circle back to the most pressing topic of the day: S&P may be nitwits but their downgrade of our debt was utterly correct. We have not made any real inroads on our staggering debt load, the hysterics over the debt ceiling not withstanding. Until we address entitlements, we’re not serious. The S&P downgrade is not some esoteric financialspeak that has no relevance to us. It’s the canary in the coal mine: the warning that we’re heading toward very serious problems.

But the WaPo makes a good point this morning. If we want to get out of this, we should be more like Canada. Seriously:

A quick Canadian history lesson: in the early 1990s, things were looking pretty grim. The country had regularly run fiscal deficits since the 1960s. In 1993, stood out among the G-7 as having the most foreign indebtedness. As one analyst noted, “From the beginning of 1990 to the end of 1993, Canada experienced a long slide in economy activity and employment.” The country lost its AAA rating in 1993. Feel familiar?

Facing an unprecedented fiscal crisis, Canada got down to work. The country passed a landmark budget in 1995. The plan tilted heavily towards cutting expenditures but also included some new revenue (the ratio was about $7 in cuts for every $1 of revenue). Canada cut the civil service by about 25 percent and overhauled its pension program. The plan worked. Canada is now on much more financially-sound footing; S&P restored its AAA rating in 2002. The turnaround is now referred to, in some economic literature, as “The Maple Leaf Miracle.”

The heavy ratio of spending cuts to tax increases was because Canada had high taxes to begin with. But they are not alone in restoring their debt rating this way. Australia, Denmark, Finland and Sweden also restored their ratings. They got there in different ways but they all had something in common: they didn’t stick their thumbs up their asses and wait for the problem to solve itself. Restoring the debt rating wasn’t the goal, per se. But it was a useful harbinger of their overall finances. When S&P upgraded them, it was a sign that things were finally under control.

We’re not serious yet. Despite Obama’s supposed overtures on the subject, his party remains diametrically opposed to entitlement reforms (Pelosi has made it clear she will oppose any “grand bargain”). Last night’s GOP debate saw all the candidates oppose a theoretical 10-to-1 cuts to tax hikes deal. The so-called “Super-Committee” is being rigged for failure.

I don’t know what it will take for us to follow Canada into serious reform. Maybe another downgrade or stock market crash. But we can’t put with this shit any longer. We can’t afford to.


I’ve been thinking a lot about the job problem in this country. Jobs are the problem right now. One in eleven Americans is unemployed, the knock-on economic effects are making a bad deficit situation worse and a long-term culture of dependence is being created. I am under no delusion that a blog post will change anything. But I thought I’d write up about 2000 words of thoughts on the subject so you’ll know where I’m coming from.

The fundamental problem with fixing the job situation is that we have two parties absolutely devoted to failed policy. On one side we have the Republicans insisting that just a few more rounds of Bush-style demand-side tax cuts will get things moving. However, there is very little evidence that these would help, even if we could afford them. We know what the Bush tax cuts did for jobs: jack.

The Bush tax cuts were followed by low GDP growth, negative median wage growth, and little job growth. Even before the Great Recession, growth in the Bush business cycle was the weakest since World War II. And the cuts cost about $2.6 trillion between 2001 and 2010, according to the Economic Policy Institute—adding to a debt future generations of taxpayers will pay for, plus interest.

To be fair, Sarbanes-Oxley played a role here as well. But the record is stark — one of the weakest economic booms since World War II and the tax cuts distinctly failing to “pay for themselves”. Tax cuts can pay for themselves when you’re cutting a marginal rate of 97% (Kennedy) or 70% (Reagan). The don’t pay for themselves when the marginal rate is in the 30’s or lower. No one is quite sure where the Laffer Curve turns over, but it’s not at 0.

On the other hand, we have a bunch of Democrats calling for more stimulus spending under the Keynsian theory that … actually I’m not sure what the Keynsians are on about. The stimulus failed and their response is to claim it wasn’t big enough — the equivalent of saying we’ll really really fly if we just jump off a taller building. Will Wilkinson called it a religion, a belief that government can create an infinite multiplier of loaves and fishes. Given the immunity of the Keynsians to fact, that’s a fair description.

So what do we need to do to get the economy moving?

Deficit Reduction: Bruce Bartlett:

Government mainly affects savings not so much through tax rates as through the budget deficit, which constitutes negative saving. When government borrows, it takes funds out of the economy that would otherwise be available to finance domestic investment. Alternatively, the U.S. must borrow more from foreigners, which increases the trade deficit. In the national income and product accounts, the trade deficit is subtracted from GDP, thus lowering growth.

The bottom line is that neither taxes nor spending by themselves are the most important government contribution to the investment climate; it’s the budget deficit. Consequently, a reduction in tax revenue which raises the deficit is unlikely to stimulate domestic investment because more money will have to be borrowed from abroad. Conversely, a tax increase dedicated to deficit reduction could well be stimulative, as was the case with the 1982 and 1993 tax increases. Contrary to Republican dogma, rapid growth followed on both occasions.

But, scream the Keynesians, austerity kills! Look at Ireland! Look at the UK!

OK, assholes. Let’s look at Ireland:

Ireland was the first of the debt-plagued European countries to cut government consumption significantly in 2009, mainly by reducing government paychecks from 12.3% of GDP in 2009 to 11.8% in 2010.

While such gestures toward fiscal frugality lasted, the country was rewarded with a tolerable risk premium on government bonds. The yield on 10-year Irish government bonds was still 5.3% as recently as last August, compared with 10.7% in Greece. This May, the interest on Irish bonds reached 17.6%. What went wrong?

Back in June 9, 2010, I wrote that “unlike Greece, the Irish economy is showing encouraging signs of recovery.” Ireland’s real GDP had increased by 1.7% in the first quarter, with an 11.7% quarterly rise in industrial production. Manufacturing output increased 29% from November 2009 to July 2010, thanks to growing exports.

Ireland tanked shortly after, which the Kenysians blame on austerity. To them, the logic is inescapable — Ireland cut spending, the economy crashed, QED. They leave out the intermediate step, when Ireland did was Iceland refused to do — bailed out foreign investors in their banks and quadrupled their debt overnight. It was an incredibly stupid move that the EU bullied them into. Claiming that austerity caused Ireland’s ongoing economic woes is like claiming that Mexico won World War II. Yeah, they contributed, a little. But let’s not ignore the bigger players.

OK, OK. But certainly the UK is fucked because of … what was that?

Unemployment is falling at its fastest pace in a decade, official figures reveal, in a boost for George Osborne as he prepares to deliver his Mansion House speech. The Office for National Statistics (ONS) said the number of people unemployed fell by 88,000 in the three months to April, to 2.43 million — the largest drop since the summer of 2000. The unemployment rate was 7.7%, down from 8% three months earlier.

The UK has gained 100,000 private sector jobs even as the government has cut 24,000. The recovery is still fragile and could crumble underneath them. But if we had similar numbers in the United States, the President would be turning cartwheels on the White House lawn and prank-calling Mitt Romney (“Hey Mitt, heard you’re unemployed, hahaha.”). Canada and Puerto Rico have followed this model as well.

The ultimate example here, of course, is Germany, which refused to engage in a stimulus despite pressure from the Administration. I’ll have more to say on them later. But I want you to savor this — at least two, possible more European welfare states have righted the ship while keeping their deficit under control. According to both the Keynsians and the Norquistians out there, this should be impossible. Without stimulus spending or tax cuts, you can’t get an economy moving. But the example of these countries belies this. Hell, the example of our own country in the 80’s and 90’s show this to be false. Both decades saw tax hikes; neither saw any stimulus (the GOP filibustered Clinton 1993 stimulus bill). And yet — miraculously — we recovered. Recovered enough that we could later ease the tax burden.

The Tax Code: Despite my aversion to yet more tax cuts, overhauling the tax code would help a great deal. The tax code, because of its complexities, imposes $200-300 billion of deadweight loss on our economy every year. Cutting that in half would be the equivalent of a permanent and massive tax cut. Reagan’s 1986 tax hike was eased by tax reform, which more than compensated for the economic hurt of higher rates. American corporations spend more time figuring out the tax implications of their business decisions than the business implications of their business decisions. Does this strike anyone as healthy?

The most important thing is to broaden the tax base. Our income tax has become highly dependent on the top earners, who now pay almost all of the tax. This is a problem because when the economy is doing well and the rich are getting seven figure bonuses, revenues boom and governments spend like mad. Then the economy stalls, the rich make less and revenues crash, creating a gaping budget hole. Coburn’s idea of increasing revenue by closing loopholes and tax credits is the right one. It’s not just that it bring in more revenue, it stabilizes the revenue by making it less dependent on a few key economic sectors.

The tax code has also contributed to numerous bubbles, especially the housing bubble through the mortgage interest deduction and the home buyer tax credit. The last thing we need is the government stimulating another bubble — this time in green tech — through either direct spending or tax breaks.

There are other anchors on American business as well — notably the failure of the Administration to enact free trade agreements and the hideously awful Sarbanes-Oxley law. Both need to be dealt with as well.

Our regulatory structure also needs help. How do we expect to build a green economy when it takes a decade just to get the paperwork done for a new power line? Congress should create an agency specifically designed to identify regulatory problems. The idea is that a business could go to this agency and say: “Here — this is the law that’s holding everything up. This is why it’s taking us two years to start a business instead of two minutes. This needs to be fixed.” And Congress would fix these not with waivers doled out to powerful industries but with a repeal that benefits everyone. The most important business to help are the ones that don’t have lobbyists.

The German Model: You can read here about what Germany did to make their economy healthy. It’s a long post, but the gist is that Germany made jobs their sole focus. They enacted provisions to make sure that people stayed working. This meant reforming their unemployment system so that people had to take any job they could find, even if it was “beneath” them. Their unemployment system focused on finding people jobs — any jobs. They also made it easier to hire and fire workers.

I’m not so sure how well this would work here. Our unemployment benefits aren’t as generous and a government job-matching service isn’t that useful in the internet era (and our government would inevitably find a way to fuck it up). But the philosophy — a focus on jobs — is the right one.

One thing we should do it make it easier and cheaper to hire people. The problem is that everything this Administration has done has made it more expensive to hire people. From health insurance mandates to supporting Davis-Bacon mandates to raising the federal minimum wage, they have made it more and more expensive to hire people. And they’re surprised that people aren’t hiring.

The solution seems simple. First, suspend Obamacare provisions or lighten them by allowing cheap high-deductible insurance and HSA’s to qualify (the latter, in my opinion, having the added benefit of fighting rising healthcare costs). Second, suspend Davis-Bacon provisions in federal spending. The Democrats seem to think that 100 jobs at union wages is better than 120 jobs as sub-union wages. I don’t see that. The other thing we could do is lower the “employer contribution” on Social Security and Medicare. Obama almost did this, but decided to cut the employee contribution instead — yet another failed supply-side tax cut.

If you make it easier to hire people, more people will be hired. Take it from a rocket scientist — this isn’t rocket science.

So to sum:

  • Close the deficit, even if it means broadening the tax base.
  • Overhaul the tax code.
  • Repeal Sarbanes-Oxley.
  • Sign the pending free trade agreements.
  • Create a process to identify and remove the most damaging regulatory provisions.
  • Suspend Obamacare or allow HSA’s to qualify.
  • Suspend Davis-Bacon provisions.
  • Reduce the employer contribution on payroll taxes.

I’m not a complete moron. I don’t expect all of the above to happen, certainly not on my suggestion. But we are moving on the first goal. There are rumblings on the second and fourth. And each goal we move on multiplies the effect of the others. If you close the deficit, signs the FTAs and overhaul the tax system, the combined effect will be greater than any of them.

Anyway, those are my thoughts. And I’m judging candidates based on them. Mindless anti-tax rhetoric doesn’t impress me — Pawlenty’s proposal is especially ridiculous. What impresses me is someone looking directly at the issue — thinking in terms of how we make it easier for jobs to be created. When one of our six hundred Presidential candidates gets there, I’ll let you know.

Update: Heh.

A Deal In the Making?

Ugh. What a day today. Not much time to blog. I’m cooking up a post for the weekend, but I’ll pre-season it with Ezra Klein’s wonkbook from this morning:

The Biden group is readying itself for the final sprint towards a debt deal. “Now we’re getting down to the real hard stuff,” Biden told reporters. “I’ll trade you my bicycle for your golf clubs.” The hope is to get to $4 trillion in deficit reduction eventually, and at least $2 trillion in the deal to raise the debt ceiling. But perhaps the strongest sign that they’re likely to succeed isn’t coming from inside the room, but from outside of it.

Earlier this week, Senate Republicans voted to close out some ethanol subsidies in the tax code and use the savings to reduce the deficit. That was an explicit signal that they’re willing to increase revenues so long as the mechanism is closing loopholes, ending tax breaks and shaving expenditures. Now, it’s a lot easier to close $6 billion of reviled energy subsidies than raise hundreds of billions in new revenues by attacking popular tax breaks like the mortgage-interest deduction. But it’s at least clear we can now move onto that discussion.

Meanwhile, AARP has quietly dropped their blanket opposition to Social Security cuts. The reason? They figure they’re inevitable. “The ship was sailing,” John Rother, AARP’s policy chief, told the Wall Street Journal. “I wanted to be at the wheel when that happens.” That makes it much likelier that Social Security will see reform later this year. But perhaps more importantly, it shows that the major players in Washington are entering dealmaking mode. And that’s usually a pretty good predictor that some deals are about to be made.

This is good news. The goal of $2 trillion in budget closing has apparently been met and they’re eyeing off $4 trillion. I’m also glad the GOP is showing some flexibility in taxation, which is a tribute to Tom Coburn. I love having taxes low but I love low deficits more. And closing loopholes and credits is the best way to increase revenue. It doesn’t raise marginal rates and it broadens the tax base, making us less susceptible to huge swings in revenue. And if the economy picks up, it could set the table for a broader overhaul of the tax system that could dramatically reduce the deadweight loss.

If ethanol and Social Security are on the table, we’re looking good. Both of these have powerful interests behind them. The only way to stand up to them is to get both parties in on it, so that neither can demagogue. Let’s hope we see yet more sanity emerge.