Saturday, December 11, 2010

More on Tax "Cuts"

Just yesterday, over at the "Progressive" blog, FireDogLake, Daniel Dayden contributed a piece claiming that  the "Payroll Tax Cut Would Mean Higher Tax Rates for Working Poor". Dayden makes this assertion based on a shift in tax policy from the "Making Work Pay" credit to an across-the-board 2% payroll tax decrease. But then he strangely conflates this issue with the expiration of the Bush tax cut.
The issue concerns the difference between the Making Work Pay tax credit, which was a flat rate of $400 per worker, and the payroll tax cut of 2%. Because of this, people who make less than $20,000 will get less than $400, and will see their tax bill rise.

“I think it’s an unintended consequence,” said a charitable Michael Linden of the Center for American Progress. “But that will have the effect of raising taxes on people making less than $20,000.” Linden says that there are advantages to the payroll tax cut. For one, it’s bigger – twice the size of Making Work Pay on an annual basis. “If what we should worry about is job creation, a bigger stimulus is better,” said Linden. “But on a micro level, I’m disappointed families will have to pay more.

The working poor will still benefit from the refundable tax credits like the expansion of the Earned Income Tax Credit. But those are in place now, and so it won’t make up for the fact that this bill puts in place a lower-class tax hike while saving millionaires $139,000 per person.
But there are actually a number of problems in this quoted passage, at least in terms of how it frames the issues in play, and with its lack of appropriate distinctions between them.

For one thing, we're talking about apples & oranges; Tax Credits vs. Tax Rates.

Tax credits are essentially government spending, whereas tax rates are about how much money government believes they are taking and ostensibly effect revenue. Once all the tax money has been collected (in theory - since in practice a lot of this happens with borrowed or printed money anymore), the government allocates payouts to various people based on factors like income, education, marital status, home ownership, etc. The credits are what determines how much you "get back" at the end of the year - assuming you are poor enough to qualify.

They are basically a "fix" designed to compensate for over-taxation (and honestly, they are a great way to make people forget that they've been over-taxed and that the government has spent all year earning interest on their money instead).

As Cass Sunstein & Richard Thaler wrote in their book, "Nudge":
"Note: Three-quarters of Americans get refunds when they file their taxes... If these refunds were described as interest-free loans to the government, they probably would not be so popular."

Higher income tax rates on anyone decreases the amount of money they have each month to pay for their various required expenses much less anything else. Since the poor tend to live paycheck-to-paycheck, and don't have money left over for many non-essential costs, higher tax rates on income are a bigger direct problem for poor people in general than rich people.

So, given that we have income taxes at all, and given that they are structured in a progressive manner (meaning graduated based on income level, not meaning "leftist anti-progress idiot"), it's worth having a discussion about whether or not the current rates and/or credits are doing the job they're intended to do to help poor people.

If it is true that the Making Work Pay credit provides more nominal cash at the end of the year, maybe that's a worth keeping it in play... But let's not forget that it is at the end of the year! It's a one-time increase in someone's bank account, whereas lower rates mean more money in people's pockets with every paycheck.

We're talking about less government theft vs. more government spending. And that is a really important distinction... When people are allowed to keep more of their own money, they have many more options than when they are allowed to keep less of it - even when they do get the refund check at the end of the year, they tend to just spend that money all in one chunk. They wind up "coming up for air" and using the refund check to pay for the things they couldn't afford on their comparatively lower salaries.

Additionally, when talking about credits vs. rate cuts, the administrative costs are immensely increased with credits - since they require people to run programs determining whether or not you qualify. When the government just lets you keep more of your money instead, the administrative costs are lowered as well as it requires less action on the part of the IRS... So there are a lot of additional benefits to just cutting rates.

So going back to Dayden's point - if it is, in fact, true that the poor are winding up paying more taxes with a 2% across the board rate cut vs. handing out a flat $400 in low-income tax credits, then perhaps the better overall solution might be to increase the rate cuts. Say we go with a 4% decrease in rates. That way if you're making a paltry $10,000 a year, you still get the $400 - and if you're making $20,000 a year you'd get to keep $800. Isn't that better?

Plus it rewards you for earning more instead of punishing you.

That would certainly make more sense, as it would let people keep more money every month and thus afford a higher standard of living consistently, rather than having the government run an inefficient scheme of taking earned income and then giving it back later.

Maybe the real argument with Republicans is "ok, well I see your point on tax cuts, but you haven't gone far enough, 2% isn't good enough to help this country's poor workers, we should cut rates 4% (or whatever)".

But that's really just one issue here. Dayden (and his source at the Center for American Progress - a pretty blatantly partisan economic policy organization, I should add) then makes two further points. One of which is totally false, and the other is a non sequitur.

Michael Linden says:
“If what we should worry about is job creation, a bigger stimulus is better,”
Uhh... No. Incorrect.

If what we worry about is job creation, LESS GOVERNMENT SPENDING is better!! This post isn't really about the issue of why the stimulus hasn't, is not and will never work to improve economic growth or to create a strong, sustainable economy. Fortunately, I've done more than enough to explain why this is the case already. So for more on that point - look to these essays:
Trust me though... If you want to help the economy, government spending isn't the way to do it. And the poor benefit from bigger and more opportunities far more than whether or not some particular tax credit is $400 a year or $500. The opportunity to work and earn more is what really matters... and high government spending inhibits those opportunities.

The non sequitur part comes in when Dayden starts making it seem like the income tax rates for the top income brackets are somehow taking away from the poor.

They're not.

It's probably also worth remembering that the top 10% of income earners pay 71% of the total income taxes in the US. Thus lower taxes on the higher income brackets barely effects the bottom 50% of wage earners at all, let alone the bottom 10%.


It's not as if a lower rate on one group means a higher rate on another. So please, let's just get that straight right now.

Remember that tax rates are about what the government takes away from people, not what they spend. So when the tax rates for the top income earners have 35% of their incomes taken from them each year, as has been the case since 2003, that has very little direct bearing on what the government gives to the poor or anyone else through credits. That's ultimately a matter of spending priorities. If the government takes in $2.1 Trillion as they did in 2009, politicians decide how to allocate that money - if they decide to spend 10,000,000,000 on a $400 tax credit given to 25 Million poor people, then by rights they should have $2.09 Trillion left over to fund other projects. Right?

The problem is that our political leadership have never learned to live within their means.

And by the way, at least according to this chart from the Heritage Institute (which, before anyone whines about it being a conservative outfit, was produced with Congressional Budget Office data and on stuff like this, they're pretty solid), the lower tax rates established in 2003 actually increased the revenue generated by the richest quintile vs. everyone else.

As counter intuitive as it might seem, this actually makes a lot of sense, because of how people respond to changes in tax rates. But hey... Let's not talk about that, because let's be honest; the important thing isn't really helping the poor - but punishing the "rich".

For groups like the Center for American Progress, the higher rates area foregone conclusion, so anything that isn't the higher rate they're advocating is considered a "tax cut" - even if it's exactly the same rate as we've had for the past 7 years. So they frame extension of current rates as a "tax cut". 

Well... That's idiotic. Going to a higher rate is an increase in taxes - staying the same is *staying the same*. It doesn't wind up "saving millionaires $139,000 per person". If tax rates stay the same, they stay the same. If they go up, they go up. Let's call a spade a spade, shall we?  

And the truly mind-blowing part of all this is that higher marginal tax rates being discussed aren't very likely to do a damn thing to improve overall revenue anyway.

Once tax revenue reaches about 19% of yearly GDP, the government can do whatever they want with tax rates, and it has pretty much no effect at all. We're already at that 19% cap of what government has historically been able to collect in revenue and they're still planning on spending 22-23% of GDP in upcoming budgets, and even more as the debt burdens become harder to manage. Seems to me that the question really should be focused on how to cut back on spending, not on populist gimmicks that punish rich people but do almost nothing else.

So yeah... I think we're really talking about 3 separate things here all jumbled up into one issue.
  1. Tax "cuts" vs. tax increases vs. tax credits. Each are different and need to be defined & framed correctly.
  2. Does government spending improve economic growth? No.
  3. Will the Making Work Pay credit be better for the poor than an overall reduction in income taxes?
I don't necessarily have an answer to that last one. But it certainly seems to me that if you want to help the poor, allowing them to keep 100% of their paychecks is a far better - and certainly more elegant - way to help than bungling about with some inefficient tax credit nonsense which only those who know to claim it on their returns will get anyway.

So let's talk about how to maximize that if we want to use set up a tax system to disproportionately benefit the poor (even more than it already does), rather than making this into a "soak-the-rich" issue. That makes much more sense.


Kevin said...

I haven't read the entire post, but I noticed at least one very wrong statement when I skimmed it.

"Once tax revenue reaches about 19% of yearly GDP, the government can do whatever they want with tax rates, and it has pretty much no effect at all."

Nonsense. Tax revenue has not gone above about 19% of GDP because no attempt has been made to raise it above 19%, not because it *can't* go above 19%. Other countries have had no problem raising raising tax revenue far above 19% of GDP. I would love to hear your explanation of why you think Sweden can collect 49% of GDP in tax revenue while the United States is only capable of collecting 19%.

Sean W. Malone said...

Hey Kevin,

First off, I didn't say it was impossible to break the 19% of GDP revenue cap anywhere but rather that the United States has seen top marginal income tax rates balloon to over 90% and come back down to 35% and everywhere in between, and yet for the past 60+ years, there has been no over-all effect on that 19% average.

Visit the previous blog I wrote before this one for more on that (and numerous links):

As for why Sweden can collect 49% of GDP in revenue, I think there are a number of serious distinctions to make between the US and Sweden to begin with and I think we also have to have somewhat of an understanding of the overall costs of taking that much out of the productive sector of the economy.

An economy of 9 million, virtually entirely homogeneous people in a very small geographical area isn't really remotely comparable - and more important, scalable - to the United States; a VERY heterogeneous nation in both population demographics, geography & industry made up of 310 million people.

So it's really hard - almost impossible - to compare apples to apples here.

If you compare any of the bigger economies with respect to revenue as a % of GDP, you get some pretty similar numbers to the US.

I think the OECD average is around 35% and that's weighted significantly higher than US data depicts... For instance, the 19% figure comes from the US Census Bureau data, but the OECD shows the US as having revenue up to 26% of GDP, even as high as 28%.

So I guess you really have to skew everything a little higher for their numbers anyway. That's something I'm not really capable of aggregating and compensating for in a blog comment - and is certainly better left to the teams of economists who produce the data in the first place.

Of course, the real point here is that it's been pretty consistent regardless of what the tax rates here have been - and so I think the one thing that is quite clear is that bumping up rates a few points isn't going to do anything positive for government revenue - but it could actually do a significant amount of harm to the economy at large... Since taking more money away from this country's investors & business owners isn't a very smart way to encourage the creation of new jobs or new products.