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Wednesday, May 25, 2011

Shaviro: 1986-Style Tax Reform: A Good Idea Whose Time Has Passed

Tax Analysts Daniel N. Shaviro (NYU) has published 1986-Style Tax Reform: A Good Idea Whose Time Has Passed, 131 Tax Notes 817 (May 23, 2011). Here is the abstract:

The Tax Reform Act of 1986 combined base broadening (such as the curtailment of tax expenditures) with a reduction in tax rates, in a manner designed to be revenue neutral and distribution neutral. It established an influential model for tax reform that continues to be cited frequently. This report argues, however, that while 1986-style tax reform was a good idea in its time, it is no longer appropriate for three main reasons. First, if tax expenditures are properly viewed as spending through the tax code, a revenue neutrality norm in which the budgetary gain from their repeal ostensibly needs to be offset by rate cuts is intellectually incoherent. Second, the long-term U.S. fiscal gap makes rate-cutting, in particular for individuals, potentially imprudent. Third, if one wants to address rising high-end income concentration in the United States since 1986, the option of raising, rather than reducing, the top marginal income tax rates may need to be squarely considered.

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Comments

This statement from the abstract is incorrect.

"Third, if one wants to address rising high-end income concentration in the United States since 1986, the option of raising, rather than reducing, the top marginal income tax rates may need to be squarely considered."

Raising marginal tax rates on high income taxpayers will not address the problem of concentration of income in the U.S., that is an ineffective method and the rates cannot be raised high enough to have much of an effect. Rates were raised in the Clinton era and the concentration continued.

Still, there should be a rate increase with a return to Clinton era rates on those makiing over $250k to

1. Decrease (admittedly to a small extent)the deficit and
2. To bring a sense of perceived fairness to taxes.

However, to reduce the growing concentration of income and wealth in the top 1%, 5% or 10% of Americans will require government programs that result in investment in education, infrastructur, R&D, reducing health care costs, addressing hard core poverty etc. The objective is not to reduce income and wealth of the top 10%, but to create economic growth and direct those benefits to the bottom 90%.

The Economist this week had an excellent example of how this is working in Brazil.

http://www.economist.com/node/18712379

(Yes, we in the U. S. can learn from experiences in other countries, we do not have all of the answers)

Of course, this policy is in conflict with Consevative ideology, but then reality is often in conflict with ideology.

Posted by: Sid (real one) | May 25, 2011 9:27:48 AM

I am not in agreement with the author's first point.

"First, if tax expenditures are properly viewed as spending through the tax code, a revenue neutrality norm in which the budgetary gain from their repeal ostensibly needs to be offset by rate cuts is intellectually incoherent."

This point seems to be based on a dollar for dollar equivalency between tax expenditures and direct government budgetary spending. Tax incentives have been shown to be a poor and inefficient way to economically motivate people.

Logically, the "tax expenditure" crowd should be for eliminating ALL deductions. Isn't it "intelectually incoherent" not to be?

Posted by: Ed D | May 25, 2011 10:35:42 AM

The enduring wisdom of the Tax Reform Act of 1986 is that you can raise revenue and improve efficiency simultaneously by stopping ta shelters, defined here as transactions that have a higher return after tax than before tax. Raising tax rates does no good for taxpayers who are sheltered out. After all Leona Helmsley was right that only little people pay tax or at least all her friends were zeroed out because they materially participated in real estate or were married to someone who was. We do need to shift the tax burden upward giving the prosperity is at the top, we shoudl do eg by ending deductions that leas to negative capital accounts and the imaginary costs created by section 1014. Ending secton 1014 alone would improve lockin problem and make our taxable income figures more closely approximate standard of living.

Posted by: Calvin H. Johnson | May 25, 2011 10:41:38 AM

"First, if tax expenditures are properly viewed as spending through the tax code, a revenue neutrality norm in which the budgetary gain from their repeal ostensibly needs to be offset by rate cuts is intellectually incoherent."

!!

If this article is properly viewed as begging the question, ... . Same old same old. Fortunately it's just tax theorists talking to other tax theorists and will (properly!) be rejected out of hand by the voting public.

Posted by: Nonce | May 25, 2011 10:45:07 AM

Sid (the real one) may be surprised (I was) to find that we agree on one point.

"The objective is not to reduce income and wealth of the top 10%, but to create economic growth and direct those benefits to the bottom 90%."

No, the objective is not to beggar the rich. The question is to find an effective way provide the skills/incentivize those who appear stuck in the lower quintile.

They say insanity is doing the same thing over and over and expecting a different result. I have watched program after program since LBJ started his War on Poverty with little result. Where I live in NJ, the whacked out NJ Supremes have forced the so-called Abbot funding plan that has doubled the spending per pupil in towns like Asbury Park to over $20,000 per capita with no statistically observable result. Perhaps we should try something other than just increasing the spending.

Posted by: Ed D | May 25, 2011 10:46:58 AM

The best tax reform is not "revenue neutral" but results in less money to a government that already spends more than it should. Our objective should not be to continue growing government or keep it at the same level, but to reduce it or starve it, if necessary.

Posted by: Woody | May 25, 2011 11:28:20 AM

Fourth, history has shown that 1986-style tax reform merely restarts the cycle of selling tax breaks for votes. It is unstable. Politicians want to repeat this cycle, but why should the public want to?

Fifth, high marginal rates will definitely reduce the high-end concentration of reported taxable income. What will increase is unrealized capital gains (asset lock-in), non-taxable income (tax avoidance), and unreported income (tax evasion). The illusion of reduced inequality will be perfect, even as tax revenue declines.

Posted by: AMTbuff | May 25, 2011 1:05:18 PM

If 1986-style reform is passe', what is the future of tax reform as a concept, or does it inevitably mean tax increases?

Posted by: mike livingston | May 25, 2011 1:08:12 PM

Johnson's comment above is correct. Shaviro is a bright fellow, but his article misses the mark in exalting abstract macroeconomic analysis over common sense microeconomic insights about how individuals react to taxation. It is the same kind of 35,000-foot view that led Bob McNamara to escalate the war in Vietnam.

Besides a balanced budget amendment, the Constitution also needs a codicil to the Sixteenth Amendment that caps the top marginal income tax rate at a reasonable level, with a narrow exception for a temporary hike to finance a war properly declared by Congress.

Posted by: Jake | May 25, 2011 10:25:31 PM

Having some unexpected spare time, I opened the pdf of the full article. Whoa, there is some seriously delusional stuff in here!

I'll give him partial credit for one caveat he makes: he repeatedly prefaces claims with "if we accept the tax expenditure analysis ..." or words to that effect. Only partial credit, though, because the sequel always makes it clear that he assumes the tax expenditure analysis is a given and not seriously in dispute. This may be true in the closed circle of tax theorists, but in the wider world of actual voters and taxpayers it is truer to say that the tax expenditure view is not seriously in consideration.

As a cure for the tax expenditure fallacy, I recommend writing out 100 times "it's built into the rates, it's built into the rates, it's built into the rates, ...". I recall that in 1993 some Congressman or Administration spokesperson explained that while the new rates might seem high, the reason was that so much income was excluded that rates had to be correspondingly higher on the remaining income. So the exclusion of qualified mortgage interest and the non-inclusion of health insurance premiums, which were well known when the rates were being set, are already accounted for in the rates. It may be hard luck on other taxpayers who do not own a (mortgaged) home or who do not have generous employer-paid health benefits, but Uncle Sam has been paid, in full.

Thus the example on p. 824 fails by ("simplistically", to use a word of the author's) taking the rate as a given but the deductions as in question. What actually happens is that Congress, in its wisdom, has decided that a taxpayer who has income of $170,000, mortgage interest of $20,000 and whose employer has paid $10,000 in health insurance benefits, owes $40,000 in tax. Whether Congress saw this as representing 4/18 of income + health benefits or 4/15 of income less mortgage interest, not including health benefits, is immaterial. The rate is the last parameter to be set (almost always, and certainly in the case of the mortgage interest deduction and the non-inclusion of employer-paid health benefits). Treating it as the one fixed item stands the actual history on its head. Congress in 1993 wanted to raise revenues, worked out specific revenue targets, and set the rate as a final item to produce the desired result. "Your tax bill is $40,000". "What's my rate?". "Whatever it needs to be to make your tax bill $40,000".

The most jarring item was the mention of imputed rent (p. 823). Anyone who thinks this should be included in a definition of income at all, let alone taxed at the present rates, needs to get out more. Seriously.

Posted by: Nonce | May 26, 2011 2:25:31 PM

Shaviro uses pretax, pretransfer income data to suggest the tax system and earned income credit are not doing enough to redistribute income. We could double top tax rates and triple the EITC and that would have NO direct effect at all on pretax reported income. But it would have a huge behavioral effect on what would or would not not be reported to the IRS (e.g., unrealized gains, tax-free bonds) and how other income is reported (e.g., as retained corporate income rather than passed-through to individual returns).

The elasticity of taxable income is very high among the top 1% (0.5 - 1.5 according to Raj Chetty), so more income and capital gains were reported at the top when top tax rates went down in 1988 and 2003. Put top federal income tax rates back up to 45-50%(or 28-35% on capital gains), and many top incomes will indeed appear to vanish in the Piketty-Saez pretax data. But so will that tax base.

Posted by: Alan Reynolds | May 28, 2011 5:15:24 PM