At Least We Have the Fed

January 26, 2012 at 4:59 pm

The Federal Reserve signaled this week that it still has the weak economy on its radar screen and sees no imminent threat of inflation.  That’s welcome news, because an accommodative, low-interest-rate monetary policy is the only game in town right now for nurturing the struggling economic recovery.

As I posted yesterday on U.S. News and World Report’s new “Economics Intelligence” website, economic and budget policy will likely run on autopilot this year in the run-up to the November elections.  We can’t realistically expect any bold policies to bring down the jobs deficit; this Congress will have a hard enough time doing the bare minimum, namely, extending the payroll tax cut and extra weeks of unemployment insurance through the end of this year.  (Both are due to expire at the end of February.)

Fiscal and budget policy gridlock may be our friend at a time when there are worse alternatives, such as actually enacting the misguided “reforms” to the budget process now working their way through the House or pursuing the discredited idea that sharp, immediate spending cuts are the best way to boost the recovery.

That leaves it up to the Fed.  Though still subject to sniping from those who believe inflation is a more serious threat than continued sluggish economic growth, the Federal Open Market Committee stated yesterday that it will keep short-term interest rates near zero through late 2014, arguing that “economic conditions — including low rates of resource utilization and a subdued outlook for inflation over the medium run — are likely to warrant exceptionally low levels for the federal funds rate.”  The Fed may even be prepared to take further action, as the economist Tim Duy observes.

With Congress largely on the sidelines for now, we should be thankful the Fed is not listening to the inflation hawks.  And let’s hope that additional steps are indeed in the cards.

The Buffett Rule Revisited

January 26, 2012 at 12:27 pm

The “Buffett Rule” basically says that people at the top of the income scale shouldn’t face lower tax rates than middle-income people.  The Urban-Brookings Tax Policy Center has found that people making over $1 million a year who receive more than two-thirds of their income from capital gains and dividends — as some at that income level do — pay a combined individual income and payroll tax rate of just 12 percent, on average.  That’s lower than the combined income and payroll tax rate that many middle-income Americans face.

At the invitation of David Leonhardt of the New York Times, I participated this week in a back and forth with Greg Mankiw, the Harvard economist and former economic advisor to President George W. Bush, over the Buffett Rule and related issues.

Professor Mankiw makes two points.  First, Congressional Budget Office (CBO) data show that, on average, people with higher incomes face a higher federal tax rate than other people.  In other words, the federal tax code is progressive.  Second, in assessing an individual’s overall federal tax rate (i.e., the percentage of income that he or she pays in taxes), one must take into account the burden of corporate income taxes, which are effectively paid by individuals.  Let’s take each of these points in turn:

On tax progressivity. Most policymakers and opinion leaders who call for those at the top to pay somewhat more in taxes do not make the mistake of claiming that rich Americans pay a lower tax rate, on average, than ordinary Americans.  What they say, as President Obama reiterated in his State of the Union address, is that some high-income people pay a lower rate — and should not.

The federal tax code is progressive.  But Americans also pay state and local taxes, and nearly every state’s tax system is regressive.  The U.S. tax system as a whole is only mildly progressive.  A good part of the progressivity of the federal tax code is needed simply to offset the regressivity of state and local taxes.

Furthermore, the same CBO data that show the federal tax code to be progressive also show that inequality has grown very substantially in recent decades, with incomes at the very top growing by far the most.  This trend came even as federal policymakers were dramatically cutting the taxes that high-income people face.  And the federal tax system as a whole is doing less to push against increases in income inequality than it used to.

Finally, we now face a serious long-term deficit problem, to which these tax cuts have contributed, and some leading lawmakers and presidential candidates are calling for steep cuts in programs that serve families of low or modest incomes even as taxes for individuals at the top are at their lowest level in decades.

On the corporate income tax. Professor Mankiw correctly points out that CBO assumes that investors essentially pay the corporate income tax, and that corporate taxes should be taken into account in figuring high-income households’ overall tax rates.

But while the corporate tax may add significantly to the tax burdens of some high-income people, it adds much less to the tax bills of others.  That’s because many high-income taxpayers generate their business income through so-called “pass-through” entities that don’t pay the corporate tax.  And many corporations pay a very low effective tax rate, which means they pass a very low tax burden onto their shareholders.

Taking the trends both in tax rates and inequality into consideration, we believe that those at the top of the income scale — some of whom do pay tax at a very low rate — should make a contribution to the deficit reduction that the nation will need.  They should pay somewhat more in the interest of both fiscal responsibility and fairness.

Update on House Budget Process Bills

January 25, 2012 at 4:12 pm

We’ve updated our analyses of several bills that would make harmful changes in the congressional budget process in order to reflect their passage by House committees.  The full House is expected to vote on these and other budget process bills beginning next week.

On “Territorial” Taxation Issue, Don’t Ignore U.S. Workers’ Interests

January 24, 2012 at 4:41 pm

“We don’t have an obligation to solve America’s problems,” an Apple executive told the New York Times in connection with Apple’s decision to make the iPhone in China.  “Our only obligation is making the best product possible.”

To be sure, Apple is a business and, as such, it seeks to maximize profits for its shareholders — not improve the living standards of average Americans.  Unfortunately, policymakers tend to forget that basic reality when they are debating policy, especially tax policy.

Take the major effort by a number of corporations to convince Congress to adopt a “territorial” tax system, which would set U.S. taxes on corporate foreign profits at zero. Proponents claim it would make the United States more “competitive” with other countries, implying that we’re all in this together.  But although a territorial tax system might be good for corporate shareholders, it might not be good for America’s workers. The Congressional Research Service’s Jane Gravelle told Congress last year that it:

would make foreign investment more attractive.  That would cause investment to flow abroad, and that would reduce the capital which workers in the United States have, so it should reduce wages.  A capital flow reduces wages in the United States [and] increases the wages abroad.

Congress needs to remember the Apple executive’s statement when considering the territorial proposal.  The interests of U.S. multinationals merit consideration, but so, too, do the interests of average Americans.

Taking a Pass on “Pass-Through” Income Would Cost Kansas

January 24, 2012 at 4:30 pm

Owners of large corporations, well-heeled law firms, and big investment funds would pay no taxes on millions of dollars in income under Kansas Governor Sam Brownback’s plan to abolish the income tax on business earnings that are “passed through” to owners, rather than taxed at the corporate level.

Small Businesses That Employ Other People Generate Less Than One-Third of Pass Through IncomeThe plan would make Kansas the first state in the nation to exempt pass-through income from an otherwise broad-based income tax.  Owners of a business entity normally pay personal income taxes on pass-through income.

Proponents say the plan would be a boon to small businesses and encourage job creation.  But when my colleague Michael Mazerov and I took a closer look, we found that much of the benefit would flow to large corporations and to investment funds and other entities that have few or no employees and are unlikely to create more jobs.

Small, job-creating businesses would get much less.  Small businesses that spend at least $10,000 on labor — the small-business employers that the governor claims to be targeting — generate only 28 percent of all pass-through income, according to a recent U.S. Treasury Department study (see graph).

Moreover, the state budget would take a big hit.  The plan likely would cost Kansas $266 million a year or more in lost revenue, when schools and other vital services that bolster the state’s economy and create a better foundation for future economic growth are still reeling from deep cuts.

The plan also would make the tax code less fair.  For example, a wage earner would pay more in taxes than a pass-through business owner, even if they have the same earnings.

And exempting pass-through income could create new incentives for tax avoidance, such as prompting some taxable corporations to reorganize as pass-through entities purely to take advantage of the tax break.

With unemployment still high and balancing the Kansas budget still a challenge, this is the wrong road for Kansas to take, or for other states to follow.