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Trump’s Fiscal Brainstorm: Cut Taxes for the Rich

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This year’s US presidential election campaign differs radically from past patterns, including in the departure of the Republican nominee from many of the policy positions traditionally taken by his party.  Examples are his lack of support for international trade, military alliances, or the institution of marriage.   But when Donald Trump released some positions on tax policy recently, the differences with Hillary Clinton’s proposals fell very much along usual party lines.  His is the kind of tax policy that has long been favored by Republican presidential candidates and congressmen:  tax cuts that overwhelmingly benefit the rich and that are not accompanied with any plans to pay for them.

Should we pay attention to campaign platforms?

Of course there are reasons for hesitating to judge presidential candidates by their platforms.  Plans announced in the campaign are often a poor guide to what the president will actually do once in office.  Candidate George W. Bush, for example, promised in 2000 to renounce nation-building adventures abroad, to maintain fiscal responsibility, and to treat greenhouses gases as pollutants under the Clean Air Act.  Needless to say, his administration rocketed off 180 degrees in the opposite direction on these issues.

Mr. Trump, in particular, changes his positions with head-spinning frequency, denying that he said things that he is on record as having said a short time before.   A common tactic is to accuse the media of making up the earlier statements, even when the earlier statements are on tape.  Another tactic is to say that he was only being sarcastic.

Are we supposed to take seriously, for example, his statements during the primary debates that American workers’ wages are too high?   Or that he could and would happily contemplate negotiating the terms of the national debt with creditors, otherwise known as defaulting?   Are we supposed to overlook such reckless statements, and ascribe them to an earlier period when he was “young and irresponsible”?

Compare the zig-zags that Trump has pulled off with the minor shifts that have been sufficient in the past to get other politicians tarred with “flip-flopping”.  Remember, for example, the reaction when John Kerry in 2004 said “I actually did vote for the $87 billion before I voted against it.”   (The earlier Democratic measure that he supported would have paid for the $87 billion in Iraq war funding by reducing Bush’s tax cuts, whereas  the version that he voted against instead irresponsibly added the cost to the national debt.)

In any case, we policy wonks are obliged to try to evaluate the policy plans that the candidates offer.  The alternative is to leave the national discussion focused entirely on the current week’s poll results, reporting unedifyingly whether the candidates are rising or falling among voters classified by various combinations of gender, ethnicity, and socioeconomic status.

How the parties differ

Some positions that a candidate may truly hold don’t deserve the attention they receive because in practice he or she stands little or no chance of being able to bring them about if elected. An obvious case is when their proposals are blocked by the other party if it has a majority in congress.  Another case is international constraints.  Although there is a lot of attention to trade agreements this year, promises by presidential candidates to negotiate a new improved trade agreement are seldom if ever implementable once they get to office.  (The truth is, in international negotiations such as TPP, the US has already gotten about the best deal it can get, one that is much better than most people realize.)

The difference between the two parties lies not in some fantasized ability to reverse the rise in inequality by turning the clock back 50 years on trade, or even on somehow reversing the long-term shift from manufacturing to services.  Rather the difference lies in some very practical live policy issues, particularly some that would reverse the trend that leaves many workers behind.  Examples include universal health care (extending the ACA, i.e., Obamacare, rather than abolishing it), infrastructure spending ($275 billion cumulative, in Secretary Clinton’s campaign proposal), compensation for those who lose jobs due to trade (or other forces beyond their control), and a more progressive tax structure (including expansion of the Earned Income Tax Credit).

Trump’s tax plan

Trump made his most serious attempt at a fiscal plan on August 8.   The tax proposal has four salient features, fairly described as tax cuts for the rich.  There is no indication how the tax cuts will be paid for and every indication that they will sharply expand the budget deficit, as happened when Reagan and Bush enacted record budget-busting policies.   All of this is very much in line with proposals from Republican politicians over the last four decades, all the while attacking Democrats for running deficits.

  • Trump proposes to abolish the estate tax entirely. Bush and congressional Republicans tried hard to do this, and got close, but didn’t quite make it.  Trump, like his predecessors, tries to hide the fact that only the very rich would benefit because the current estate exemptions are so high:  $10.9 million for the estate of a married couple (and half that for an individual).  In the most recent year available, only 4,700 estates in the entire country, out of 6 million deaths, required the reporting of some estate tax liability.  Trump repeated the old fairy tale of farms or small businesses that have to be sold by heirs to pay the estate tax; but Republicans after all these years are still unable to come up with specific instances of this actually happening.
  • He proposes to cut corporate income taxes very sharply, to 15%. It is true that the US corporate income tax rate is among the highest in the world, at 35%, and that this probably contributes to companies keeping profits overseas, rather than repatriating them to the US.  But as most tax policy experts will tell you, a reduction in the overall rate should be accompanied by base-broadening.  In particular, we should abolish corporate tax deductions such as those designed to encourage corporate debt and oil drilling.  We could thereby reduce harmful distortions in the economy while simultaneously making up revenue.
  • Trump’s proposals to cut personal income taxes have now changed a bit.
    • Before the primaries, his fiscal proposals included cutting the top marginal income tax rate from 39.6 %, the current level, to 25%. Independent analysts pointed out that his tax policies would lose about $10 trillion in revenue over the first decade, a mind-bogglingly big number.  They would rapidly drive to record levels the national debt as a share of GDP, which has been coming down over the last five years.  His most recent proposal is to cut the marginal tax rate for high earners by about half as much, to 33%.
    • A new proposal, apparently added at the urging of daughter Ivanka Trump: Allow tax deductions for the entirety of average child care costs.  Any such deductions benefit only those in high enough tax brackets to itemize deductions (like mortgage interest), which is mostly those who earn more than $75,000.   That is well above US median household income of $54,462 in 2015.

The Democrats would love to be able to accuse Trump of designing his tax cuts so as directly to benefit him, his family, and people like them.   It is harder to make this accusation because the candidate still refuses to release his own income tax records (unlike all previous candidates since Richard Nixon).  There is no shortage of guesses as to what it is that Trump must be trying to hide.  One good guess is that in some years he has paid no taxes at all, by taking advantage of loopholes already available to big real estate developers.  If so, his annual tax bill can’t be cut further.  But he would still gain from the elimination of the estate tax.

How to pretend that tax cuts = fiscal discipline

Basic arithmetic says “government outlays minus tax receipts equals the budget deficit.”  Republican presidential candidates have seemingly had trouble understanding this equation since 1980.  They propose large specific tax cuts without specific spending cuts, and yet claim they are going to reduce the deficit.  The outcome was the record increases in budget deficits during the terms of Ronald Reagan and George W. Bush.

Trump’s tax cut proposals follow in this tradition of fiscal irresponsibility. The budget plans are still too vague — particularly with respect to discretionary government spending, social security and Medicare – to allow an informed estimate of their impact on the federal deficit and national debt.  But the candidate may be subjected to pressure to become more specific as the date of the election draws near.

Trump may look to his predecessors’ strategies for guidance.  It is worth recalling the four magic tricks that politicians calling themselves fiscal conservatives have been using for 35 years, evasions to facilitate making fiscal promises with a straight face.  These tricks are often deployed in sequence, one succeeding another as they fail to work.

(1) The “Magic Asterisk.”   The candidate promises to balance the budget at the same time as cutting taxes by spending cuts that are not specified but supposedly will be in the future (“future savings to be identified”).

(2) “Rosy Scenario.”  One can forecast an increase in tax receipts if one forecasts an increase in the national rate of growth of income.  One PhD economist has finally signed on as an adviser to the Trump campaign (though he has apparently yet to talk to the candidate); he has suggested that under a Trump presidency the American GDP growth rate will magically double.  This is the same tactic adopted by Jeb Bush during the primaries, and many other politicians before.

(3) The Laffer hypothesis.  But why should growth double?   Reagan, Bush, McCain, and other candidates signed on to the proposition that their proposed cuts in tax rates will spur economic activity so much that total tax revenue (the tax rate times the economic base) will go up rather than down.   Although this “Laffer proposition” has been disproved many times, and the economic advisers to those three candidates clearly disavowed it, the temptation to square the budgetary circle by making this claim is too strong to resist.  Watch for Trump to come out with it.

(4) The “Starve the Beast” hypothesis.  Finally, after the other justifications for big tax cuts turned out wrong, Presidents Reagan and Bush fell back on the theory that, even though tax revenue had in fact fallen rather than rising, this was a good thing after all: it would politically force congress to approve spending cuts.  But these are cuts that the president himself never gets around to proposing.

Perhaps it is inevitable that candidates at the platform-making stage wish away such real-world constraints as congressional politics or international realities, leaving voters disappointed after taking office by failed “promises”.  But politicians shouldn’t be able to wish away the constraints of arithmetic — not when the promises reflect the same failed sleight of hand that has been tried and exposed so many times before.

[A shorter column appeared at Project Syndicate. Comments can be posted there or at Econbrowser.]

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Inequality: Diagnoses and Prescriptions

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Three things are striking about the rise in economic inequality since the 1970s in the United States.  (1) It doesn’t really matter which measure of income distribution we choose; they all show a rise in inequality.  (2) There are many different competing possible explanations and interpretations.  (3) We do not need to agree on the explanation to agree on what are sensible policies to lessen inequality.

(1)   Measures of inequality

There are many different measures of inequality.  Even when just measuring inequality of income, one might look at the Gini coefficient, the poverty rate, income going to the upper 1% or ¼ %, the high-low range, the wage share, or median income.  Also of interest are measures of the distribution of wealth and measures of inter-generational mobility.  They can give different answers.  If the topic is global inequality, for example, the historic economic success of many Asian countries has generated a reduction of inequality by some measures (e.g., a big fall in the poverty rate) but not by others (an increase in the high-low range).

In the United States, however, all measures have pointed the same direction since the turn of the century.  They all reflect that the benefits of economic growth have gone to those at the top. The share of income going to the top 1/2 of 1 percent, for example, is up to 14%, where it was in the 1920s.

(2)        Diagnoses

Normally one would think that diagnosing the cause for such a fundamental shift would be a necessary step in prescribing a cure.   In that case one might be discouraged by the over-abundance of plausible explanations that have been offered and the difficulty in choosing among them.

Thomas Piketty’s Capital in the Twenty-first Century emphasized what he saw as a very long term trend arising from a high return to capital which causes inherited wealth to accumulate at a faster rate than earned income grows.  The 2013 book did much to restore priority to the subject of inequality on the agenda of economists.  But research suggests that widening US inequality comes primarily from within earned income, rather than arising from the difference between earned income (wages and salaries) and unearned income (return on capital).   According to the Piketty-Saez figures, of the substantial 1970-2010 increase in the share of income going to the upper 1% of Americans, 68 percent is due to increased inequality within labor income.  (32 % is due to increased inequality within capital income, and 0 % to a shift in income from labor to capital.)

Several causes of increased inequality of earned income have been identified.

  • The first of the explanations is technological change (such as information technology) that raises the demand for skilled workers faster than the supply.   It can explain an observed widening gap in wages or incomes between skilled and “unskilled” workers, defined according to whether they are college-educated.   But this has little to do with the gap between the upper 1% and the rest.
  • The second explanation is “assortative mating,” according to which highly accomplished professional men no longer marry their secretaries but instead marry highly accomplished professional women.
  • The third is the “winner take all” aspects of many professions, from dentists to university professors to movie stars.   Because modern media tell us who is the best dentist in town or the best movie actor in the world, relatively small differences in abilities win far bigger differences in income than they used to.
  • According to the fourth explanation the very high compensation of corporate executives, especially in the financial sector, is not a return to services that are in demand because they are socially valuable (like having gone to medical school or having been born with acting talent).   Rather, managers essentially get to set the terms of their own pay, through compensation packages that reflect failures of corporate governance, tax law, and financial engineering.  Options, for example, have failed in their original goal of relating pay to performance.
  • A political economy explanation is especially popular:  the rich have captured the levers of power, through campaign donations, and so are able to get policies adopted that are favorable to them.

(3)     Must the diagnosis determine the treatment?

It sounds reasonable that to address a problem one first has to figure out what caused it and then undo that cause.  But this is not always the right approach.   One does not necessarily have to figure out why a particular physical injury occurred to determine the best medical procedure for treating it.

Consider, for example, another explanation for inequality that is particularly popular in this election year: trade.  To avoid the contentious question of whether trade has helped or hurt lower-income American workers generally, let’s focus on one sector where the claim that trade has hurt the employees is almost certainly true:  the auto industry.   50 years ago workers who lacked a college education but were lucky enough to get a job in the auto industry could earn high wages — much higher than other US workers, let alone those abroad.  But Detroit back then had a near-monopoly, which allowed it to produce cars that by modern standards cost a lot, got poor gas mileage, and broke down often.   A subsequent flood of auto imports from Japan and elsewhere ended all that.  One result was that the US auto industry adjusted and today is globally competitive.  Another result was that the wages of auto workers were badly hit.  (Notice that these were the effects of trade, not of regional trade deals like NAFTA.)

Even if one cares only about the auto workers’ wage losses and believes that trade is the sole reason for it, what remedy does one arrive at?  To protect Detroit fully against foreign competition, the government would have had to raise tariffs on auto imports astronomically, so that domestically produced cars today would cost several times more than foreign produced cars.  Does anyone seriously think that is a practical policy solution?

(4)   Policy prescriptions

Many of the same policy prescriptions to ameliorate inequality apply regardless what is the cause.   Most of them are ways to make the tax system more progressive.  This includes lowering the effective marginal tax rate for low-income workers – what President Obama called “Making Work pay” (in 2009, when he passed a refundable tax credit for low income workers, until Republicans took back the Congress and eliminated it].   Enhancing the earned-income tax credit is a live option today.   Obama also proposed in January’s State of the Union message expanding wage insurance, which currently helps workers who lose their jobs because of trade but could be made to help as well those who lose their jobs due to technological change. Another possible proposal would eliminate the payroll tax for low-income workers.

In light of looming deficits in social security and Medicare, it would probably be good to make such changes in the tax code revenue-neutral. (Ten years ago, reducing the deficit should have been a clear priority; five years ago, stimulating the economy should have been the short-term priority.  Today there is not so strong a presumption either way.)  The Republican candidates for president this year, as usual, propose massive tax cuts, focused on the rich, without a plan how to pay for them.

The lost revenue could be balanced with some measures from the following list:

  • End the tax break for “carried interest” — by taxing it at regular income tax rates, rather than at low capital gains tax rates (which is a pure a gift to hedge fund managers) — as Hillary Clinton wants to do.
  • Reduce the estate tax exemption (originally expanded by George W. Bush].
  • Raise the cap on payroll taxes for upper-income workers.
  • Remove oil subsidies and use the gas tax to fund the federal highway trust fund.
  • Tighten some distorting tax deductions like mortgage interest for upper income households.

A lot should be done on the spending side too.  Examples include universal high-quality pre-school, health care insurance for all, and infrastructure spending.  Many of these measures have been pursued by President Obama.

It is striking how little this list of policy prescriptions depends on the precise diagnosis of the problem.

Many of those who are upset about inequality — perhaps lacking patience for the minutiae of fiscal policy — are attracted to the banner of Bernie Sanders (or the banner of Donald Trump).  They like the argument that one must break up banks in order to address the root cause of the problem, which is thought to be that the rich use campaign contributions to influence politicians.

Money in politics is indeed a big problem.  But what do politicians use all that money for? It doesn’t go into their pockets (at least not in the US). Rather the money goes to running for office: campaign advertisements and getting out the vote. In my view, voting for the right candidates (by which I mean those who will enact the right policies) is a far more direct strategy than the convoluted Rube-Goldberg chain of causality which says one should vote for the people who want to break up the banks in order to reduce the amount of money in politics so that there will be fewer ads trying to dissuade one from voting for the right candidates.

[A shorter version of this column appeared at Project Syndicate. Comments can be posted there or at the Econbrowser site.]

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Gas Taxes and Oil Subsidies: Time for Reform

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World oil prices have been highly volatile during the last decade.   Over the past year they have fallen more than 50%.

Should we root for prices to go up, down, or stay the same?   The economic effects of falling oil prices are negative overall for oil-exporting countries, of course, and positive for oil-importing countries.  The US is now surprisingly close to energy self-sufficiency, so that the macroeconomic effects roughly net out to zero.  But what about effects that are not directly economic?   If we care about environmental and other externalities, should we want oil prices to go up or down?  Up, because that will discourage oil consumption?  Or down because that will discourage oil production?

The answer is that countries should seek to do both: lower the price paid to oil producers and raise the price paid by oil consumers.  How?   By cutting subsidies to oil and refined products or raising taxes on them.   Many emerging market countries have taken advantage of the last year of falling oil prices to implement such reforms.  The US should do it too.

Congress continues to shamefully evade its responsibility to fund the Federal Highway Trust Fund.  On July 30 it punted with a 3-month stop-gap measure, the 35th time since 2009 that it has kicked the gas-can down the road!  There is little disagreement that the nation’s roads and bridges are crumbling and that the national transportation infrastructure requires a renewal of spending on investment and maintenance.  The reason for the repeated failure to put the highway fund on a sound basis for the longer term is the question of how to pay for it.  The obvious answer is, in part, an increase in America’s gasoline taxes, as economists have long urged.  The federal gas tax has been stuck at 18.4 cents a gallon since 1993, the lowest among advanced countries.  Ideally the tax rate would be put on a gradually rising future path.

Fuel pricing is a striking exception to the general rule that if the government has only one policy instrument it can achieve only one policy objective.   A reduction in subsidies or increase in taxes in the oil sector could help accomplish objectives in at least six areas at the same time:

  1. The budget. It is estimated that energy subsidy reform globally (including coal and natural gas along with oil) would offer a fiscal dividend of $3 trillion per year. The money that is saved can either be used to reduce budget deficits or recycled to fund desirable spending, such as US highway construction and maintenance, or cuts in distortionary taxes, e.g., on wages of lower-income workers.
  2. Pollution and its adverse health effects.   Outdoor air-pollution causes an estimated annual 3.2 million premature deaths worldwide.  A gas tax is a more efficient way to address the environmental impact of the automobile than alternatives such as CAFÉ standards which mandate fuel economy for classes of cars.
  3. Greenhouse gas emissions, which lead to global climate change.
  4. Traffic congestion and traffic accidents.
  5. National security.   If the retail price of fuel is low, domestic consumption will be high.  High oil consumption leaves a country vulnerable to oil market disruptions arising, for example, from instability in the Middle East.  If gas taxes are high and consumption low, as in Europe, then fluctuations in the world price of oil have a smaller effect domestically.   It is ironic that U.S. subsidies to oil production have often been sold on nationalsecurity grounds; in fact a policy to “drain Americafirst” reduces self-sufficiency in the longer run.
  6. Income distribution.  Fuel subsidies are often misleadingly sold in the name of improving income distribution.  The reality is more nearly the opposite.  Worldwide, fossil-fuel subsidies are regressive: far less than 20%  of them benefit the poorest 20% of the population.  Poor people aren’t the ones who do most of the driving; rather they tend to take public transportation (or walk).   As to producer subsidies, owners of US oil companies don’t need the money as much as construction workers do.

The conventional wisdom in American politics is that it is impossible to increase the gas tax or even to discuss the proposal.   But other countries have political constraints too.  Indeed some governments in developing countries in the past faced civil unrest or even overthrow unless they kept prices of fuel and food artificially low.  Yet some of them have managed to overcome these political obstacles over the last year.  The list of those that have recently reduced or ended fuel subsidies includes Egypt, Ghana, India, Indonesia, Malaysia, Mexico, Morocco, and the United Arab Emirates which abolished subsidies to transportation fuel subsidies effective August 1.

Besides raising taxes on fuel consumption, the US should also stop some of its subsidies to oil production.  Oil companies can “expense” (immediately deduct from their tax liability) a high percentage of their drilling costs, which other industries cannot do with their investments.  Most politicians know that sound economics would call for this benefit to be eliminated.  But they haven’t been ab le to summon the political will.  Among the other benefits given to the oil industry, it has often been able to drill on federal land and offshore without paying the full market rate for the leases.

Those politicians who complain the loudest about the evils of government handouts are often the biggest supporters of handouts in the oil sector. Political contributions and lobbying from the industry must be part of the explanation.  Even so, it is surprising that self-described fiscal conservatives see more political mileage in closing the Export-Import Bank – which earns a profit for the US Treasury while it supports exports – than in ending oil subsidies, which cost the Treasury a great deal.   ‘

A recent study from the IMF estimated that global energy subsidies at either the producer or consumer end are running more than $5 trillion per year.  (Petroleum subsidies account for about $1 ½ trillion of that. A lot also goes to coal, which does even more environmental damage than oil.)  US fossil fuel subsidies have been conservatively estimated at $37 billion per year, not including the cost of environmental externalities.

Leaders in emerging market countries have now recognized something that American politicians have apparently missed, that this is the best time to implement such reforms.  Oil prices have recently fallen to around $50 a barrel – down from a level well over $100 a barrel in the summer of 2014. So governments that act now can reduce energy subsidies or increase taxes without consumers seeing an increase in the retail price from one year to the next.

For the US and other advanced countries it is also a good time for fuel price reform from the standpoint of macroeconomic policy.  In the past, countries had to worry that a rising fuel tax could become built into uncomfortably high inflation rates.  Currently, however, central bankers are not worried about inflation except in the sense that they are trying to get it to be a little higher.

Congress will have to come back to highway funding in September. If other countries have found that the “politically impossible” has suddenly turned out to be possible, why not the United States?

[A shorter version of this column was published at Project Syndicate.  Comments can be posted there.]

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