Tax Receipts and Tax Rates

Will increasing taxes on the rich help deficits?  90% tax rates on the wealthiest or 28% on the wealthiest, and no discernible change in Federal Tax revenues as a proportion of GDP.  This relationship, known as Hauser's Law, is quite robust.  Below, see the relationship (click to enlarge).

Rule of thumb: people who want to raise taxes on the rich don't want to do so to fix deficits;  they have ulterior motives.

Taxation and Tax Avoidance

Corrections offers a nice figure from Emanuel Saez's "Do Taxpayers Bunch at Kink Points?" (American Economic Journal: Economic Policy 2010) (gated) (ungated).   The figure is a histogram of reported income by tax filers (married and single) in $800 categories from NBER's public use tax data.  Note the dramatic bunching for single tax filers around the first increase in marginal tax rates (click to enlarge).  See paper for table notes.

Rule of thumb: distortionary taxation is first order.  Everything else is second order. 

Supply-Side Economics

Here Corrections provides a powerful graph on the distortionary nature of taxation from Marco Bianchi, Bjorn R. Gudmundsson and Gylfi Zoega's paper "Iceland's Natural Experiment in Supply-Side Economics" (AER 2001).  Before 1987, Icelanders had to pay taxes on the previous year's income.  In 1987, they had to pay taxes on the current year's income.  Consequently, 1986 had no substitution effect away from work, though taxes were still being paid.  Compared to the surrounding years, there was an increase of  4.16% in real GDP.  Employment jumped by 4.16% for women: to put this into perspective, this is 15% of the entire increase in the employment rate of women between 1960 and 1980, a sexual revolution.

Among the best graphs Corrections has seen in economics displaying a relatively clean natural experiment can be found below (click to enlarge).  

Anything resembling a 4.16% increase in GDP growth per year is something worth fighting for.  Compare if we could capture less than one fourth of this hypothesized 4.16% effect.  By 2020, US GDP would be 1.8 trillion dollars higher: enough to solve any welfare problem one can come up with.  To see this graphically, see projected US GDP with a 3% real growth rate (the average) or 4% real growth rate below (click to enlarge).

Rule of thumb:  nothing but growth matters.

No Closing Time for Income Taxes

New York Times article "No Closing Time for Income Taxes" (June 11th, 2010) cautions against relying on marijuana taxes as partial substitutes to income taxes based on America's experience with repealing prohibition:

Prohibition had been dead for three years, but the damnable taxes Pierre du Pont had expected to die with it lived on. Contemporary Californians indulging a fantasy of income tax relief emerging from a cloud of legalized marijuana smoke should realize that it is likely only a pipe dream.

However, the article gives no reason why the prohibition experience should generalize to marijuana. Specifically, the article notes a major confound to the repeal of prohibition--the New Deal--but maintains its position that the effects of taxing alcohol will be similar to those of taxing marijuana.

Roosevelt and Congress did respond to the repeal windfall by cutting income tax rates for workers earning less than $3,000 a year. But the New Deal had little sympathy for the wealthy, whose taxes actually increased over the next few years. Rather than the trade-off du Pont expected, the government used the excise income to expand.

Argument by anecdote, or by one historical experience confounded with everything else that happened at the time, should leave anyone unconvinced.  In a time of economic recovery, when the Republican party is gaining favor, why would we expect taxes to rise?  Certainly, this is not the same landscape as Pierre du Pont saw cloud his attempt at income tax relief.  History should be analyzed with its complexity in mind, not applied blindly.

We may, however, rehabilitate the point in an economic manner by suggesting that government spending obeys the law of demand: as the price of government taxation goes down, as it would by introducing a new good (an economic result from Ramsey's Optimal Tax), then we should expect consumption of government to go up.

Keeping Politics Safe for the Rich

New York Times editorial "Keeping Politics Safe for the Rich" (June 8th, 2010) misunderstands the idea of an implicit tax when writing about free speech. Specifically, it describes the idea of an implicit tax on political expression causing a "chilling" of freedom of speech to be "pretzel logic." The #1 standing of the Times in Corrections provides good evidence of familiarity with such logic.

The candidates argued that the matching funds “chilled” their freedom of speech because they were afraid to spend more than the limit that triggered the funds. A lower court agreed with that pretzel logic, but last month a panel of the United States Court of Appeals for the Ninth Circuit disagreed. It said the speech of the plaintiffs had not been chilled. “The essence of this claim is not that they have been silenced,” the panel said, “but that the speech of their opponents has been enabled.”

The actual causality of political victories and campaign spending is difficult for Corrections to discern (we expect, if political donations are a form of bribery or iterative bribery/wages, that the expected winner should be given more money, purely as a fact that he is expected to win, not because the money helps him win). However, even if we forego that qualm, the impact on political spending should look exactly like a tax.

The idea of the law is as follows.  Individuals can either be given a lump sum of money if they agree to forego large private campaign donations, or raise money but not receive the grant.  However, if an individual who raises their own money spends more than the lump sum amount the other individual has been given, then the lump-sum candidate gets some matching funds.  Corrections depicts this situation graphically below (click to enlarge): it is a graph of political spending ad effectiveness of that political spending for a donation-accepting individual.  As we see, our donation-accepting individual has an increasing effectiveness as he spends more money.  However, upon meeting the threshold, the effectiveness of his political spending declines, as his opponent is gaining matching funds to counter the impact of his commercials.

Our point, however, is that the same graph of effectiveness could have been produced by a simple system of taxation--say, 0% from $0 to the threshold, and 90% thereafter.  This is depicted graphically below (click to enlarge).  In this case, we would have to raise ten times as much post-threshold to have the same impact as we had before crossing the threshold--the response to individuals of Arizona's campaign finance system can be produced just as easily by an explicit tax on donations--surely a "chilling" of political speech and hardly "pretzel logic."

5 Myths about your taxes

Washington Post opinion "5 Myths about your taxes" (April 4th, 2010) offers an ill-concieved dismissal of tax "myths." Among them is a non-sequitur rebuttal to the notion that "Americans are overtaxed." Another suggests that the claim "Most people's tax returns are way too complicated" is erroneous, while giving no support for the argument.

Bottom line: We may hate our taxes, but we pay far less than people in other wealthy countries.

This does not take on the form of an argument to Corrections. Just because Americans pay less taxes than people in other countries does not mean that taxes are too high, or too low. The suggestion that European tax rates at optimal levels would amount to a joke to an economist. The only sensible way to argue optimal taxation is the Ramsey Tax problem or other optimal taxation arguments. Simple comparisons between countries give no insight.

The Post then claims that taxes are not too complicated:

But most Americans have relatively simple tax returns. Nearly two-thirds of us claim the standard deduction and don't have to itemize our deductible expenses.

However, it also gives data that its claim is not true.

Small wonder that three out of five tax filers pay someone to prepare their returns, and another one in five uses software.

When four out of five people need help filling out their returns, and three cannot do it on their own, it seems self-evident that taxes are too complicated for an individual to fill out on their own. If they could, they would not pay others or take up their own time with the frictions of having others fill out their paperwork. Corrections recognizes that it would be in the interests individuals with a very high shadow wage to pay others to fill out their taxes, but suggests that when three fifths of the population meets this criterion, it appears true, by definition, that taxes are too complicated.

Within healthcare reform, a push to tax the rich

Christian Science Monitor article "Within healthcare reform, a push to tax the rich" (March 13th, 2010) describes as an incidental note a mastodonically foolish piece of the Obama medicare reform. It notes that one of the administration's new taxes is a tax on capital gains.

Obama would boost the Medicare tax by 0.9 percentage points for households with incomes over $200,000 for singles and $250,000 for joint filers. In addition, he’d impose a 2.9 percent tax on these same people on interest, dividends, annuities, and most other investment income. While the official Obama summary does not say so, the new tax would apply to capital gains as well.

Individual households supply capital. They enjoy consuming today rather than tomorrow. They are only willing to put off consumption today until tomorrow if they are paid for it--otherwise, they consume today. This is due to their discount rate, a primitive that is largely taken as given. Their discount rate does not change, and therefore, household supply of capital is perfectly elastic. If this is the case, then the whole incidence of a tax falls on the firm. However, both households and firms are able to relocate. In this case, government taxation of capital is optimally zero as it only harms production and raises little in taxes. The drastic impact taxation can have when both supply and demand are relatively elastic is graphically displayed below (click to enlarge).




This result is given relatively robustly by Andrew Atkeson, V.V. Chari and Patrick J. Kehoe, in "Taxing Capital Income: A Bad Idea" (Federal Reserve Bank of Minneapolis Quarterly Review, 1999). To quote the paper, "The intuition for why optimal source-based taxes are zero is that with capital mobility, each government faces a perfectly elastic supply of capital as a factor input and therefore optimally chooses to set capital income taxes on firms to zero."

In the hamartiology of economics, there are cardinal and venial sins. The taxation of capital is a cardinal sin.

Video poker? Not here.

Chicago Tribune article "Video poker? Not here." (December 14th, 2009) submits legalized gambling to an auto-de-fé. The Illinois legislature has passed a law enabling legalized video poker machines. A portion of the revenue generated by these machines is transferred to the state. The Chicago Tribune vociferously objects:

If your county or community is on the first of these two lists, congratulations. Your local officials have "opted out" of legalized video gambling. They have declared their disgust with the Illinois legislature's decision to bankroll a $31 billion capital improvements bill in part by luring more people into neighborhood gambling. These communities have said: Go somewhere else.

If your county or community isn't on the first list, get cracking.

It is a herculean task to describe the foolishness this represents. Six powerful economic arguments for legalizing video gambling abound. First, and foremost, individuals should be free to choose. Second, even if gambling is addictive, individuals still make rational decisions. Third, when utility is concave, even taking unfair bets can be a rational decision. Fourth, if even unfair bets are in the interest of multiple individuals, they will likely provide gambles privately. Fifth, the creation of another good to tax decreases deadweight loss for all other objects, on average. Sixth, if all other districts ban gambling, and a significant number of individuals from other counties are willing to travel to gamble in mine, it is in my interest to provide gambling to other districts.

The first argument, that individuals should be free to choose, should not need explanation. As a matter of conditional probability, the chances that a government has decided to limit an individual's liberties for his own good, and is correct in its conjecture, is miniscule compared to the chance that it is doing so for the narrow, personal incentives of legislators, or that it is incompetent in execution, even if well-meaning.

The second point, that gambling may be addictive but should still be legal, is more interesting. Following the earlier argument in Corrections, there is ample evidence that individuals are rational in their decisions, even about addictive goods.

The third point, that individuals are able to accept even unfair gambles is best depicted graphically below (click to enlarge). If they find themselves at a spot where there is local convexity, expected utility from a gamble is greater than expected utility without that gamble. Our fourth point, related to this, is that if we take away efficient private means of redistributing wealth efficiently, individuals will provide them, under the conditions that they are able to match with one another properly and able to provide bets with sufficiently cheap overhead, which it seems apparent they would be able to do.

We turn to the fifth point: the "creation" of a new, taxed good decreases existing deadweight loss (the amount of possible economic gain that disappears in the face of taxation) on average. This point is a subtle one, an idea that will likely be entertained in more depth in a later article. The idea behind this is the same lessons as one gains from the Ramsey Tax problem: if one can, one wants to tax every good at an equal percentage--given that one cannot, one wishes to tax the most inelastic goods. This new good decreases deadweight loss from all other goods, which all have increasing marginal deadweight loss, while creating its own (which starts at a smaller base for its increasing marginal deadweight loss). Additionally, presuming video poker is as addictive as many detractors would claim, the deadweight loss from taxing it is minimal, and such a tax decreases the deadweight loss for other goods.

Sixth and finally, if all or most other localities have successfully banned gambling in their districts, then it is in one's own localities interest to legalize video poker, provided that a large enough number of individuals from foreign localities put a sufficient amount of their money in local businesses for a locality to recoup whatever moral deracination that occurs from allowing the travesty that is video poker to exist.