Published for www.dmarron.com, April 2, 2012

The 2010 health reform legislation introduced a new 3.8% tax on the net investment income of high-income taxpayers. That tax, which I suspect you will hear more about in coming months, goes into effect on January 1, 2013.

This tax raises important policy issues, not least of which is whether Congress should give the name “Unearned Income Medicare Contribution” to an investment tax whose proceeds have nothing to do with Medicare.

The most pernicious myth, however, is that this new tax will apply to home sales. This meme appears regularly in the blogosphere. I even encountered out at the Kauffman bloggers conference. But it’s completely untrue.

As Howard Gleckman explains over at TaxVox:

Yes, the health law will impose a 3.8 percent tax on investment profits and other non-wage income starting in 2013. But that tax applies only to couples with adjusted gross income of $250,000 (or individuals with AGI [adjusted gross income] of $200,000). About 95 percent of households make less than that, and will be exempt from the law no matter what.

In addition, couples who sell a personal residence can exclude the first $500,000 in profit from tax ($250,000 for singles). That would be profit from a home sale, not proceeds. So a couple that bought a house for $100,000 and sold it for $599,000 would owe no tax, even under the health law.

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Published for www.dmarron.com, March 28, 2012

In a new paper, my Tax Policy Center colleague Eric Toder and I argue that the federal government is larger than conventional budget measures suggest. Why? Because many tax preferences are effectively spending programs. Adding these “spending-like tax preferences” back to federal spending and revenues gives a better picture, we think, of the federal government’s true size.

In 2007, for example, federal spending was officially recorded as 19.6 percent of GDP. If you add in the tax preferences that Eric and I believe are effectively spending (the SLTPs), that figure rises to 23.7 percent. In round terms, the government was one-fifth larger than traditional budget figures indicate:

And that’s not all. We also consider the many user fees and premiums that the government charges for various services, ranging from regulatory activity (e.g., patent fees) to Medicare premiums. Such payments are treated as negative spending in official budget calculations. This is sometimes done as a pure budget gimmick to make the government look smaller. More often, however, it’s done for a good reason: to focus on government activities that are funded collectively. That’s an important thing to measure when budgeting. But it’s not the only one. If you want to know how much economic activity is occurring through government agencies, you should consider the gross size of those activities, not just the net. The third column thus adds back user fees and premiums to get the full size of the federal government: 25.4 percent of GDP in 2007.

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Published for www.dmarron.com, March 22, 2012

My latest column at the Christian Science Monitor lays out the case for corporate tax reform:

April 1 is often a day for pranks. In the tax world, however, it will mark something more serious. Barring another Fukushima Daiichi-like catastrophe (which delayed its plans last year), Japan will cut its corporate tax rate by five percentage points. That move will leave the United States with the highest corporate tax rate in the developed world: 39.2 percent when you add state and local taxes to the 35 percent federal rate.

The corporate income tax is a particularly problematic way to collect tax revenues. Corporate taxes are often more harmful for economic growth than ones on personal income or consumption, as noted in a recent study by the Organization for Economic Cooperation and Development. Moreover, a high corporate rate is an invitation for US multinationals to play games with their accounting, locating profits overseas while reporting as many tax-deductible expenses as possible here at home.

That’s why there’s a growing bipartisan consensus that the federal rate needs to come down. President Obama recently proposed lowering it to 28 percent. His likely Republican challenger, Mitt Romney, wants to bring it down to 25 percent.

But corporate tax reform can’t just be about lowering the statutory rate. America faces enormous budget challenges and cannot afford to simply cut future revenue. Moreover, the high statutory rate isn’t the only problem with our system. The code is riddled with tax subsidies and loopholes. Those tax breaks, more generous than those in many nations, reduce corporate tax burdens significantly.

That leaves us with the worst possible system. It maximizes the degree to which corporate managers must worry about taxes when making business decisions but limits the revenue that the government actually collects.

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Published for www.dmarron.com, March 21, 2012

Rhetoric matters in economic policy debates. Would allowing people to purchase health insurance from the federal government be a public option, a government plan, or a public plan? Would investment accounts in Social Security be private accounts, personal accounts, or individual accounts? (See my post on the rule of three.) Are tax breaks really tax cuts or spending in disguise? Is the tax levied on the assets of the recently departed an estate tax or a death tax?

In an excellent piece in the New York Times, Eduardo Porter describes another important example, how we characterize differences in income:

“Alan Krueger, Mr. Obama’s top economic adviser, offers a telling illustration of the changing views on income inequality. In the 1990s he preferred to call it “dispersion,” which stripped it of a negative connotation.

In 2003, in an essay called “Inequality, Too Much of a Good Thing” Mr. Krueger proposed that “societies must strike a balance between the beneficial incentive effects of inequality and the harmful welfare-decreasing effects of inequality.” Last January he took another step: “the rise in income dispersion — along so many dimensions — has gotten to be so high, that I now think that inequality is a more appropriate term.’”

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Published for www.dmarron.com, March 16, 2012

Over at the Atlantic, Mark Bowden tells the tale of Don Johnson, who managed to win $4 million playing blackjack at Caesars in Atlantic City, $5 million at the Borgata, and $6 million at the Tropicana.

How’d he do it? By negotiating favorable odds:

Johnson is very good at gambling, mainly because he’s less willing to gamble than most. He does not just walk into a casino and start playing, which is what roughly 99 percent of customers do. This is, in his words, tantamount to “blindly throwing away money.” The rules of the game are set to give the house a significant advantage. That doesn’t mean you can’t win playing by the standard house rules; people do win on occasion. But the vast majority of players lose, and the longer they play, the more they lose.

Sophisticated gamblers won’t play by the standard rules. They negotiate.

…

Johnson started negotiating.

Once the Borgata closed the deal, he says, Caesars and the Trop, competing for Johnson’s business, offered similar terms. That’s what enabled him to systematically beat them, one by one.

In theory, this shouldn’t happen. The casinos use computer models that calculate the odds down to the last penny so they can craft terms to entice high rollers without forfeiting the house advantage. “We have a very elaborate model,” Rodio says. “Once a customer comes in, regardless of the game they may play, we plug them into the model so that we know what the house advantage is, based upon the game that they are playing and the way they play the game. And then from that, we can make a determination of what is the appropriate [discount] we can make for the person, based on their skill level. I can’t speak for how other properties do it, but that is how we do it.”

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Published for www.dmarron.com, March 5, 2012

NPR aired an interesting trio of segments this morning about inconsistency and flip-flopping. I particularly enjoyed Alix Spiegel’s report on Jamie Barden, a psychology professor at Howard University. Barden’s work considers how “tribal” affiliation affects our perceptions of inconsistent behavior by politicians. In one experiment, Barden asked students their view of a hypothetical political operative named Mike who crashed while driving drunk and then, a few weeks later, gave a speech against drunk driving:

“Now obviously there are two possible interpretations of Mike’s actions. The first interpretation is that Mike is a hypocrite. Privately he’s driving into poles. Publicly he’s making proclamations. He’s a person whose public and private behavior is inconsistent.

The other interpretation is that Mike is a changed man. Mike had a hard experience. Mike learned. Mike grew.

So when do we see hypocrisy and when do we see growth?

What Barden found is that this decision is based much less on the facts of what happened, than on tribe.

Half the time the hypothetical Mike was described to the students in the study as a Republican, and half the time he was described as a Democrat.

When participants were making judgments of a Mike who was in their own party, only 16 percent found him to be a hypocrite. When participants were making judgments about a Mike from the opposing party, 40 percent found him to be a hypocrite.”

I suspect this is the same phenomenon that leads sports fans to systemtically disagree with referee decisions against their favorite team.

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Published for www.dmarron.com, February 28, 2012

Harvard Business School professor Mihir Desai believes American companies and investment firms have erred–horribly–by linking manager compensation so tightly to financial market performance. In the current Harvard Business Review, he identifies this as a giant FIB, a Financial Incentive Bubble:

American capitalism has been transformed over the past three decades by the idea that financial markets are suited to measuring performance and structuring compensation. Stock-based pay for corporate executives and high-powered incentive contracts for investment managers have dramatically altered incentives on both sides of the capital market. Unfortunately, the idea of compensation based on financial markets is both remarkably alluring and deeply flawed: It seems to link pay more closely to performance, but it actually rewards luck and can incentivize dangerous risk-taking. This system has contributed significantly to the twin crises of modern American capitalism: governance failures that cast doubt on the stewardship abilities of U.S. managers and investors, and rising income inequality.

Mihir has nothing against well-functioning financial markets. He emphasizes that they “play a vital role in economic growth by ensuring the most efficient allocations of capital,” and he believes that capable managers and investors should be “richly rewarded” when their talents are truly evident.

The problem is that incentive compensation based on financial performance does a lousy job of distinguishing skill from luck. In finance-speak, managers and investors often get rewarded for taking on beta, when their pay really ought to be linked to alpha. In practice, luck gets rewarded with undeserved windfalls (that are by no means offset by negative windfalls for the unlucky). And that, he argues, results in an important ”misallocation of financial, real, and human capital.”

Well worth a read.

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Published for www.dmarron.com, February 26, 2012

The tax code is like a garden. Without regular attention, it grows weeds that will soon overwhelm the plants and flowers. Unfortunately, no serious weeding has been done to the tax code since 1986. In the meantime, many new plants and flowers have been added without regard to the overall aesthetic of the garden. The result today is an overgrown mess. There is a desperate need to pull the weeds, cut away the brush, and rethink some of the plantings to restore order, beauty, and functionality to the garden.

So begins Bruce Bartlett’s The Benefit and the Burden, an excellent guide to the promise and peril of tax reform.

Beauty is too much to ask of any tax system, but order and functionality are fair aspirations. As Bruce documents, however, we fall far short. Our code is too complex, unfair, and economically harmful. And it doesn’t raise enough revenue to pay the government’s bills.

Bruce takes readers on a tour of many crucial issues in designing a coherent tax system. How should we measure income? Should capital gains count? How should the tax burden vary with income? Are all tax cuts and increases created equal? What can we learn from other nations? Should we tax income or consumption? How should we think about the inevitable politics of choosing winners and losers?

Bruce’s writing is clear, concise, and crisp. And he provides excellent suggestions for further reading for those who want to delve deeper (I found several items to add to my reading list).

Highly recommended for anyone wanting a pithy introduction to the challenges of designing a tax system we can be proud of.

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Published for www.csmonitor.com, February 22, 2012

It’s a shame that can-kicking isn’t an Olympic sport. Imagine America’s elected leaders facing off against their European counterparts in a contest to see who can avoid difficult decisions the longest.

My money would be on the Americans. Our team has taken the game to a new level in recent years and is ready to shine on this year’s Olympic stage. At home, however, it’s not clear whether that can-kicking prowess will end in gold or tears.

Despite its bad reputation, can-kicking is sometimes the best we can do. Putting off long-term decisions makes sense, for example, when the world is riven with uncertainty. If you aren’t careful, however, you will find your path littered with unresolved issues.

That’s where we are on fiscal issues today. Start with our tattered tax code, which now contains a six-pack of temporary tax cuts. The largest are the Bush-era cuts originally enacted in 2001 and 2003 that were scheduled to expire in 2010. Rather than decide their fate, President Obama and Congress extended them another two years.

That legislation also included additional tax cuts championed by Mr. Obama and an estate tax compromise, all of which expire – along with the original tax cuts – at the end of 2012.

Then there’s the dreaded alternative minimum tax. It expired Dec. 31, but Congress for years has passed an annual “patch” preventing the AMT from hitting more middle-class families. A hodgepodge of temporary tax breaks known, tellingly, as the “extenders,” also expired at the end of last year, but many lawmakers and beneficiaries want to bring them back. Various stimulus measures, including the payroll tax holiday and corporate investment incentives, are set to lapse soon, too.

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Published for www.dmarron.com, February 24, 2012

he President’s new Framework for Business Tax Reform is two documents in one. The first diagnoses the many flaws in America’s business tax system, and the second offers a framework for fixing them.

Much of the resulting commentary has focused on the policy recommendations. But I’d like to give a shout out to the diagnosis. The White House and Treasury have done an outstanding job of documenting the problems in our business tax system.

As the Framework notes, our corporate tax system pairs a high statutory tax rate with numerous tax subsidies, loopholes, and tax planning opportunities. Our 39.2 percent corporate tax rate (including state and local taxes) is the second-highest in the developed world, and will take over the lead in April when Japan cuts its rate. But our tax breaks are more generous than the norm.

That leaves us with the worst possible system – one that maximizes the degree to which corporate managers have to worry about taxes when making business decisions but limits the revenue that the government actually collects. It’s a great system for tax lawyers, accountants, and creative financial engineers, and a lousy system for business leaders and ordinary Americans. Far better would be to fill in the Swiss cheese of the tax base and move to a lower statutory rate, just as the President proposes (albeit with much more clarity about the rate-cutting than the cheese-filling and with proposals that would make some of the holes bigger).

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