Monthly Archives: December 2017

Carried Interest and Your Private Sweat Equity

30 Saturday Dec 2017

Posted by in Central Planning, Taxes

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Suppose your rich uncle buys an old house to do some fix-ups and hopes to resell it at a gain. He has the cash and is willing to split the profit 50-50 if you’re willing to handle a few restorations over the next year. Even better, under the partnership he’ll form with you, your profit will be taxed as a pass-through capital gain. You’ll be taxed at only 15% (or 20% if your income is already very high). You’ll provide the labor, but your cut won’t be taxed at ordinary income tax rates.

That’s Just Like Carried Interest

A similar example is provided by Greg Mankiw, along with several others, to illustrate the ambiguity of “capital gains” under our tax law. What might surprise you is that the tax treatment of the deal with your uncle is exactly the same as the tax benefit received by the general partner (GP) in a private equity fund. The GP is the “worker”, as it were, who manages the capital paid-in by the fund’s investors (or limited partners). The GP attempts to build the fund’s value in various ways. The investors, on the other hand, take the same role as your uncle. The GP earns fees as a cut of the investment gains; those fees are essentially treated as capital gains for tax purposes. In the case of the private equity GP, however, the income is called “carried interest”, but there is no real difference.

The tax treatment of carried interest has been a target of progressives and populist critics for many years. This article in The Hill derides the GOP’s failure to close the carried interest “loophole” in the Tax Cut and Jobs Act (TCJA) recently signed into law by President Trump. Of course, wealthy private-equity players have sought to protect the rule with generous campaign contributions to key politicians. However, as illustrated by the partnership with your uncle, pass-through business taxation combined with the treatment of capital gains provides the same benefits to any business-person who invests “sweat equity” into the improvement of an asset for ultimate resale, including the business itself.

Should “sweat equity” earned by a worker be taxed more lightly than the direct receipt of “sweat wages”? The worker does not “own” the asset in question prior to the work effort, a fundamental distinction from what we normally consider to be a capital gain. On the other hand, the worker shoulders risk that the asset’s value will fail to meet expectations. My view is that it is not appropriate for the tradeoff between private risk and return to be managed via the income tax code or by government generally. Nevertheless, the sweat-equity conversion of labor value into asset appreciation is treated by tax law as a capital gain and is taxed at a lower rate than wages (except at low levels of taxable income).

Equal Protection Under the Tax Law

The carried interest rule and relatively “light” taxation of returns on capital are not at the root of the problem here. Rather, it is the disparate treatment of different kinds of income for tax purposes and the high taxation of ordinary income, even in the wake of the the TCJA’s passage. Diane Furchtgott-Roth argues that the low carried-interest tax rate is necessary to encourage productive investment. Peter Wayrich agrees, but again, that is not a good rationale for disparate (and high) taxation of labor income. This note in the Economic Policy Journal contains a quote on Senator Ron Johnson’s proposal to tax all productive entities at the 20% carried-interest tax rate. The potential loss of revenue might require a higher rate, but the proposition that rates should be equal across all forms of business organizations is more sensible than the complex changes promulgated for pass-throughs under the TCJA. Moreover, the progressive premise that tax rates on capital income should be high is a prescription for low rates of saving, a diminished pool of investment capital, and ultimately low growth in labor productivity and wages.

Demonizing Private Equity

The private equity business is criticized for reasons other than carried interest, but mainly due to superstition that these firms routinely engage in plundering healthy enterprises to extract value and victimize helpless employees by reducing wages or leaving them without work. Simple economics reveals the shallow thinking underlying such claims. As a first approximation, private equity can be profitable only when target firms are under-performing or undervalued. A healthy market for business ownership is necessary to ensure that firms with untapped value survive. Weak performance might stem from any number of circumstances but must be addressable under new management. That includes a management shakeup itself, and it could include a capital infusion to upgrade facilities, elimination of unprofitable product lines, a spin-off from a neglectful parent company, or wage renegotiation to improve competitiveness (but never ask a leftist if wages are too high, even as the employer fails).

Interest Deductibility

The tax benefits of carried interest enhance private equity deals relative to traditional merger and acquisition activity. Again, that illustrates the oddity of having different tax rules for different firms. In the past, the gains from carried interest have been magnified by another unfortunate aspect of the tax code: the interest-deductibility of business debt. The TCJA doesn’t completely eliminate this economic peculiarity, but it places a severe restriction on its use (see #6 on the list at the link).

In general, interest deductibility has favored the use of debt in the capital structures of all businesses. That leverage increases financial risk and bids up the level of interest rates faced by all borrowers. Private equity firms have made liberal use of debt in structuring buyouts. Their borrowing capacity combined with carried interest and the debt subsidy has undoubtedly made deals more attractive at the margin.

The new restriction on interest deductibility is likely to reinforce an existing trend in private equity: gradually, GPs have been putting more “skin in the game“. That is, they are risking a bit more of their own capital. That is generally a good thing for investors. The article at the last link was written in March 2017, so the data shown for 2017 is almost meaningless. In 2016, however, the average GP commitment as a percentage of fund size was still less than 8% and the median was just 4%. These percentages should continue to increase with competition for deals and more restricted deductibility of interest expense.

Taxes and Value

If you want to encourage value-maximizing behavior, then don’t tax its makers (or its markers) heavily. Carried interest extends the tax treatment of “sweat equity” to those who “police” the private sector for unexploited value: private equity firms. By eliminating waste, resuscitating formerly productive enterprises, and exploiting new profit opportunities, their efforts are socially accretive. The popular narrative of an “evil” and “vulturous” private equity industry is both misleading and destructive. Beyond that, there is no reason to tax different forms of productive activity at different rates, but we do. The TCJA has lessened the tax disparities to some extent, but more equalization should be a priority. At least the business interest deduction has been restricted, which should lessen the artificial reliance on borrowed capital.

Tax Cuts Yes, Simplification a Mixed Bag

18 Monday Dec 2017

Posted by in Taxes, Trump Administration

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President Trump signed the Tax Cuts and Jobs Act (TCJA) this morning, the GOP tax bill with an acronym that simply won’t roll off my tongue. A useful summary of the Act produced by the House -Senate conference, and the full text of the Act, appear at this link. The TCJA hews more toward the earlier Senate bill than the House version. I’ve written about both (the House bill here and both here). Here is a good summary of the Act from Peter Suderman at Reason.com.

In my earlier assessments, I relied upon the principle of tax reform and real simplification as a justification for a tax cut without revenue neutrality. There are a few reforms and partial reforms, and the bill may simplify taxes for a number of individual taxpayers. However, on the whole I’m disappointed with the progress made by the GOP in those areas.

Notwithstanding my disappointment with the overall reform effort, the TCJA cuts taxes for most Americans and is likely to have salutary effects on economic growth and the job market. In fact, one of the most remarkable things about  the Act is the claim made by its adversaries on the Democrat side of the aisle. They apparently believe that the benefits of the TCJA flow primarily or even exclusively to the rich. This is a huge mistake for them. High-income taxpayers will receive greater benefits in absolute dollars, but not proportionally. This is shown by the table above, prepared by Chris Edwards from data produced by the Joint Committee on Taxation (JCT). In fact, the TCJA will extend tax reductions to a larger share of the middle class than either of its predecessor bills would have done. You cannot meaningfully reduce the taxes generated by a steeply progressive tax system without reducing the absolute dollars paid by high-income taxpayers. And you can’t lay the groundwork for sustainable economic growth without improving the investment incentives faced by high-income taxpayers and producers.

Here are some additional additional thoughts on the bill:

Yeah, I like me some tax cuts: The Act reduces taxes for many individuals and families by doubling the standard deduction and reducing tax rates. More importantly, perhaps, it will also reduce taxes for C-corporations, providing some relief from double taxation of corporate income, as will the switch to a territorial tax system on U.S. corporations doing business abroad. The latter is a real reform, while I consider the former a partial reform. Investment incentives are improved via the corporate rate cut and elimination of the corporate Alternative Minimum Tax (AMT) — a real reform, as well as the ability to write-off spending on new equipment immediately. As I argued last month, lower corporate taxes are likely to benefit both workers and consumers. The actions of few companies (AT&T, Comcast, Wells Fargo, and Fifth-Third) seem to demonstrate that this is the case: they have announced bonuses and increases in their base wage rates in the immediate wake of the TCJA’s massage.

Pass-through tax cuts are iffy: One of the most difficult parts of the TCJA to evaluate involves the implications for pass-through business entities like sole proprietorships, partnerships and S-corporations. Some might not receive significant cuts. The Act includes a maximum 25% rate on business income, but that is dependent on the proportion of the owner’s income deemed to be business income under the new rules. It also allows a flat deduction of 20% against business income. These provisions will be of benefit to very successful and very capital-intensive pass-throughs. Owners of smaller or less profitable firms will get the benefit of lower individual tax rates and the higher standard deduction, but might not have income high enough to benefit from the 25% rate cap.

Simpler for some, but it is not simplification: The doubled standard deduction will mean fewer taxpayers claiming itemized deductions. That sounds like simplification, but many will find it reassuring to calculate their taxes both ways, so a compliance burden remains. The Act retains or partially retains a number of deductions and credits slated for elimination in earlier versions, failing a simple principle held by reformers: eliminate deductions in exchange for lower rates. Along the same lines, the individual AMT is retained, but the exemption amount is increased, so fewer taxpayers will pay the AMT. Again, simpler for some, but not real simplification.

Elimination of the corporate AMT is simplification, as are immediate expensing of equipment purchases and territorial tax treatment. However, most of the complexities of corporate taxes remain, as do certain tax breaks targeted at specific industries. What a shame. And unfortunately, taxes for pass-through entities are anything but simplified under the Act. Complex new rules would govern the division of income into business income and the owners’ wage income.

Reducing deductions and bad incentives: The mortgage interest deduction encourages over-investment in housing and subsidizes the wealthiest homebuyers. The TCJA leaves it intact for existing mortgages, but allows the deduction to be claimed on new mortgage loans of up to $750,000. So the bad incentive largely remains, though the very worst of it will be eliminated. There have been complaints that this change could reduce home prices in states with the highest real estate prices. Good — they have been inflated by the subsidy at the expense of other taxpayers.

The tax write-off for state and local taxes (SALT) will be limited to $10,000 a year under the TCJA, though it adds some flexibility by allowing that sum to be met by any combination of state or local income, sales or property taxes. This change will reduce the subsidies from federal taxpayers residents of high-tax states, and should make leaders in those states more circumspect about the size of government.

The TCJA preserves and even expands a number of individual deductions and credits, subsidizing families with children, medical expenses, student loans, graduate students, educational saving, retirement saving, and the working poor. The interests benefiting from these breaks will be relieved, but this is not simplification.

Yet another case of “simpler for some” is the estate tax: it remains, but the exemption amounts are doubled. The estate tax does not produce much revenue, but it is fundamentally unjust: it ensnares the families of deceased property owners, farmers and small businesses; planning for it is costly; and it often forces survivors to sell assets quickly, sustaining losses, in order to meet a tax liability. The TCJA will significantly reduce this burden, but the tax framework will remain in place and will be an ongoing temptation to ravenous sponsors of future tax legislation.

Individual cuts are temporary: The corporate tax changes in the TCJA are permanent. They won’t have to be revisited (though they might be), and permanence is a desirable feature for sustaining the impact of positive incentives. The individual cuts and reforms, however, all expire within eight to ten years. The sun-setting of these provisions is, as some have said, a gimmick to reduce the revenue impact of the Act, but sunsetting means another politically fractious battle down the road. It is also a device to ensure compliance with the Byrd Act, which limits the deficit effects of legislation under Senate reconciliation rules. Eight years is a fairly long “temporary” tax cut, as those things go; for now, the impermanence of the cuts might not weaken the influence on spending. However, that influence is likely to wane as the cuts approach expiration.

Deficit Effects: The TCJA’s impact on the deficit and federal borrowing is likely to be somewhere north of $500 billion, possibly as much as $1.4 trillion. Deficits must be funded by government debt, which competes with private debt for the available pool of savings and must be serviced, repaid via future taxes or inflated away. In the latter sense, government borrowing is not really different from current taxes, a proposition known as Ricardian equivalence.

Nonetheless, the incentives, complexities and compliance costs of our current tax code are damaging, and the TCJA at least accomplishes some measure of reform. Moreover, the incremental debt is small relative to the impact of prior estimates of government borrowing over the next decade, with or without extension of the individual tax cuts. The most fundamental problem that remains is excessive government spending and its competing demands for, and absorption of, resources, with no market guidance as to the value of those uses.

Art and Its Political Hijacking

15 Friday Dec 2017

Posted by in Art & Politics

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Art and politics have a long connection that is often quite awkward. One philosophy holds that art cannot be divorced from its social origins, that it is a legitimate platform from which to confront injustice and oppression, and indeed, that art must “serve some moral or didactic purpose”. In the nineteenth century, the contrary view was expressed by the phrase “art for art’s sake“, which has been credited to several individuals including Edgar Allen Poe. At the time, Marxists said the slogan served to prop-up the “petty bourgeois”, as if artistic beauty and exploration must themselves be inspired by political interests. Exploiting art to promote a point of view is not the exclusive domain of the Left, however. The Right has its own variations on political expression through art. But all such varieties on the Left and Right make me cringe just a bit; I cringe even when the intent of art is to promote views with which I strongly agree.

Art and Advocacy

Great art derives from an amorphous combination of talent, certain acquired technical skills, and inspiration. Inspiration can come from anything that might be, strictly speaking, non-art, such as natural beauty, any kind of human drama, the spiritual, or even politics. While many of us can agree that certain artistic works are great, it will always be a subjective matter to one degree or another.

Art may cross subjective boundaries of propriety, and it may offend. No matter the specific topic or the intent, art becomes confrontational and political when some parties object to whatever is portrayed, and especially when attempts are made to suppress it. A work of art is tendentious if the intent is to promote a political viewpoint or a policy, either as a matter of protest or when it is used by either the state or “subversive elements” in an effort to propagandize. It ranges from state-sponsored “artistic” propaganda to private but jingoistic expression, to “protest art”, and to any kind of politically-motivated art.

Obviously, tendentious art can be good from a purely technical perspective even while the subject matter is unappealing to a particular observer. As well, TA can appeal to the emotions effectively, and it can be interesting as a sociological exercise. However, art can portray conditions, dire or otherwise, and appeal to emotions without advocating social policy, and art can be abstract and devoid of any political implication whatsoever.

Even worse than tendentious art are attempts to either censor it or subsidize it. May tendentious art live on as a tool in the marketplace of ideas, free of government involvement. However, on the whole, public or private, I find it unappealing.

Why I’m Averse to Tendentious Art 

Here are several propositions about tendentious art (TA) to which I subscribe. They are overlapping to some extent, and I emphasize they are often matters of degree rather than kind:

  1. It compromises artistic standards;
  2. Persuasion is its purpose, making art subsidiary to the politics;
  3. It demotes art to a tool of delivery, subservient to the message;
  4. TA exploits art for political purposes;
  5. Art often functions as a refuge or escape; TA cannot;
  6. TA is often angry;
  7. the appeal of TA is often self-reverential;
  8. It confuses artistic value and political “virtue”;
  9. practitioners of TA often engage in willful historical distortion;
  10. TA can be self-antiquating;
  11. TA often recycles and co-opts existing art;
  12. It is never Pareto-improving.

I’ll elaborate on some of these points:

TA demotes the art part: To the extent that the art and the political message are separable, art becomes subsidiary to the message, and that is almost always true when the message is explicit. In fact, art becomes a mere conveyance.

Artistic compromise: Your political message does not make you an artist. This is worth extra emphasis in the age of the meme and the meme “artist”. I’ve seen what I consider bad art. I’ve seen a great deal of bad TA. It is as if the artist can be forgiven for an unimpressive artistic effort so long as the message is valued by like-minded partisans. In this way, TA creates confusion over artistic value relative to political “virtue”.

Politics attempts to exploit art: I am appalled at the recent treatment of certain celebrities, artists or otherwise, who are facing demands to publicly state their political views, to support or denounce this or that person or policy. Whether or not one’s work intersects with the political sphere should be up to the artist. It is within one’s rights to be apolitical.

TA is Pareto-violating: Tendentiousness makes art unappealing to certain observers, and that might even be what the artist intends. A particular policy position embodied in TA, if adopted, might actually be threatening to some individuals in terms of their economic welfare or personal liberties. Even worse, extreme forms of TA might serve to incite violent action (free speech demands that government may not engage in “prior restraint”). The point I’m making here is distinct from any issues posed by physical presentation, such as high volume or lighting, that might make a third-party worse off.

In economics, exchange is said to be Pareto-improving if two trading parties are made better-off while no one is made worse off. Of course, one can always ignore certain forms of art, or one can try to if its expression is non-threatening. But someone may well be made worse-off by an exercise of TA, and in a value-free sense, that makes TA inferior to other art.

Trapped like a rat: TA tends to be ineffective as a refuge or escape, no matter how cathartic some might find the message. The observer is bound by the political reality and the conflict it implies. Art doesn’t have to transcend reality to serve as an escape, but it can transcend explicit advocacy.

Your art and your virtue: I don’t think it’s unfair to say that an observer who enjoys tendentious art indulges in a pleasure that is strongly self-reverential. They feel virtuous, and that is the wrong sentiment to derive from art. TA derives some of its value and power by stroking the ego of the observer.

Distorting history: I have seen many examples of inaccurate historical accounts in theatre and elsewhere. The musical Hamilton is prominent in this respect. The musical Annie has its share of distortions regarding the largely similar policies of Herbert Hoover and Franklin Delano Roosevelt. Che Guevara is sometimes depicted in art as heroic, yet he was murderous, misogynistic, and tyrannical. Got any Stalin shirts? I could go on….

TA can get stale: In some circumstances, TA can make art self-antiquating: captive to the time in which it is created and reducing its relevance as times change, especially if the artist is on the losing side of the politics.

What Prompted This? A Band Beyond Description

This post was motivated by my observation of comments on “fan pages” to which I belong on-line. I’ve been an avid follower of a certain group of musicians over the years, and these fan pages give me an opportunity to interact with other enthusiasts, view concert video, and get news about the band. The fans tend to be affable and we share a certain cultural zeitgeist. However, there is division on these pages over politics, and while I’d describe many of the fans as leftist, there is more diversity of opinion than one might guess. One fan page actually has a “no politics” rule, as it’s proven to create unwelcome strife on other pages. I believe the page administrators are correct in viewing politics as “off-topic”. That is not censorship; it is private governance — house rules, as it were, to which I can’t object. Some fans just can’t help violating the rule, however. There, and on other fan pages, a significant segment of fans seem to believe that one cannot really “get” the band and their music without sharing certain political opinions. That doesn’t surprise me, but I dislike the “groupthink” attitude it reflects.

I realized early-on that the band tended to avoid tendentious art, greatly to their credit. Their music often focuses on traditional themes like love, love lost, celebration, the human condition, and many fascinating stories populated with colorful characters. They even cover some biblical topics that are just great stories. Other frequent musical themes are quite abstract, by turns sinister and dreamy.

There is no doubt that the members of the band have opinions about politics. They have supported a number of causes such as the anti-war movement, ending the drug war, environmental causes, and gay rights. But I believe they have intentionally avoided explicit advocacy in their music. They tend not to use the stage as a pulpit, except generally as a pulpit of musical celebration and fun. They sing sweetly (mostly) and they can rock!

Again, the distinctions I’m making are matters of degree. For example, occasionally the group plays concerts to benefit causes or even candidates for office. That’s fine. I might not support their candidate, or I might disagree with a policy position, but that sort of explicit advocacy seldom if ever intersects with their music. It imposes little or nothing on me.

The band has written and performed a few songs expressing concerns that I don’t fully share. In my opinion (in seeming violation of some of the principles I listed above), I consider those songs to be great from a purely musical perspective; the lyrics are well-turned; and they tend to reveal general sentiment and anxiety about things we’d all like to resolve, rather than direct advocacy of specific policies. I like those songs, though I might disagree with the policy prescriptions of the musicians themselves. In any case, they don’t claim technical expertise in those subject areas. I like their art and don’t really care about their policy preferences, unless they rub my nose in them. But they don’t.

Again, while these are matters of degree, this band has always tended not to use their music as a political soapbox. Perhaps the band’s greatest luminary once said the following:

“You need music, I don’t know why. It’s probably one of those Joe Campbell questions [who said, ‘Follow your bliss.’], why we need ritual. We need magic, and bliss, and power, myth, and celebration and religion in our lives, and music is a good way to encapsulate a lot of it.“

Denouement

My admittedly subjective opinion is that the explicit messaging of tendentious art cheapens artistic expression in several ways: it demotes art in favor of political messaging; it subverts the role of art as an escape; it may be inferior by making third-parties worse off; its enjoyment is something of a self-reverential exercise; it confuses artistic value with political “virtue”; it makes art less durable to the extent that the message it embodies may become less relevant with time; and it is usually angry.

The band I’ve referenced in this discussion is the Grateful Dead. I’ll continue to celebrate their great music with anyone who appreciates it as music. (The name of the band originally appealed to the group partly because it seemed somewhat repellent to conformists. That’s a bit confrontational, perhaps, but the name is folkloric.) Their politics don’t much matter to me because I believe they are artists first. They have kept their art largely free of politics.

I close with lyrics to a Grateful Dead song about music and it’s effect on the human spirit, written by John Perry Barlow and Bob Weir. It is non-tendentious:

The Music Never Stopped

[First voice]
There’s mosquitoes on the river
Fish are rising up like birds
It’s been hot for seven weeks now
Too hot to even speak now
Did you hear what I just heard?

Say, it might have been a fiddle
Or it could have been the wind
But there seems to be a beat now
I can feel it in my feet now
Listen here it comes again

[Second voice]
There’s a band out on the highway
They’re high-stepping into town

It’s a rainbow full of sound
It’s fireworks, calliopes and clowns
Everybody’s dancing

[First voice]
Come on children, come on children
Come on clap your hands

The sun went down in honey
And the moon came up in wine
You know stars were spinning dizzy
Lord the band kept us so busy
We forgot about the time

They’re a band beyond description
Like Jehovah’s favorite choir
People joining hand in hand
While the music plays the band
Lord they’re setting us on fire

Crazy rooster crowing midnight
Balls of lightning roll along
Old men sing about their dreams
Women laugh and children scream
And the band keeps playing on

[Second voice]
Keep on dancing through to daylight
Greet the morning air with song
No one’s noticed but the band’s all packed and gone
Was it ever here at all?
But they kept on dancing

[First voice]
Come on children, come on children
Come on clap your hands

Well the cool breeze came on Tuesday
And the corn’s a bumper crop
And the fields are full of dancing
Full of singing and romancing
The music never stopped

Liar-Left, Daft-Left Bellow: It’s the Unkindest Tax Cut of All

08 Friday Dec 2017

Posted by in Health Insurance, Taxes

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A misapprehension of progressive leftists is that the tax reform bills under debate by the GOP will revoke something from the needy: the poor, cancer patients, the working class, the aged, you name it. Well, that is a misapprehension held by many earnest leftists, but it amounts to deceitful rhetoric from others. David Harsanyi, in an article about the Left’s penchant for corrupting the English language, attempts to set the record straight:

“Whenever the rare threat of a passable Republican bill emerges, we learn from Democrats that thousands, or perhaps millions, of lives are at stake. …

… the most obvious and ubiquitous of the Left’s contorted contentions about the tax bill deliberately muddles the concept of giving and the concept of not taking enough. This distortion is so embedded in contemporary rhetoric that I’m not sure most of the foot soldiers even think it’s odd to say anymore. …  Whatever you make of the separate tax bills the House and Senate have passed, though, the authors do not take one penny from anyone. In fact, no spending is being cut (unfortunately). Not one welfare program is being block-granted. Not one person is losing a subsidy. It’s just a wide-ranging tax cut without any concurrent spending cuts.“

The Left may have a basic math incompetency, or maybe they know better when they insist that the GOP plans will inflict a new burden on the middle class. The middle class actually receives larger reductions in taxes than higher strata. Veronique de Rugy highlighted this point recently:

“President Trump’s intention to give a real tax break to the middle class is counter-productive considering the middle class barely shoulders any of the income tax as it is. The top 10 percent of income earners—households making $133K [or more], not $1 million as most assume—currently pay more than 70 percent of all income tax revenue. The middle quintile pays, on average, 2.6 percent of the federal income tax.

And yet, in both the House and Senate plans the middle class receives the largest tax relief by reducing their marginal tax rates, increasing the child tax credit and doubling the standard deduction. The result is fewer taxpayers would be paying income tax at all, problematic from a small government perspective. It also means a more progressive income tax code than it already is.

The House plan also effectively jacks up the top marginal rate for some high earners by using a 39.6 percent bubble rate on the first $90K earned by single taxpayers making $1 million and married taxpayers making $1.2 million and a 12 percent rate like everyone else.“

I have listened to horror stories about school teachers who, in the past, were able to deduct supplies they purchased for their students. Now, the cruel GOP is trying to take that away! This argument neatly ignores the doubling of the standard deduction. Many teachers will find that it no longer makes sense to itemize deductions, and they will come out ahead. But for the sake of argument, suppose a teacher earning $50,000 itemizes and spends $2,500 on unreimbursed supplies for their students every year. At the Senate plan’s new rate in that bracket, the lost deduction will cost the teacher $550, but about $300 would be saved via rate reductions for every $10,000 of taxable income. The teacher is likely to come out ahead even if he unwisely passes on the improved standard deduction.

Liberal thought-whisperers have goaded their minions into believing that the GOP intends to cut Medicare funds by $25 billion a year going forward. The bills under discussion would do no such thing. However, in a rare gesture of fiscal responsibility, President Obama in 2010 signed the Statutory Pay-As-You-Go Act (Paygo), which may require automatic reductions in outlays when spending or tax changes lead to an increase in federal debt. The act has never been enforced, and Republican leadership in both houses insists that Paygo can and will be waived. Clearly, the GOP’s intent is not to allow the Paygo cuts to take place. Even the left-leaning Snopes.com is reasonably neutral on this point. But if Paygo takes hold, the lefties will have themselves to blame.

At the last link, Snopes also touches on one actual provision of the Senate tax plan, the repeal of the Obamacare individual mandate, or rather, the repeal of the “penalty tax” imposed by the IRS on uninsured individuals. The Supreme Court ruled that it is a tax in 2012, at the time giving rise to a mixture of delight and embarrassment on the Left. The ruling saved Obamacare, but the Left had been loath to call the penalty a tax. The supposed rub here is that repeal of the mandate will be greeted enthusiastically by many young and healthy individuals. Freed from coercion, many of them will elect to go without coverage, leading to a deterioration of the exchange risk pools and causing premiums paid by the remaining exchange buyers to rise. However, the critics conveniently ignore the fact that Obamacare individual subsidies will automatically ratchet upward with increases in the premium on the Silver Plan. So the panic related to this portion of the Senate tax bill is misplaced.

One other point about the mandate: because it coerces the payment of cross-subsidies by the young and healthy to higher-risk insurance buyers, the mandate distorts the pricing of risk, the incentives to insure, and the use of resources in the provision of health insurance and health care itself. This is how the proper function of a market is destroyed. And this is how resources are wasted. Good riddance to the mandate. The high-risk population should be subsidized directly, not through distorted pricing, at least until such time as a market for future insurability can be established. As Jeffrey Tucker has said, repeal of the mandate is a very good first step.

The loss of the medical expense deduction is not a done deal. While the House plan eliminates the deduction, the Senate plan reduces the minimum medical expense requirement from 10% to just 7.5% of qualified income, so it is more generous than under current law. I’ve seen bloggers commit basic misstatements of facts on this and other provisions, such as confusing this limit with a total limit on the amount of the medical deduction. This deduction tends to benefit higher-income individuals who itemize deductions, which will represent a higher threshold under the increased standard deduction. Of course, this deduction appeals to our sense of fairness, but like all the complexities in the tax code, it comes with costs: not only does it add to compliance costs and create a need for higher tax rates, but it subsidizes demand for medical care, much like the tax breaks available on employer-provided health care, and it therefore inflates health care costs for everyone. To the extent that these deductions and many others are still in play, the GOP plans fall short of real tax reform.

The GOP tax bills certainly have their shortcomings. I hope some of them are rectified in conference. The bills do not offer extensive simplification of the tax code, and they would not be truly historic: in real terms, an earlier version of the House bill would have been the fourth biggest cut in U.S. history relative to GDP, and I believe the version that passed the House is smaller. However, many of the arguments mounted by the Left against the bills are without merit and are often deceitful. The Left strongly identifies with the zero-sum philosophy inherent in collectivism, and the misleading arguments I’ve cited are plausible to the less-informed among that crowd. That brings me back to David Harsanyi’s point, discussed at the top of this post: “intellectuals” on the progressive Left find value in corrupting the meaning of words and phrases like “budget cuts”, “giving” and “taking”:

“Everyone tends to dramatize the consequences of policy for effect, of course, but a Democratic Party drifting towards Bernie-ism is far more likely to perceive cuts in taxation as limiting state control and thus an attack on all decency and morality.“

“There is a parallel explanation for the hysterics. With failure comes frustration, and frustration ratchets up the panic-stricken rhetoric. It’s no longer enough to hang nefarious personal motivations on your political opponents — although it certainly can’t hurt! — you have to corrupt language and ideas to imbue your ham-fisted arguments with some kind of basic plausibility.“

Weighing Tax Reform vs. Spending and Deficits

05 Tuesday Dec 2017

Posted by in Taxes

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The tax reform legislation likely to come out of the House and Senate reconciliation process will be far from ideal, but it will be much better than current tax law in several respects (see my last several posts listed in the left-hand margin). One complaint raised by Democrats and others, however, is that the GOP tax compromise will lead to higher budget deficits. Of course they are right, but Democrats fail as legitimate critics given their hypocrisy on the issue of deficit spending. And chronic deficits are ultimately a symptom of government excess. Deficits exist when the polity is unwilling to support the explicit taxes necessary to pay for the spending that politicians are willing and able to authorize.

Nevertheless, there is near-universal consensus that the tax plans passed by the House and Senate would add to the deficit if either were to become law, the biggest exception to that consensus being Republican leadership. The Joint Committee on Taxation (JCT) has estimated that the Senate plan would add $1.4 trillion to the deficit without the benefit of economic feedback. That shrinks to about $1 trillion with the dynamic feedback effect of resultant economic growth. Others believe the gap would be smaller, however. The Tax Foundation, for example, estimates the net cost in tax revenue at $500 billion. Veronique de Rugy quotes a dynamic score by Quantria/Inforum that would put the revenue loss at about $300 billion, based on the starting JCT static estimate. The Tax Foundation, as noted by de Rugy, believes the JCT errs in treating the U.S. economy as a closed economy in which business funding is limited to a fixed pool of domestic saving, and in assuming that the Federal Reserve would attempt to offset the economic growth spurred by the tax cuts. These JCT assumptions mute the economic and revenue responses to tax changes.

But whether you believe the JCT’s estimates or the others, the impact is relatively minor compared to the existing fiscal shortfalls brought on by government excess. Brian Riedl puts the proposed tax cuts in perspective. The 10-year deficit was already projected at $10 trillion, with little apparent concern from Democrats. Riedl notes that the opposition has repeatedly shown itself unwilling to address fiscal problems such as Obama’s deficit legislation, Bernie Sander’s $30 trillion health care plan, and a shortfall in Social Security and Medicare funding of $82 trillion over the next three decades:

“Critics who are unwilling to confront these mammoth spending deficits are in no position to lecture others on the deficit implications of a (comparatively modest) $2 trillion tax cut.“

Jeffrey Tucker, whose posts I usually enjoy, seems to assert that deficits are not worthy of great concern. He offers a negative and somewhat muddled assessment of Ricardian equivalence, the idea that deficit spending is neutral because the expectation of future taxes discourages private spending. Tucker’s position is rooted in impatience with the rhetoric of revenue neutrality, but I think his real point might not be too far from Reidl’s. To his credit, Tucker condemns “fiscal profligacy”. He says:

“To be sure, this is not a defense of fiscal irresponsibility. Debts and deficits are terrible. Fiscal conservatism is a good thing. The budget should always be balanced. But there is one proviso: none of this should happen at the expense of the wealth creators in society: you, me, and the business sector. Government should bear responsibility for its own profligacy.“

I will interpret that last remark generously to mean that Tucker would cut spending to shrink deficits, but he also advocates for the sale of federal assets, which I generally support.

Concern by some Republicans over the deficit effects of tax reform prompted a debate during the Senate negotiations over a so-called “trigger” that would have increased taxes automatically if revenue fell short of certain benchmarks. At the last link, Ryan Bourne explains what a bad idea that would have been. A future revenue shortfall could be attributed to any number of future developments, not all of which would be compatible with a tax hike as a fix. The trigger would also create uncertainty, dampening the positive revenue effects that would otherwise be operative. It’s a relief that the trigger idea was abandoned by the GOP.

Despite the corrosive effects of big government and excessive spending, there is a relatively painless solution to closing the fiscal gap, with or without GOP tax reform. (I use the word “painless” guardedly, because big government inflicts distortions and costs well beyond mere spending levels.) Dan Mitchell has updated his calculations showing that the annual deficit would be eliminated by a decline in the budgeted annual growth of spending from 5.49% to 2.67% over ten years, starting in 2019. That hardly seems draconian, but watch: progressives and even relatively reflective Democrats would call such growth reductions “heartless cuts”. Such is the intellectual integrity of the left.