Asymmetrical Information

From the desk of Jane Galt:

What are those wacky supply siders up to now?

Here's something I've seen over and over: Democrats, and some moderates, denouncing the Bush Administration's belief that if you lower tax rates, you can actually raise tax revenue by stimulating supply-side economic growth. This is a ridiculous belief -- or rather, it is a true belief, but it is not true at the levels and structure of taxation that we have here in the United States -- and it should rightly be denounced. One little problem, however -- I haven't actually found any instances of the Administration making that argument.

I've found examples where they said the important thing was growth, not deficits.

I've found examples where they said that the current deficits weren't all that large, and that the projected deficits are a little hard to plan for given that two years ago we were planning for surpluses at least as large as the projected deficit.

I've found examples where they said that we would lose less in revenue than the Democrats were projecting, because the reduction in taxes would lead to some new economic activity. I've even found some rather aggressive estimates on how little we would lose.

But nowhere have I found the Republicans saying "Don't worry about those tax cuts -- we'll raise more revenue than we lost through new economic activity." In fact, I haven't heard anyone argue that outside of a few wingnut wonks since the Reagan administration.

Since the people writing the articles and blog posts don't offer any examples of Administration people saying this, I presume they couldn't find any either.

It kind of kills any incentive I have to listen to anything else they have to say. Especially since not a single one of them shows any interest in speaking about the wacky Democratic "temporary tax cut" stimulus proposal, or the deficit-exploding Medicare proposals on the table. Leading me to believe that they don't really care about the deficit. It's just a useful club. What they really care about is that the Federal government is reducing what they consider to be its rightful take.

Update: Brad DeLong offers examples in the comments.

From the desk of Jane Galt:

Tax Evasion

This article on tax avoidance by Ariana Huffington is incredibly silly, even by the standards of a woman who starts an organization aimed at persuading people to stop driving SUV's even as she is driven around in an . . . er . . . enhanced light truck. She tries to make accountants who force clients to sign NDA's on confidential work product sound shifty, rather than following standard practice in intellectual-property based work with low levels of appropriability -- or in other words, trying to keep people who aren't clients from using tax dodges invented by the accountants without paying for the work involved in thinking them up. She maligns law firms for issuing opinion letters -- " law firms are reaping millions in easy money handing out so-called opinion letters, which theoretically provide assurance to clients that tax shelters are legitimate but, in reality, are little more than the legal equivalent of crossed fingers" -- which I think means she believes rich people should forgo consulting tax attorneys, follow their heart, and see if the IRS buys it. She tries to sound clever in a superior, rich-people-really-are-different-plus-I'm-a-real-live-columnist sort of way:

The tax ploys these shelter savants concocted were so convoluted that even the finance-savvy executives they were hawking them to often had a hard time understanding how they worked. But that was OK, because they certainly understood the end result: a seriously lowered tax bill.

This would be easier to pull off if she did not, in the next paragraph, demonstrate that she doesn't understand it either.

Take the smoke-and-mirrors trickery Ernst & Young used to obliterate the millions in taxes that Esrey and LeMay owed on the $288 million they'd made off Sprint stock options. First the accountants waved their hands over the execs' money and turned it from income into capital gains. Presto! Then they wiggled their slide rules and raised the cost of Sprint stock. Change-o! Next thing ya know -- Poof! -- Esrey and LeMay didn't owe the IRS a cent.

I mean, I understand why Ariana Huffington believes that all you need to do to make money is wiggle and poof!, but I don't know why she'd advertise it.

What she's really trying to get at, of course, is the old "Tax Shelters Are Evil" complaint. I will spare you the lecture on how tax shelters are a byproduct of mostly liberal attempts to use the tax code to do a little stealth social and economic engineering without taking the manly risk of telling the voters about it -- but they are, so there. Anyway. She has this silly piece on a 1991 ruling allowing accountants to keep some of the money they save that implies that it is the reason we have aggressive tax planning, as if $1000 hourly rates and a tax code more complicated than -- actually, metaphors fail me. The tax code is so complicated that I can't think of anything even remotely close, in complicatedness, to compare it to. As long as there are different rates on different kinds of income, people will spend time and money trying to take their income in the form that has the lower tax rates. I'm reminded of this magnificent passage from Milton Friedman's Free to Choose:

What would you think of somewone who said, "I would like to have a cat provided it barked?" Yet your statement that you favor an FDA provided it behaves as you believe desirable is precisely equivalent. The biological laws that specify the characteristics of cats are no more rigid than the political laws that specify the behavior of governmental agencies once they are established. THe way the FDA now behaves, and the adverse consequences, are not an accident, not a result of some easily corrected human mistake, but a consequence of its constitution in precisely the same way that a meow is related to teh constitution of a cat. As a natural scientist, you recognize that you cannot assign characteristics at will to chemical and biological entities, cannot demand that cats bark or water burn. Why do you suppose the situation is differnet in the social sciences?"

What is really ludicrous about all this, of course, is that I have no doubt at all that Ariana Huffington employs the same sort of people to do the same sort of thing for her money. Unless she is making sure that all her income comes as highly taxed wages and salaries, refusing to take more than the standard deduction, and otherwise making sure that she pays what I consider to be her "fair share", I'm not really interested in hearing her carp about how people even richer than she is are getting away with something. If she wants to convince me, she can start by releasing her tax returns to assure us that she's not wiggling and poofing our tax dollars away.

From the desk of Jane Galt:

Tax Cheats?

One of Asymmetrical Information's moles forwards this item from Businessweek:

A sure-to-be-contentious issue in the Jan. 28 confirmation hearings for Treasury Secretary nominee John Snow: His company, railroad giant CSX, didn't pay any federal income taxes for two of the years when he sat at the controls.

CSX took deductions on depreciation of capital investments relating to its acquisition of Conrail and didn't pay taxes in 1998 and 2001, says spokesman Adam Hollingsworth. Indeed, Uncle Sam refunded CSX more than $50 million in each of those years.

While this is not unusual for capital-intensive companies, some lawmakers feel it's unseemly for a Cabinet official. Watchdog group Citizens for Tax Justice director Robert McIntyre says it makes Snow a "corporate freeloader." CSX counters that it paid taxes 9 out of the 11 years that Snow was the chairman.

The issue may spark fireworks, but it's unlikely to derail the nomination. Insiders say that Snow has been charming members of the Senate Finance Committee behind the scenes. "While we're not taking anything for granted, we've not been made aware of any serious concerns with his confirmation," reports Treasury spokesman Rob Nichols.

As my correspondant says:

Note the Al Gore-like, "some lawmakers feel..." followed by a quote from...a liberal lobbying group! . . .
To paraphrase Roman Weil's quote on WorldCom, "This is stuff we do in the [seventh] week [of intro accounting]!" My wife (who did corporate taxes for six years at Deloitte and Touche) read the article and concluded that CTJ is advocating CSX ignore the tax code. To put it another way, if Bush nominated a homeless man for Treasury Secretary, CTJ would be all over him for not paying income taxes.

This is a very silly article, and especially in Businessweek, which is generally a very sharp publication.

I'm willing to bet that CSX didn't just take depreciation allowances in the years it didn't pay any taxes, but in the years it did. I'm willing to bet it took them every year. Depreciation, for those of you who have always wondered, is how companies with capital assets expense the wear and tear on those assets. The basic idea of financial statements is that they should fairly and accurately represent the value of the company, to the extent that such a thing can be fairly and accurately represented in this imperfect world. Now, every year, capital assets generally become less valuable. Buildings are one year closer to being condemned or torn down to make way for a Multiplex. Computers are one year closer to not being able to run the next version of whatever OS they're on. Machinery is one year closer to breaking down from accumulated wear and tear. The financial statements should show this loss of value. That's what depreciation is: the loss of asset value over the course of the year.

Now, since it's a little hard to get the accountants to go down and calculate exactly how rundown your buildings are, how obsolete your computers have become, or how much wear and tear your machinery has experienced, assets are depreciated on a depreciation schedule: each type of asset basically has a table telling you what percentage of its value it loses each year. Thus computers are depreciated on something like a 3-year schedule, while machinery and equipment can depreciate over 20 or 40 years.

Thus, we can be fairly sure that CSX, whose assets are composed of highly depreciable physical plant like rails and cars, took substantial depreciation every year.

But how did they get money back, I hear you cry!

How did you get money back from the government last year, even though you'd lost your job and weren't going to pay any tax this year? You crook, you.

The answer is, you'd overpaid your previous year's taxes.

In the case of CSX it's more complicated. They probably used an NOL carry -- a Net Operating Loss credit.

A company's taxes are based on a snapshot -- roughly, the net cash position of the company over 12 months. But such a snapshot can be wildly inaccurate. Say they get a big contract with a juicy cash payment in December. They have to pay taxes on that. Now say that contract runs for the next year and goes over budget and costs them a bundle. You've taxed them on a profit they didn't really make. That's not only unfair -- it could push them out of business. Not what the government wants, no matter what the fellows at the local Chamber of Commerce lunch say after they've gotten into the Molson.

So companies can apply this year's Net Operating Losses -- the losses that they took on their regular business operations (not their financing activities, such as loans or stock sales; or their capital investment, like buying the railcars they exploit to get those juicy depreciation allowances) against earnings in other years. These losses can, if memory serves, be carried forward as many as three years, or back as many as one. This helps to smooth the tax picture, so that companies are in the long run paying taxes on the money they actually earned, rather than the distorted picture one might get from the calendar year.

At this juncture, I've undoubtedly got more than a few readers wearing a sarcastic expression and saying "If it's such a good idea for companies, how come I can't do it?"

Well, because if you have a couple of bad years, the government will make sure you have a roof over your head and something to eat. It doesn't do the same for the companies it puts out of business -- or so we lightheartedly hope.

And saying that it's "unseemly for a cabinet official" not to have paid taxes in a year when his company didn't make any profits. . . well, I thought the folks who write for Businessweek were supposed to know something about, y'know, business.

You know, Businessweek, it occurs to me . . . I know something about business. And I'm available. For very reasonable rates.

From the desk of Mindles H. Dreck:

The Boss' Plan is My Plan

I agree with the commenters on my earlier post that the administration's proposed rules on marking up shareholder basis are going to be a complex nightmare. Every broker and money manager will have to spend millions on record-keeping systems to keep track of basis at the lot level (what? We don't have a field for this!). As far as time spent on tax returns, well, this is a tax-preparer full employment act.

Pamela Olson (Assistant Treasury Secretary for Tax Policy) is quoted describing the plan in the WSJ article I linked. Poor Pamela - she has been a champion of tax simplification...up until now. This is her on December 18, 2002 speaking at the Tax Executives Institute (as printed in the New York Sun but not available on the web):

This is surely not a tax system anyone would set out to create, but it is the system that has evolved over time. Let's face it. We have reached the point where our tax system is held together by chewing gum and chicken wire....

....The following are the goals we (the administration) will strive to achieve:

1. A system that is simple and easy to understand, with reasonable filing and record-keeping requirements, and non-intrusive tax administration.
   
2. A system that is efficient and minimizes interference in economic decisions.
   
3. A system that supports the international competitiveness of U.S. business and workers.
   
4. A system that is fiscally sound, raising the revenues necessary for government operations.
   
5. A system that is stable enough to avoid the constant tinkering of years past.
   
6. A system that is understood to be fair, treating similarly situated taxpayers alike and equitably distributing tax burdens.

Well, the administration's formulation of dividend tax relief doesn't really achieve many of these goals. But, Pamela, you had me at (1)...

UPDATE: One of the reason's I am harping on complexity actually does go to the potential stimulus of the administration's bill. It seems to me that one of the necessary condition's to the Permanent Income Hypothesis, the premise on which we claim marginal rate relief stimulates investment, is that consumers and investors actually should be able to project easily their permanent increase in income. Anything that makes tax relief less transparent or certain will dilute the effect.

Another interesting comment in the prior post pointed out the potential generational differences in experienced relief. People who receive dividends as a meaningful part of their income tend to be older. Is the administration softening them up for social security reform?

I think policy has taken a back seat to politics. While this may be necessary to passage of any tax relief, it's a shame. Incidentally, David Frum, editorializing in the New York Sun yesterday, agrees:

..delivering the benefit to individuals rather than corporations makes reform look less like the elimination of an injustifiable disparity between two methods of finance and more like a juicy freebie for one class of the population, people who happen to own stock.

Burton Malkiel also weighs in today endorsing the policy:

My guess is that eliminating the double taxation of dividends would lead to a powerful rally in stock prices and would do much to lift the penumbra of uncertainty that has bedeviled both consumers and corporate managers. The U.S. is one of the few countries in the world where dividends are taxed at both the corporate and the individual level. Treating debt and equity in an equivalent fashion will eliminate a major distortion in the tax code.
In the longer run, the effect on corporations and the economy will be unambiguously beneficial.

From the desk of Mindles H. Dreck:

More Details on Dividend Taxation

Oops. major clarification to the dividend tax relief:

But the plan also is structured to give shareholders a potential tax break on profits even when a company retains or reinvests them in the business, Treasury officials said.

Here's how that part of the plan works: For every $1 a company retains as earnings instead of paying it out as dividends, a shareholder would be allowed to exclude $1 per share from his taxable gain at the time the share is resold.

The purpose of the plan, Treasury officials said, is to prevent the pendulum from shifting too far in favor of dividends, and forcing companies to pay out dividends when they would prefer to reinvest the money.

"What we're trying to do is get rid of the bias against dividends," said Assistant Treasury Secretary Pam Olson. But at the same time, administration officials "don't want to create a bias" that pressures companies to pay dividends when they shouldn't.

Treasury officials said the change for retained earnings actually reduces the cost of the dividend plan as a whole, estimated at $364 billion over 10 years, by about $40 billion. It does so by eliminating some incentives companies would have had to game the new system, Ms. Olson said.

It'll be a while before the market sorts this out. This would seem to result in a heavier taxation of stocks that have multiple-expansion potential compared to others.

From the desk of Mindles H. Dreck:

Dividend Taxation

Just some preliminary thoughts on dividend tax relief.

I'm sure there are political reasons behind the administration's chosen construction of relief from double taxation of dividends, but I agree with Martin Mayer that the tax relief should come at the corporate level, not the individual. Why?

Most Americans who invest in the stock market don't currently pay taxes on dividend income. Their savings are in retirement plans like 401(k)'s, and dividends paid to these funds are not taxed. A law that made dividends tax-free would do nothing to put money in the pockets of people with all their stock in retirement plans.

Hard data on actual direct stockholding comes from the Federal Reserve Consumer Finance Survey. The 1998 survey suggested 48% of the population owned stocks, but only 15% owned stocks (and 12.3% mutual funds) directly in taxable accounts. Furthermore, the vast majority of the value of held stock remained in the top income cohorts. For readers interested, the 2001 data are due out in February 2003. In the meantime, The Investment Company Institute has their own 2002 study.

If the point is to boost the stock market, excluding the dominant tax-exempt institutions from dividend tax relief doesn't make a lot of sense, and corporations won't be able to report higher earnings from a dividend exclusion. However, boosting the stock market is not necessarily an effective stimulus. The Federal Reserve, at least, has found the wealth effect smaller than originally feared. (Of course, it could be asymmetrical...)

Apparently, a large part of the intended stimulus is an effective marginal rate cut for the top tax bracket (more accurately those owning stocks directly, but the two groups are essentially the same). Critics are correct in pointing this out.

I believe marginal rate cuts help the economy in the long run, but do not constitute a particularly effective short-term stimulus for consumption or investment. I'm also disappointed, but certainly not surprised, that double taxation will continue mostly without relief.

While good for the wealthy, the administration's plan does not appear to have been designed for corporations. Companies get neither a dividend deduction, nor hopes of a market boost to get rid of that pesky pension under-funding.

From the desk of Jane Galt:

We have met the enemy and he is us

Robert Shapiro explains why we'll never get the Jane Galt Tax Plan. Sigh.

From the desk of Jane Galt:

The Jane Galt Tax Plan

Fritz Schrank asks how we should simplify taxes. Well, here's the Jane Galt version, guaranteed to please no one but its author:

1) Get rid of all our poverty programs, except those aimed at the disabled, and temporary unemployment assistance, and institute the negative income tax. That is to say, the system should be continuously progressive, from a steep negative rate of up to 100% on very low earners, gradually declining until it zeroes out around $28,000 a year, and then rising gradually until it maxes out around 35% on the top brackets.

2) Eliminate FICA and pay for Social Security and Medicare out of general revenue. It's time to stop pretending it's a pension system, when there are no assets in the "trust fund"

3) Eliminate the corporate income tax

4) Eliminate the special treatment for capital gains. All income should be taxed at the same level, regardless of its source.

5) Eliminate all deductions. Period, end of statement. No mortgate, student, child, etc. All causes are equally worthy in the eyes of the person who possesses the deduction; it is a waste of our time as a nation to sit around arguing about who deserves what.

6) Just say no to the Value Added Tax. In theory, it's a good tax. In practice, because it is extremely hard to tell what proportion of the price of anything represents the tax, it removes the good and natural pressure upon tax rates.

7) Get rid of the estate tax, and tax the capital gains on whatever is sold.

So why these particular features?

Well, the negative income tax does two things: encourages work by removing the disincentives created by potential loss of benefits; and means that the entire country, poorest to richest, faces a marginal tax increase if they want more spending: the poor have to give back some of their rebate, while the rich have to pay higher rates. For many on the left, that may of course be a bug, not a feature, as it forces the electorate to think much harder about whether or not they want new spending.

The arguments between conservatives and liberals often go like this:

C: The rich pay all the taxes
L: That's not true -- what about FICA?

Both have points. But the central issue that the conservatives are trying to get at is that the majority of the electorate does not face a marginal tax increase when they agitate for new spending. FICA may indeed be regressive, but its rates are unaffected by the level of spending in government. So a majority is prone to agitate for higher taxes, because they will not be paying those taxes.

I don't think it's a healthy situation for the electorate when a large majority is voting for spending that costs them nothing. To the minds of someone who pays no income tax, there's no cost/benefit analysis to be made; they're getting stuff for free. Even something of trivial benefit to them is thus better than not raising taxes. So we end up spending money on a lot of crap, because most of the voters don't care -- it's not their money.

On the other hand, liberals have a point about fairness. It isn't fair to say that some guy who brings home $20K should pay the same quarter of his income as Warren Buffett. The decrease in Joe Schmoe's standard of living represented by that 25% is much greater than the decrease in Warren Buffett's SOL from taking a quarter of his loot.

A negative income tax increases fairness, removes perverse incentives from the current benefit system, and makes sure that everyone has to think about whether they really want that new spending they're voting for -- enough to give up some of their cash.

Killing FICA increases fairness while removing some of the obstacles to reform by eliminating the fiction of an insurance program.

Eliminating the corporate income tax while equalizing treatment between capital gains does a number of things. It mitigates the current bias towards (tax deductible) debt financing. It ends all the ridiculous distortionary crap that corporations do to get around taxes. It ends the bias towards retained earnings that helped produce such interesting results in the stock market. It takes away a large chunk of the ability of the rich to avoid taxes by deferring their income in capital gains. It ends the tax preference for stock options that helped make the start of the new millenium so lively. Under this plan, income is income is income, no matter where it comes from. Thus we can stop the multi-billion dollar industry in shifting income from tax-disadvantaged to tax-advantaged forms.

If you just end the corporate tax without changing capital gains, you keep much of the distortion and shelter for the rich. If you eliminate special capital gains treatment without eliminating the corporate tax, you bias the economy away from investment, because now income is taxed at a high level twice -- once when its made by the company, and a second time when its distributed to the company's owners. This way, we tax it once, when it hits a real person.

We eliminate deductions for two reasons. First of all, they're distortionary. If it makes economic sense for adults to go to school, they will go to school. Giving a tax credit for it just encourages marginal activity that wouldn't pay for itself without a subsidy. Try thinking of it not as a tax credit, but as you giving someone else money to follow their dream of learning Old Church Slavonic, and you see what I mean.

Second of all, deductions are the way that the rich make sure that they pay a lot less taxes than the upper middle class. There is a reason that Barbra Streisand thinks that income taxes should be raised; she isn't going to pay much more tax. Most of her money is in assets, earning more money. It's the guy who owns the gas station down the street who's going to get it in the teeth. If we want to tax the rich, let's tax them, not give umpteen zillion deductions so they have the same marginal rate as your average bike messenger.

That's fine, I hear you say, but why all the deductions? Why not just the bad ones?

Because, as we've found since Reagan's simplification, there's no such thing as just one deduction. If you want the mortgage tax credit, you're going to need to give someone else the land-use abatement, and then there's the guy with his Urban Empowerment Zone Qualified Small Business, and next thing you know, we haven't gotten anywhere. The only way to get a clean code is to get rid of all of them. This won't be fun for many people. Housing prices will drop, for starters. On the other hand, so will tax rates. And come on -- why should an apartment renter be paying more taxes so you can frolic in the greenery?

Why get rid of the estate tax? Because the revenues raised are trivial, and people spend an enormous amount of time and money structuring their estates to get around them. Again, a disproportionate share of the tax is paid not by the super rich, but by the poor schmucks with one or two big assets they can't structure to get around the tax. On the other hand, when it's sold the inheritors should pay all the capital gains -- if you get rid of the estate tax, you should get rid of the stepped-up basis as well.

So that's Jane's plan. As you can see, it would be efficient, fair, and has absolutely no chance of ever getting passed unless they make me Dictator for the Decade.

Sigh. I could solve so many problems, if only people would let me tell them what to do. But no, they insist on mucking it up by deciding for themselves.

From the desk of Jane Galt:

It's About Time

Here's something you won't hear from other New Yorkers: subway fares are going up, and that's a good thing.

In 1910, when most of the system had been completed, the subway fare was 5 cents -- 1/20th of an average day's wage.

Even the minimum wage workers in New York don't pull any $30 a day. And minimum wage workers are a trivial segment of New York's labor force.

In 1910, the system covered its operating expenses, and even made enough to cover capital costs, with a little profit thrown in.

Now it doesn't cover expenses, certainly doesn't cover capital costs, and profit? Who dat?

It's overused, because its price is artificially below market. It's overcrowded, and its services are underappreciated.

A bus fare ought to cost $4.00 just to cover its operating expenses. That doesn't include negative externalities like traffic, pollution, and noise, nor does it cover the cost of buying the bus, maintaining the Metropolitan Transit Authority, or other physical plant -- just gas, maintenance, and driver wages. Yet the fare has stayed $1.50 for ten years, while the trains and buses overcrowd, and the transportation system on the East Side, which is strained to the breaking point, cannot afford expansions which would ease traffic levels.

25 or 50 cents -- the proposed raises -- are a drop in the bucket.

But what about the poor, you say? If the poor really can't afford to ride the trains, we should raise their income until they can, not subsidize every pinot-noir-guzzling investment banker and corporate lawyer along with them. But let's be real. We're talking about a trivial expense alongside the average $8-10 cost of lunch in a New York City deli. People aren't complaining because they can't afford to ride the subway at $2.00; they're complaining because they don't want to pay. Liking to get things for less than the cost of providing them is hardly unique, but neither is fulfilling those wishes some sort of civic duty.

It's time for New Yorkers to pay their way.