Tax Shifts

One of the most marvelous things about George W. Bush is how he has managed to make Max Sawicky sound like the Concord Coalition:

MaxSpeak, You Listen!: G.O.P. TAX HIKE WATCH: There are no tax cuts. Banish that phrase from your mind. You haven't seen any. Republican control of the White House and Congress has yielded trillions in tax increases since January of 2001. How can this be? Simple. When you spend more, and when you pass laws that commit the government to spending more in the future, you increase taxes, sooner or later. Spending not financed by current taxes will be financed by future taxes. A debt increase is the present value of future increased taxes. If taxpayers merely pay interest on the debt incurred, forever, the present value of the interest payments is the initial increase in debt.

Suppose you raise future spending on X but later you cut spending on Y? You have still raised taxes. If you had cut spending on Y and foregone the spending on X, taxes would be lower. To spend is to tax. There are no tax cuts. There are only tax shifts.... Exhibit A in the Hall of Bush Tax Hikes is of course the Medicare drug benefit. The cost of this over the indefinite future is $23.5 trillion-with-a-T (of which $18.2T is not matched by any dedicated financing source -- p. 112).... Exhibit B is our largest new government program, known as "Iraq." This is not nearly as big, assuming we slink out of there with our tails between our legs before the next election, proclaiming mission accomplished all the while. Approximate dollar cost to the taxpayer would be about $250 billion. The more important human cost is of course beyond ordinary economic calculation.

Exhibit C is a capital gains tax increase, otherwise known to morons as "death tax repeal." The Estate and Gift Tax termination legislation provides for the taxation of capital gains on assets bequeathed to heirs, when said heirs sell those assets (and "realize" the gains as income). Under current law, any gains up until the point of transfer are not taxed as income. For most heirs, they are not taxed under the Estate Tax either. Hence the "death tax repeal" is really a tax shift to beneficiaries of smaller estates whose bequests currently fall under the minimum taxable threshold.

Exhibit D is the merry run-up in non-defense discretionary spending, in what I call The Era of Hard Work for Limited Government. In keeping with our 'compared to what' stricture above, any assumption about a baseline rate of growth ought to be made explicit. I should stipulate that in general I welcome this sort of spending/tax increase myself. So how big is it? If we grant that this sort of spending "ordinarily" tracks GDP, then growth in excess of GDP growth should be defined as an increase....

Who will pay for these tax increases? Increasingly, as the "Bush tax cuts" (sic) focus the Federal tax system on wages, it will be current and future workers. You may recall that these are the folks upon whom we were told it would be immoral to bequath an insolvent (sic) Social Security system.

So pay no attention to rumors of tax cuts. To be sure there are rewards for assorted vested interests, as so-called tax cuts grease the skids for heavier taxation of wages in the future. Your invoice will be in your pay envelope.

Unfortunately, the Concord Coalition no longer sounds like the Concord Coalition. Its Republican members are pretty quiet.

It's no longer clear to me that there ever were many grownup Republicans. They're certainly thin on the ground today. In an average day I see more wild turkeys than I do grownup Republicans

Comments

[John Emerson]

Like I've been saying, they're like tooth fairies and unicorns.

[Kathleen]

"be careful what you wish for" proved true daily - whatever grown-up GOP there was, lthey aid down with the wing-nuts, and can't get back up.

*I think I smushed a few too many cliches into that post.

[nate]

with roth 401(k) and IRAs lots of people who currently have extra disposable income may sock money away and avoid future taxes anyways.

[ob]

Question. From the quoted article: "Spending not financed by current taxes will be financed by future taxes."

The debt is repaid, or defaulted on, but can't it also be inflated away to some degree- what with fiat money and all?

I understand that 'inflation is bad', but if we have to have a hard landing (think close to default), wouldn't that be a good time to pursue a policy of inflation? (I really don't know- this is a question, not advice)

[W. Raymond Mills]

Shifting taxes away from current high earners is the main objective of Bush supporters. They label it a tax cut so as to create support.

"Tax shift, not a tax cut" should become the new battle cry of the anti-Bush crowd.

The label that is affixed to a thing has become more important than the contents.

[anne]

OB

There can be no default of Treasury debt, for the obligation is Constitutionally instructed and Congress can always raise funds through taxing or debt issuance. Default is not an issue.

Inflating away debt which is increasingly held internationally is in a sense defaulting, and there would be a terrible price for us in rising long term interest rates and investment difficulties. I cannot imagine using inflation to wish away the value of Treasury bonds.

[KNZN]

Just bear in mind, if the US weren’t running a large deficit, the European and Japanese economies would be in even worse shape than they are. (I’ll bet you 10,000 Lira.)

[RT]

Inflation is also essentially a tax: if the government takes 20% of my wealth through taxes, or if its monetary policies bring about inflation that reduces the value of my wealth by 20%, is there a material difference?

Grownup Republicans exist, but in statistically insignificant numbers. And none have been sighted in the present Congress.

[Captain Button]

'The Estate and Gift Tax termination legislation provides for the taxation of capital gains on assets bequeathed to heirs, when said heirs sell those assets (and "realize" the gains as income).'

And if there aren't proper records of the cost basis of the asset, the heirs will be taxed on *entire* value of the asset when they sell it. This is entirely possible if either party was careless with their paperwork, or if it was lost or destroyed when cleaning out the deceased's papers.

Under the old system, cost basis for the heir is the asset value when the deceased died, which simplifies the record keeping.

[save_the_rustbelt]

There are plenty of grown-up Republicans, we just aren't allowed at the table right now.

The revolt is slowly fermenting, starting in Ohio I believe (we're still in a recession here, it seems) where Governor Bob Daft (sic) has proven to be both incompetent and dishonest, instead of merely incompetent.

Ken "Praise the Lord" Blackwell is having his TABOR derailed, and the General Assembly shows some signs of sanity. Time will tell.

You might be surprised at the amount of anti-war sentiment among the GOP middle class, and we all may be surprised how fast it breaks into the open.

All my saintly conservative GOP wife can talk about lately is gas prices and the "idiot war."

[Charles]

As usual, anne has it right.

Inflation is a very dangerous means to get out of debt. It hurts people on fixed incomes. It hurts investors except those in commodities, land, and gold. It damages long-term, capital-intensive projects. In other words, the impacts are widespread, deleterious, and lasting.

That said, Bushco may have left the US no alternative. We don't have a means to balance our current account except by selling assets, and that can become a vicious circle.

I do think anne is...not exactly "wrong", but perhaps incautious on one point. While servicing the federal debt is Constitutionally-mandated, so is the right to counsel and a speedy trial. As Jose Padilla can tell you, what's on paper is trumped by political reality.

[Yamil]

Ok, I understand you disagree w/GW's tax cuts, but they are bona fide cuts. My tax rate, and anyone who paid taxes was lower last year than the year before.

And, although you state spending not financed by current taxes will be financed by future taxes, hose taxes do not necessarily have to come via an increase in the tax rates. Growth in GDP will increase tax revenuews to the Treasure without increasing marginal tax rates.

We have "grown" our way out of problems before, and may do it again in the future. I just quibble with the absolutist tone of the post. It is misleading, and does not reflect other plausible avenues. There are more ways to skin this cat.

[anne]

Charles

"Inflation is a very dangerous means to get out of debt. It hurts people on fixed incomes. It hurts investors except those in commodities, land, and gold. It damages long-term, capital-intensive projects. In other words, the impacts are widespread, deleterious, and lasting."

Thank you for being more exacting. Significant inflation will almost certainly result in wages lagging price increases, and to a rise in income and wealth inequality.

[anne]

The structural and rate changes in our federal tax system have left us with a structural government budget deficit. We cannot grow fast enough for increased tax revenue to limit the growth of the deficit to the growth of the economy. The deficit will grow. Also, spending cuts large enough to stem deficit growth that is faster than the economy can grow are not possible.

[Tom Cecere]

It's not a matter of "for" big centralized government or "against" big centralized government -- it's merely a matter of who the power is going to be used to benefit. Even the alledgedly grown-up Republicans will vote to use the power for the already rich and their (probably idiot) children.

[Lewis Carroll]

"with roth 401(k) and IRAs lots of people who currently have extra disposable income may sock money away and avoid future taxes anyways."

If by "avoid future taxes" you mean "pay through the nose", then yes.

When the tidal wave of debt becomes too big to ignore, and marginal rates have necessarily been raised, those who have systematically built 'tax-deferred' accounts will be taking distributions from said accounts with no basis thereon, no more mortgage interest deduction (typically paid off), no more dependent child exemptions etc., all (Roth IRAs excepted) subject to ordinary income tax.

Should be good for a few laughs. Don't you think?

[Yamil Hernandez]

However, Lewis, in case you didnt know, in addition to ROTH IRAa you can use 401kRoth accounts, Whole Life Insurance, and other financial instruments if you think that taxes will be higher in the future than they are today.

That is, you as an individual investor, can sensibly hedge against that risk.

[ob]

Thanks for the commentary on inflation. I am by no means a fan of high inflation. The deficit problem seems like it will come to a head when the auctions run so slow as to raise the effective interest rates. I guess I just don't understand global demand for US treasuries to have an expectation of whether demand growth (for USGov debt) will continue to outpace supply.

I really wish that fiscal discipline was a primary goal of both the Right and Left.

[nate]

How will the implementation of roth 401 (K) affect fed tax revenue and overall aggregate demand in the U.S.? (during the year of implementation and down-the-road)

The effects on distribution of income would be interesting as well.

[Lewis Carroll]

"However, Lewis, in case you didnt know, in addition to ROTH IRAa you can use 401kRoth accounts, Whole Life Insurance, and other financial instruments if you think that taxes will be higher in the future than they are today."

1. What is a 401k Roth?

2. Whole Life insurance is problematic if you want to take significant withdrawals from it. If, as you imply, you want to take tax-free withdrawals, that would involve loans beyond your basis (which is accessed first from dividends). There are two major problems with this. First, you put your life insurance in jeapordy. Second, if the policy lapses with a large loan, then in addition to losing your coverage you get a fat 1099, which brings back the original problem, only worse - a huge gain on the lapsed policy with an immense ordinary income tax bill.

I don't know what the other instruments are that you're talking about, but I'm in the business, and I'm not aware of any others that can insulate you from future taxes so well. Unless you're truly in the investor class, in which case you won't have to worry if present tax law persists, since it favors capital in the forms usually held by the wealthy (e.g. non-qualified CGs and dividends).

[Yamil Hernandez]

A 401K Roth, is a defined contribution plan were your defferals go in post tax, and grow tax free (just like a ROTH IRA). You can have both a regular 401k and 401kRoth. The 1st year you can start is in 2006 (this new instrument was part of the tax bill).

As for life insurance, if you buy when you are young (albeit you have to afford it), by the time you retire (40 or 50 years later), there will be a significant balance in your account that you can take loans against and not incur taxes. You can draw down on it until you die, and the policy pays off your loans.

As for other instruments, you can also buy into a DRIP plan and pay the taxes as you go, so when you start taking distributions you have a substancial basis to take against (although you will eventually have to pay capital gains on the original gains).

The point of the post, is that as an individual, there are instruments and methods available for people to protect/and hedge against future uncertanties. Its all a matter of self education, and learning.

I am not in the business, and know about these products/and service, however, to your point, perhaps many people have not taken the time to learn. (Its not surprising we as a country have a 0% savings rate).

Final note. There are two ways to be rich. You can earn more, or desire less. I think some of us never think about #2.

[Lewis Carroll]

YH,

This will be my last post on this, as I already feel guilty taking up so much of Brad's thread with only a tangentially related discussion.

Yes, all of those things are available. But dealing with them everyday has given me a perspective that requires knowing not just what is good, but what is possible.

The fact of the matter is that your typical American "investor" or "saver" has nowhere near enough capital available to adequately diversify by taking enough DRIP positions to invest responsibly. And anyone who has ever really dealt with life insurance knows that you can't easily make a policy be the cash cow it's made out to be; and a lot of people don't realize they're playing with fire there.

Second, what about all of the people whose only savings over the past ten or twenty years were the traditional IRAs and 401ks that they've been squirreling money away in when they were told years ago that that was the thing to do?

I can appreciate that people need to sacrifice and learn to do without sometimes, but I'm not sure you're quite aware of the lack of flexibility that many people have, which is really the larger question here. If you live anywhere near any large city and wish to own a home, then things like mortgages, property taxes, insurance, car payments etc. are going to take up an immense share of the typical family's income (an increasing share in this day of declining real wages).

My wealthy clients are in the position where they can choose from among a number of strategies that will minimize their taxes both now and in the future (these include things like charitable planning, trusts, deferred compensation etc.). Not so for the client whose last raise was entirely consumed by the increase in their share of the health insurance plan.

Yes, they can be careful about what they spend their money on. But you can't get blood from a stone.

[Charles]

Yamil, the nation has done a controlled experiment on "growing our way out" of tax cuts. It was called supply side economics.

In a 12 year experiment, it quadrupled the national debt. Growth statistics were mediocre under Reagan and abysmal under Bush. If memory serves, about a quarter or a third of the growth was financed purely by borrowing against the future.

The economy only started growing after Clinton raised taxes on the wealthy. And the deficits declined and turned into surpluses.

Now, Bush has cut taxes, growth is mediocre, and deficits are spiraling out of control, meaning future growth is hobbled. BTW, do not believe the official figures being put out about today's deficits: they are lies.

Let me spell it out. There. Is. No. Free. Lunch.

To vastly oversimplify, you can choose between high taxes or high interest rates. I would rather pay the government to pay down Republican-caused deficits, build roads, and otherwise behave responsibly than to pay banks, especially Chinese ones.

By the way, there has been at least one genuine academic study of what the Laffer curve really looks like. At a 70% upper marginal rate, tax collection efficiency falls. Below that level, raising taxes raises revenue.

[Charles]

anne, again you add an important point. There are always people who can raise their salaries at will during inflationary periods: corporate executives, for example. Others, like doctors, have enough market power to have a fairly free hand. Most people's earnings slip back.

Debtors do gain at the expense of creditors, though, which is one reason that inflation this time around might be more popular than it was in the 1970s. Debt is through the roof.

[anne]

Nicely done, Charles. I am wondering however how much middle class debt is long term fixed rate debt, how much variable or adjustable rate debt. In western Europe by the way there is almost no long term fixed rate mortgage debt, so inflation in Europe would bring no middle class debt relief. I expect by now there would be less relief here than we might guess even with fixed rate mortgages. Nicely done :)

[anne]

This evening, I happened to hear a radio ad, in a book store of all places, for 500,000 dollars in mortgage or home financing for 14 dollars a month. No more was mentioned, just 14 dollars a month for 500,000 dollars in loans. Since there was during the Red Sox game, I am sure it must be so :) Huh.

[anne]

This really was on Red Sox radio. Sign me up :)

[piotr]

Hyperinflation is an excellant way of getting rid of the bulk of the debt, especially if we do not mind living from garbage dumps for a year or two.

On the bright side, I bet that our garbage dumps are much better than those in Argentina.

That said, I do not really understand how can we create hyperinflation, if the government cannot "create" money, i.e. all spending must come from taxes and actual borrowing. Just in case, I have a couple of Euros (ca. 10% of my savings) and you will have to pry them from my cold, cold hands.

[nate]

"The fact of the matter is that your typical American "investor" or "saver" has nowhere near enough capital available to adequately diversify by taking enough DRIP positions to invest responsibly."

I would argue the opposite: the typical American household can not afford to ignore DRIPs (Dividend Reinvestment Plan). True, the diversificaiton argument you offer is good (there is some math to show that one should own at least 20 stocks or so to adquately get rid of risk). However, there is a learning option associated with owning a DRIP. This learning option outweights the disadvantages of owning only a couple companies or only 1. You can find DRIPs in good companies that let you own stock for only $250 initial investment (possible P&G or ExxonMobil). For this $250, you get a lot more than some shares in a company. You get annual reports and shareholder communications in the mail. You have a reason to follow the company, its decisions, and annual shareholder meetings and elections. You can calculate the math behind dividends, taxes on dividends, share buybacks, and share splits. You can follow the effect of dividend payment on the stock price. You can take this learning option from a DRIP and apply it in many ways. In an age of defined contribution plans, this learning may be valuable. Call me a stock market geek...

anne-

maybe during the Red Sox games you got college and university loans confused with home loans.

[nate]

you may lose money investing even in companies that may be "good". you may be left with $0 yet a valuable learning experience.

[nate]

"adquately get rid of risk" should read something more like "adequately manage risk" --> you never get rid of all risk even through tons of diversification.

[Saam Barrager]

"I really wish that fiscal discipline was a primary goal of both the Right and Left."

ob-

Fiscal discipline was a goal of both the right and the left. Bush Sr. got the ball rolling on deficit reduction, Clinton carried it through to 2000.

In budgetary matters, the President has the principle authority. He may decide to run massive deficits, or fight to balance the budget. Congress generally rubber stamps the presidential budget, give or take 1%. (Please somebody tell me if this is not true...)

I now regret that Clinton didn't just spend the money. The game only works if you can bequeeth it to somebody who will likewise take care of it. When Republicans tie the hands of the incoming president through profligacy, it creates new and dangerous incentives. Would Clinton have labored to pay down the debt - sacrificing social programs along the way - if he knew that the next guy would take his downpayments and blow them? (I honestly doubt it.)

Our last profligate Democrat was arguably Johnson; by the time I'm 34, Republicans will have given us 16 years of sheer, irresponsible profligacy. Setting us back on track will take monumental housecleaning on the part of Republicans; otherwise I will always prefer that Democrats just go ahead with social programs, deficit be damned.

(Incidentally, until this year you would have a hard time finding a more hawkish deficit hawk than me. Willing to pay higher taxes, willing to take cuts in services, willing to delay my favorite social programs, etc. Having had fiscal solvency within our grasp, and watching it obliterated, now I'm really pissed.)

[anne]

No; friends tell me there are repeated radio ads for 1% mortgage and home equity financing for amounts up to 500,000 dollars. Of course, these are just an enticement to fiercely adjustable loans but from Boston's classical music station on there are ads explaining how wealthy everyone can be through real estate borrowing and investing.

[Jay]

Dr. Laffer, can you here me?
Dr. Laffer, can you feel me?

[Charles]

Piotr, it's true that "printing money" is usually seen as the cause of hyperinflation. There are other causes for the general phenomenon, because the real issue is the relative value of things. For example, after a disaster or war, the price of necessaries may explode, either in nominal terms or in relationship to other assets. When you go to hock your grandmother's wedding ring, you may either get 10 cents on the dollar while penicillin stays the same price, or you may get full price on the ring while penicillin costs ten times as much. These scenarios play out differently because wages and assets tend to be more sticky downward than upward, but the general effects are similar.

Now, "printing money" came into being because the gold standard was an absolute disaster. If there is a big strike, then suddenly money-- and inflation-- is created, while if no gold is discovered, there is deflation. Meanwhile, when other kinds of wealth are discovered or created, the society is no richer except to the extent they can persuade other nations to surrender their gold to obtain it. Think Smoot-Hawley and tariff wars.

As long as money is not printed faster than wealth-- whether gold, oil, improved crop yields, or drugs to treat schizophrenia-- is created, there will be no inflation. And better to err on the side of a little bit of inflation. A man who gets a 3% raise every year feels as if he is getting ahead even if inflation is eating it all. A man who works year after year with no raise feels as if he is standing still. (I assume the same result is obtained if the worker is a woman.)