Friday, April 15, 2011

Big Tax News (Relatively Speaking) From the Hearings

-- Posted by Neil H. Buchanan

The headline political event this past Wednesday was President Obama's speech at George Washington University, in which he outlined his new long-term budget proposal. I anticipate having much to say about the Obama plan in future posts (quick read: a pleasant surprise, in many ways). While the rest of the political world was waiting for the President to speak, however, the House Ways and Means Committee held a hearing on tax simplification for families and individuals. As I noted in yesterday's post, I testified at that hearing. Here, I want to discuss three rather big "wins" for the Democrats that came out of that hearing.

The hearing featured three witnesses invited by the Republican majority, and one witness (me) invited by the Democratic minority. Because the committee itself has more Republicans than Democrats, and because the Republicans focused their questions on their own witnesses (while the Democrats split their time more evenly among the witnesses), the Republicans should have held a distinct advantage in generating statements that support their policy preferences. Surprisingly, they not only failed to induce testimony that would support their policies, but they actually made matters worse for themselves.

It is not as if they did not try. The other witnesses included an economist who works at a very conservative DC think-tank, a representative of the American Institute of CPAs, and a Ceritified Financial Planner. The latter two testified that they have heard clients say that they will not work harder (or at all?) because of high taxes. One Republican Congressman asserted that this was the headline coming out of the hearing. It is difficult to agree with that assessment, given that any client is going to tell his tax planner that he hates paying taxes. (There are obviously other reasons to be skeptical of those claims.) In any event, the weakness of that claimed headline moment speaks to how little there was for Republicans to be happy about on Wednesday morning.

What were the moments that might have made waves on a day when the President was not delivering a major address?

"Rich" Means Making $250,000/year or Above

At one of the few points when a Republican member of the committee directed questions to me, he asked (in sarcastic terms) what it meant to be "rich." This tracks a common talking point among Republicans that liberals' desire to tax higher-income people is based on an arbitrary definition of "rich." I began my answer by saying that the concept was clearly a relative one, and I began to try to explain what might distinguish a rich person for tax purposes. (I was planning to talk about being past the point where saving is a real sacrifice, etc.)

The question, however, had been asked as the Member's allotted time was running out. The committee chair, Rep. Camp, called time and told me to "just give us a number," or words to that effect. I considered refusing, but then I decided that it was sensible to confront the question directly. I said (again, perhaps not verbatim, given that this is from memory), "I'm comfortable with the $250,000/year standard." The chair, looking unhappy with my answer, then decided to have all three of his witnesses answer the question. The financial planner agreed with the $250k figure. The CPA did as well. Finally, even the conservative economist (after stating that there are no absolutes) agreed that $250k was a reasonable definition.

I was astonished. I did not expect the hand-picked witnesses for the Republicans -- especially one who is a classic Washington insider -- to go so completely off script. The chairman's attempt to paint me into a corner had turned into a unanimous endorsement on the panel that President Obama's definition of "rich" is reasonable. Now it is in official testimony before Congress.

Tax Cuts Do Not Pay for Themselves

Several Democratic members of the committee wanted to explore the assumptions and claims in the budget plan issued by House Republicans last week. One of those assumptions is the old Laffer Curve. As Paul Krugman recently put it: "Republicans have once again gone all in for voodoo economics — the claim, refuted by experience, that tax cuts pay for themselves." Rep. Rangel asked the panel if any of us believed that tax cuts pay for themselves. The two non-economists raised their hands. Upon further questioning, both changed their answers. Rangel thus managed to get the entire panel to agree that cutting tax rates will result in lower revenues, not stable or higher revenues.

At least one Republican on the committee tried to undermine this consensus in follow-up questioning, with no success. The conservative economist offered the observation that the revenue loss from a tax rate cut would not be as large as one might expect, given the increase in economic activity that generally follows a tax cut. He stated clearly, however, that such an effect was not enough to offset the overall revenue loss. If asked, I would have readily agreed with that qualifying claim, i.e., that tax rate cuts can induce more economic activity and thus offset a fraction of the revenue loss. This need not be because "taxes distort economic activity" (the standard anti-tax economist's go-to sound bite), but for simple Keynesian reasons: taxes can reduce spending, which reduces GDP, which reduces tax revenues. There is nothing surprising in this, and it only makes it clearer why tax increases should be targeted on the rich, who are the least likely to reduce their spending in response to tax increases.

One humorous moment came when Rangel was trying to formulate a follow-up question. Rep. Levin, the ranking member, was sitting next to Rangel and whispered something while gesturing toward me. Rangel responded in a non-whisper: "I'm not asking him. He's with us." In one way, Rangel was wise to focus his questions on the others, because of the concessions that he ultimately extracted from them. On the other hand, it is a bit of a shame that he did not ask me, because I would have pointed out that Greg Mankiw, a former advisor to George W. Bush and a prominent Republican economist, had once (in his best-selling textbook) described people who believe that tax cuts pay for themselves as "charlatans and cranks." [Update: I now see that DailyKos had a piece quoting the "charlatans and cranks" line last Friday. And here I thought I was the only one who remembered that gem ...]

Notwithstanding that lost moment, the Republicans on the committee were unable to resurrect the Laffer Curve. Again, four out of four witnesses (three called by Republicans) had agreed that a key Republican talking point is wrong.

Consumption Taxes Are Not Simpler Than Income Taxes

The third major point arising from the hearing is, admittedly, less of a big deal than the other two. Because good things come in threes, however, and because so much of the Republican agenda involves moving away from taxing income toward taxing only consumption, a final moment is worthy of mention.

The conservative economist on the panel (who was, as I have noted, otherwise strikingly candid in many of his remarks) had not missed any opportunity to push the pro-consumption tax line. Because no one was posing questions to me on those topics, I did not have an opportunity to respond. It was difficult to hold my tongue. For example, at one point, a member of the committee opined that the tax code "punishes" all of the good things that we want to encourage, like saving and investment. This is an old, discredited line, but it is repeated constantly. I wanted to respond that, even if we accept the idea that taxes are punishment, a consumption tax punishes consumption, which the small businesses so idealized by the committee rely on to stay in business. There is an argument (with which I disagree) that consumption specifically needs to be discouraged, but that level of subtlety was not the order of the day. Everyone on one side of the committee believed that taxes are bad -- except for the taxes that the non-rich pay.

Even though I was not able to respond to the consumption tax argument, I was delighted by what happened next. The witness from the national CPA organization volunteered, essentially unprompted, that switching to a consumption tax from an income tax would do nothing to guarantee simplicity in the tax code. As she pointed out, all of the policy agendas that have led to the proliferation of complicated tax provisions in the income tax can (and surely will) be replicated in any consumption tax regime. Pointing out that the hearing was nominally about tax simplification, she suggested that the tax code was not likely to be any cleaner under a consumption tax regime. (She could have added that the complexity would be redistributed from individuals to those very same small businesses, who would have to comply with complicated exemptions, and who would be the target of all IRS scrutiny, since all of the tax collections would be at the level of retailers -- and there would be no individual taxpayers to audit.)

The CPA then suggested that the best approach might be to have both a consumption tax regime and an income tax regime. This was too much for one of the Republican members, who simply announced that such a mixed regime would be the worst of all possible worlds. (The Republicans are a bit at odds over consumption taxes, of course. Some like the idea of replacing the income tax with a national sales tax. On the other hand, the value-added tax (VAT), which is the most administrable form of a consumption tax, is derided as a "French tax system" that could collect too much money.)

In short, a hastily-convened hearing on a mom-and-apple-pie topic (simplifying taxes) effectively blew up in the collective face of the leaders of the Ways and Means Committee. They sat helplessly while their own witnesses agreed that people who earn more than $250,000/year are rich, that tax rate cuts actually do reduce tax revenue, and that consumption taxes can be as complicated as our current tax system. All in all, the Republican leadership must be happy that the spotlight this week was on Obama's speech.


egarber said...

Great write-up:

Consumption taxes are a potential mess. According to independent analysts, the "Fair Tax" for example, would require almost all transactions to be taxed if it's to truly be revenue neutral. That includes houses and cars. So in theory, a person of modest means outside the "prebate" window would have to pay an additional 30-50k on a 200k house.

Of course, such hypotheticals would produce a rush of exemptions, and sooner or later, the "simple" consumption tax would be riddled with the same complexity we see in the current code.

What's more, every exemption would require an increase in the basic consumption tax rate if the entire framework is to remain revenue neutral -- because the footprint would become narrower. Further, the inevitable leakage caused by non compliance will require a few more points.

That's just a portion of the problems.

Paul Scott said...

Nice write up and glad to see that the Republican experts were experts in the truest sense (had their own experience based opinions) and not merely title holders ready to speak the party line.

Among my many reactions is a question. Once you accept the complexity of our tax scheme would exist in a "consumption" based tax scheme as well, is it not possible that the result would be more progressive than our current income based model?

I presume, for example, that if we had such a model things such as grocery bought food would be exempt - as they are now in most (all?) States.

I also assume there will be some form of exemption for home purchases - since we apparently like to encourage that sort of thing - but doesn't it seem likely that when setting up a new system like this the exemption would be capped?

It also seems likely to me that some form of income-based annual rebate might exist?

Finally, from a simplicity stand point, wouldn't shifting models away from income force simplicity - even if only for a few decades - directly as a result of it being unlikely the entire incentives regime would be immediately copied? It has taken over a century to see our current income based regime take form. Wouldn't we expect in a reboot to consumption based taxation, that most of the old regime would be gone and only those "most well regarded" exemptions would remain?

Even if surrounded by statements and assumptions, these are really questions, not arguments. I don't have a good idea what the right answers to any of them would be.

Neil H. Buchanan said...

Thanks, for the second consecutive day, to egarber and Paul Scott. I have nothing to add to egarber's comments, which are spot on. I'll respond to Paul Scott's questions in a near-future post, because he raises important questions about the best strategy for maintaining (or, better still, increasing) progressivity.

Blud Bitter said...

I suppose, for example, that if we had a model for things like grocery stores bought food would be exempt - because they are now in many (all?) Member States.
I also assume there is some sort of exemption of sales - because it does not seem to want to encourage this sort of thing - but it seems likely that when you set up a new system that exception must be limited? It also seems likely to me that some sort of income-based annual reduction can not exist? Finally, the simplicity of the point position, leaving no revenue models valid for simplicity - even if only a few decades - it is unlikely a direct result of the whole system of incentives must be immediately copied? It took a century to see the current system based on income to take shape. We look forward to restart the consumption tax, that most of the old regime is gone and only the "most well-regarded as" exceptions to preserve?WOW Items Gold Buy WOW Items Cheap WOW Items Tera Gold Buy Tera Gold Cheap WOW GoldBuy WOW Gold WOW GoldTera Gold

Toray Parker said...

Thank you for the second consecutive day that egarber and Paul Scott. I have nothing to add to comments egarber are always perfect. I will answer the question of Paul Scott in a post in the near future, because it raises important questions about the best approach to maintain (or even better, increasing) of progressiveness.WOW Items WOW Gear eden gold buy eden gold cheap eden gold