A Pigouvian Challenge

Readers of this blog know that I am no fan of the Pigouvian tax scheme (nor, for that matter, Pigouvian welfare economics). Advocates of such taxation often ignore the problems of attempts to aggregate preferences and valuation given the inherent difficulty in doing so because of the fact that knowledge is dispersed and cannot be communicated to a single mind. Thus, I was delighted to see this challenge from Peter Klein:

Please name the activities you believe deserve Pigouvian subsidies. For each activity provide the efficient subsidy amount, explain how this was calculated, and say how the revenues should be raised.

Any takers?

What is Robert Frank Thinking?

Robert Frank blames anti-tax rhetoric for preventing the government from raising more revenue:

Because of our inability to talk sensibly about taxes, the United States has been sliding toward second-class status in the world economy. Our national debt, for example, has increased by more than $3 trillion since 2002. Once the world’s largest creditor nation, we are now its largest debtor. We are currently borrowing more than $800 billion a year from the Chinese, Japanese, South Koreans and others — loans that will have to be repaid in full with interest. These imbalances have sent the dollar plummeting.

The situation is set to become worse. On the current trajectory, the national debt will rise an additional $5 trillion over the next decade. The retirement of baby boomers will require additional revenue to cover growing deficits in the Social Security and Medicare programs.

So why not cut wasteful spending? Frank explains quite circuitously:

Anti-tax crusaders say that these problems can be solved by just cutting wasteful spending. To be sure, Congress could help keep spending in check by adopting a strict pay-as-you-go standard for all new legislation. But most existing government programs have powerful constituencies, and programs that lack such strong defenders are not always the most suitable candidates for cuts.

So, according to Frank, cutting spending isn’t as simple as raising tax rates and therefore is not optimal. Huh? Entrenched interests in Washington are a red herring. If the problem is with the entrenched interests, one should seek to reduce these interests rather than work around them. The easiest way to do this is to maintain low tax rates and thus “starve the beast.” This forces the government to make tough decisions with regards to spending.

Further, there is no reason to believe that increasing revenue through higher taxes will lead to a closing of the deficit or a reduction of the national debt. In fact, it is much more likely that the government would use any increase in revenue as new spending rather than for deficit reduction.

Nevertheless, Frank proceeds, arguing ad absurdum and proceeds down a slippery slope:

One strategy would be to inform voters that the “it’s your money” argument is incoherent. Taken to its logical conclusion, it implies that it is illegitimate for the government to collect taxes. But if that were true, there could be no government and no army, in which case, the United States would have long ago been conquered by another country. Then we’d be paying compulsory taxes to that country’s government.

Frank clearly does not understand the “it’s your money” argument. This is an argument against taxes at the margin, not in total. Everyone recognizes that we need a government to provide some services. Even some of the most ardent libertarians maintain that the government should have the power to enforce property rights, which quite obviously necessitates the levying of taxes. Even more importantly, however, is that a rejection of the “it’s your money” argument does not necessitate an increase in taxes. It is not enough to argue against a straw man to prove your point.

Quite ironically, it is Frank’s diatribe that is long on rhetoric and short on an actual understanding of arguments for lower taxes and less government.

We’re Sorry, We’ll Find a New Tax

The state of Michigan voted to repeal the service tax that was slated to go into effect today. However, in its place, they have created a 21.9 percent surcharge for businesses.

“This agreement protects health care, public safety and education while replacing revenue from the service tax,” said [Gov.] Jennifer Granholm

This type of rhetoric is what has bothered me most about this debate. Education (schools that, by the way, are failing even by the government’s arbitrary standards), public safety, and health care are not the only three expenditures of the state government. However, when it comes time to balance the budget, these seem to be the only issues discussed.

New Taxes in Michigan

Facing a $2 billion budget deficit, the state of Michigan decided to pay for it with a new 6% tax on services — not all services, only those with weak lobbying efforts. Karen DeCoster explains:

Already, there is tremendous confusion as to what services will or will not be taxed. It’s funny to note how lobbying efforts have influenced what services are excluded under this new law.

* Real estate will not be taxed thanks to the massive real estate lobby in Michigan.
* Travel tourism will be taxed, further eroding Michigan’s once-booming tourism industry.
* Dating and weight-reduction services will be taxed
* Skiing is taxed, golf is not. Michigan is one of the country’s greatest golf havens. Likely, considering the demographics and available resources, the legislators all golf at Michigan’s premier golf courses, but they go out-of-state to ski.

Other services that will be taxed are balloon-o-grams; fortune telling, palm reading, and astrology; house-sitting; personal fitness training; shoe shines; singing telegrams; baby shoe bronzing; and tattoos. The list goes on forever. “Consulting” services – which will be almost impossible to define – are expected to produce about 70% of the revenues booty.

Buffett Favors Tax Hikes

Warren Buffett is not happy with the amount of taxes he pays:

The United States’ second-richest man has delivered a blunt message to the Bush administration: he wants to pay more tax.

Warren Buffett, the famous investor known as the “Sage of Omaha”, has complained that he pays a lower rate of tax than any of his staff – including his receptionist. Mr Buffett, who is worth an estimated $52bn (£25bn), said: “The taxation system has tilted towards the rich and away from the middle class in the last 10 years. It’s dramatic; I don’t think it’s appreciated and I think it should be addressed.”

During an interview with NBC television, Mr Buffett brandished an informal survey of 15 of his 18 office staff at his Berkshire Hathaway empire. The billionaire said he was paying 17.7% payroll and income tax, compared with an average in the office of 32.9%.

Of course, this could be fixed by installing a flat tax and eliminating deductions.

Also, Mr. Buffett, the Treasury Department does accept donations.

The Rangel Tax Plan

From Dow Jones:

Corporations would see their top tax rate cut to 30.5% from 35% under a tax plan unveiled Wednesday by House Ways and Means Committee Chairman Charles Rangel, D-N.Y., to fellow committee members.

Rangel plans to publicly announce the plan Thursday morning.

To offset the cost of the lower tax rate, the plan would alter a number of business tax provisions, according to lawmakers, congressional staff and lobbyists familiar with the plan as outlined Wednesday night.

The plan will repeal a tax deduction for domestic manufacturers. It will prevent companies from using an accounting method known as last-in, first-out, or LIFO, that can cut their taxes during times of rising prices. Repealing LIFO could result in a substantial tax for companies currently using the method, but aides briefed on the plan say the change would be phased in over eight years, thereby blunting the initial impact.

The plan would also require companies to defer deductions for certain expenses of foreign subsidiaries of U.S. companies until the money is repatriated to the U.S.

[...]

Middle and upper-middle income families would benefit under the plan by a repeal of the alternative minimum tax starting Jan. 1, 2008.

Upper-income families, however, would pay for that repeal with a 4% surtax on incomes above $150,000 for a single earner or incomes above $200,000 for a married couple. That surtax would grow to 4.6% for incomes above $500,000.

The surtax will also make possible an expansion of the earned income tax credit, an increase in the standard deduction, and an increase in the value of the child tax credit for those earning too little to owe federal income taxes.

A third section of the plan would address a number of pressing tax issues, including a temporary patch of the alternative minimum tax prior to Jan. 1, 2008, and the extension of a number of expiring tax provisions.

[...]

Part of the cost of the third section of the bill would be offset by taxing carried interest paid to financial managers as regular income and not as capital gains. While some said the change wouldn’t apply to real estate investment trust managers, a source familiar with the plan said all industries are included.

The good:

• The lowering of the corporate income tax. This isn’t as low as I would prefer, but still a step in the right direction.
• The elimination of the AMT.
• The closing of corporate welfare loopholes. Angry lobbyists are a good thing.

The bad:

• This new surtax on high income earners is absurd. I am opposed to this tax on philosophical grounds, but more importantly, the bar is set too low for such a surtax regardless of one’s political philosophy. By including those with incomes above $200,000, you are placing an increased tax on many small business owners.
• Taxing carried interest as earned income. I would be okay with this provision if we eliminated the tax on dividends and capital gains for everyone else…

This bill is unlikely to become law by any stretch of the imagination, but nevertheless, this bill is important because it provides a glimpse of the debate regarding tax policy in the next few years including during the next presidential election.

The Wrong Solution

The Wall Street Journal editorial page sums up my feelings on the recent budget decisions in my home state of Michigan:

Actor Jeff Daniels makes a cool pitchman in those national TV spots inviting business to Michigan, but soon he may have to start pitching inside the state. At about 2 a.m. Monday, a handful of Republicans in the Legislature broke days of gridlock and handed Democratic Governor Jennifer Granholm the $1.48 billion tax increase she has been demanding.

The state’s personal income tax will rise to 4.35% from 3.9%, and the rest of the revenue grab will come from a new 6% sales tax on business services. Already 14th in tax burden among the 50 states, according to the Tax Foundation, Michigan is now headed up in the rankings. Congratulations.

The Michigan Chamber of Commerce estimates that two-thirds of the $750 million in new sales tax revenue will apply to business transactions that are tax exempt in most states to avoid a compounding effect that raises costs to final consumers. The tax is especially unfair to small employers that contract out for activities, such as office services, that large businesses provide in-house with no sales tax applied. By the way, last year Michigan introduced a new 4.95% business income tax, which will be applied on top of the sales tax.

Last year, amid the national expansion, Michigan was the only state outside the Gulf Coast to lose jobs and see a decline in economic output. Comerica Bank recently moved its headquarters to Texas, in part because of Michigan’s hostile business climate. Michigan’s 7.4% jobless rate is the highest of all states and far above the 4.6% national rate.

The state is suffering from the decline of Detroit’s car makers, but that’s all the more reason to promote policies that attract new businesses — or at least don’t drive current employers to Florida. Ms. Granholm argues that the combination of new taxes to balance the budget, and to finance such new public “investment” as job retraining and education, will reinvigorate Michigan.

[...]

Michigan last went on a taxing binge in 1983, and voters were outraged enough to mount a successful recall campaign against two state Senate ringleaders. This time, two of three Michigan voters have told pollsters they want budget cuts, not new taxes. It may be that the only way to get jobs back into Michigan is to make sure the taxing politicians in Lansing lose theirs.

This is just the tip of the iceberg. The state’s budget deficit will grow larger in the next several years and the politicians will quickly learn that forecasting tax revenue is difficult when the base is shrinking.

Politicians on both sides of the aisle have produced disappointing results. It is my sincere hope that all of the state’s leadership is voted out next election cycle.