Cafe Hayek

Caplan on the Gas-Tax Holiday

Think the proposed gas-tax holiday is a wacky idea?  My GMU colleague -- and EconLog's -- Bryan Caplan gives you good reason to think again.

More Mitchell on Tax Policy

Here's the third and final installment of the Cato Institute's Dan Mitchell's superb YouTube videos on the Laffer Curve.  (The first two installments can be found here and here.)

These are all superb.  I recommend them highly.

Laffer Curve: The Evidence

The second installment of the Cato Institute's three-part video series on the Laffer Curve (featuring Dan "Bulldawg" Mitchell) has just been released.  It is superb!  (You can find the first installment here.)

Learn the Laffer Curve

Dan Mitchell - former GMU student, current Cato Institute Senior Fellow, and one of the world's most die-hard Georgia Bulldogs fans - does an absolutely splendid job of explaining the logic of the Laffer Curve in this short video.  Enjoy and learn!

I Goofed, You Pay

This letter of mine was published in yesterday's edition of USA Today:

Raising taxes on private firms is a mistake

Donald J. Boudreaux, chairman, Department of Economics, George Mason University - Fairfax, Va.

Rep. Eric Cantor, R-Va., is correct that raising taxes on private equity firms is neither necessary nor appropriate for fixing the alternative minimum tax (AMT) ("Don't hike partnership taxes," Opposing view, Taxes debate, Dec. 6).

The reason, however, is more fundamental than the fact that such firms benefit ordinary Americans.

Not indexed for inflation, the AMT was never meant to tax the millions of Americans whom it will now tax if Congress doesn't fix it. In other words, taxing people in this way is a mistake.

What ethical argument justifies Congress shifting the costs of its mistake onto others?

If Jones mistakenly budgeted to spend dollars that he wrongly thought would come to him from Smith, is Jones entitled then to take this amount of dollars from Williams in order to "pay for" correcting his error?

David Henderson on Robert Frank

David Henderson, editor of the indispensable Concise Encyclopedia of Economics, takes on Robert Frank's idea that the modern American economy is infected with toxic levels of "keeping-up-with-the-Joneses."  Here an excerpt from David's Cato Policy Report essay:

A pillar of Frank's argument is that a large percentage of people care about their relative position. In Choosing the Right Pond, he defends that assumption by pointing to anomalies in the pay structure of various firms, anomalies that he attributes to people caring about relative position. Most of his anomalies have to do with pay structures that, Frank argues, are "flatter" than standard economics would predict. Standard economics states that workers are paid an amount roughly equal to the value of their marginal product--that is, the increment in value that is due to their being in the firm. But, notes Frank, if this were true, one would expect to see great disparities between the salaries of workers who have great differences in productivity. He points to, among other things, the University of Michigan pay scale for economists in 1983-84, where the highest salary was only a little more than double the lowest. He never mentions the fact that the University of Michigan is a government bureaucracy, making it not the best test of the standard economics account of freemarket wages. Nor does he mention that one of the main ways the stars of academic institutions are "paid" is with lower teaching loads and more research funds.

Even more interesting is how the world seems to have changed since Frank began writing about these issues and the contortions he goes through to sustain his argument for higher taxes. When he first began, he argued that relatively flat pay structures are indirect evidence for his view that people care a lot about relative position. But in his May 2007 testimony, Frank noted that the "anti-raiding norms of business have recently begun to unravel" so that, now, pay for top managers can be a huge multiple of pay for bottom managers. In other words, it would seem, many top managers are being paid an amount that approximates their marginal product. You might think that this would cause Frank to reexamine his earlier strongly held views. But he doesn't.

Instead, he comes up with a new argument for progressive consumption taxes. He now argues that too many people are vying for the top jobs because of the higher pay those jobs carry. They are fighting, he argues, over a fixed pie and, in a variant of the famous "tragedy of the commons," he compares the competition for the top jobs to gold prospecting. He testified that "the gold found by a newcomer to a crowded gold field is largely gold that would otherwise have been found by others." Similarly, he argues, "an increase in the number of aspiring hedge fund managers produces much less than a proportional increase in the amount of commissions on managed investments."

But he can't hold on to this argument for even a page. Just four paragraphs later, he testified: "A slightly more talented CEO or hedge fund manager can boost a large organization's annual bottom line by hundreds of millions of dollars or more." Exactly. It does make sense, therefore, for companies to look for small differences in talent because those differences can cause huge increases in profits. The problem with Frank's tragedy of the commons analogy is that there is no commons. The tragedy of the commons occurs when no one owns the resource: thus the word "commons." But those who hire hedgefund managers own their resources, so one would not expect overinvestment in being the manager. Frank implicitly admits this, writing, "To be sure, even those who fail to win the biggest prizes often go on to earn comfortable incomes." But in the very next sentence, he retreats to his old position, saying, "But career choices must be measured not in terms of absolute pay but relative to what might have been" (emphasis added). This is astounding. More than 20 years ago, Frank argued, as an empirical matter, that people care about relative income. Now in the face of evidence that absolute income matters a lot to them-- otherwise, why would anti-raiding norms have unraveled--he argues that it shouldn't-- thus his use of the word "must." If the people don't conform to his assumptions, it seems, we should tell them to.

Here is Bob Frank's webpage.

Just Fix It

Here's a letter that I sent today to the New York Times:

There's widespread agreement that the alternative minimum tax - because it is not indexed to inflation - is mistakenly raising the taxes of millions of Americans ("House Democrats Propose Tax Overhaul," October 25).  Happily, there's also widespread agreement that this mistake should be corrected.

So, given that the current operation of the AMT is a mistake, why do Rep. Charles Rangel and so many others talk of the need to "pay for" fixing the AMT?  A merchant who mistakenly overcharges customers is obliged to refund the money and stop overcharging, period.  This obligation kicks in whether or not the merchant devises some way of replacing the revenue that he loses by correcting his mistake.

Sincerely,
Donald J. Boudreaux

A Dearth of Taxes?

Yesterday's New York Times has an editorial that can only be described as jaw-droppingly dumb.  (HT: Laurence J. Dallaire)  I sent the following letter in response:

To the Editor:

Forget that Uncle Sam today rakes in tax revenues that are, in inflation-adjusted dollars, 25 percent larger than those that he took in 2001 - thus making a mockery of your claim that Washington's tax take today is "meager" ("The Dearth of Taxes," October 22).  And forget that the Wall Street Journal today reports that Congress has increased corporate welfare for the current fiscal year by nearly ten percent, to $100 billion.

When pleading for higher taxes, at least keep your story straight.  In your editorial you simultaneously blame government's alleged lack of funds for bringing many U.S. corporations "to the brink" AND you dismiss the recent growth in tax revenues as being due to "spectacular increase in corporate profits."  Such inconsistency taxes your readers' credulity.

Sincerely,
Donald J. Boudreaux

Frank Talk

In the latest EconTalk, I talk with Robert Frank about the virtues of learning economics via puzzles and stories rather than graphs and equations. I am a big fan of graphs but I'm a bigger fan of puzzles and storytelling and I believe that Frank is absolutely right that puzzling over puzzles and telling and listening to stories is a crucial way that many people learn and remember. We discuss a number of interesting puzzles from his new book, The Economic Naturalist including why people in New York might appear ruder than people in Topeka and why brides buy their dress and grooms often rent their tux even though brides usually never wear their dress again and grooms wear tuxes later on.

We spend a little time on the issue of whether people get pleasure from owning a big house or whether they only get pleasure when their house is bigger than their neighbors' houses. Frank sees the growing size of houses as an example of an arms race where the competition to have a bigger house is wasteful—yes, at first when you build a bigger house, you're better off. But when your neighbor builds a bigger house that matches yours, you're back to where you started. I see larger houses as an example of people living better with more living space. When I pressed him during the podcast on this issue, he answered by saying that both factors are relevant—it's an empirical question as to the magnitudes of the two effects.

In this editorial in the New York Times which I saw just after the interview was taped (HT: Rick Koch), Frank makes his case more forcefully and argues that the arms race for bigger houses justifies a steeply progressive consumption tax:

Consider a family that spends $10 million a year and is deciding whether to add a $2 million wing to its mansion. If the top marginal tax rate on consumption were 100 percent, the project would cost $4 million. The additional tax payment would reduce the federal deficit by $2 million. Alternatively, the family could scale back, building only a $1 million addition. Then it would pay $1 million in additional tax and could deposit $2 million in savings. The federal deficit would fall by $1 million, and the additional savings would stimulate investment, promoting growth. Either way, the nation would come out ahead with no real sacrifice required of the wealthy family, because when all build larger houses, the result is merely to redefine what constitutes acceptable housing. With a consumption tax in place, most neighbors would also scale back the new wings on their mansions.

I disagree with the premise that there is "no real sacrifice involved." I think people enjoy the larger house. By discouraging them from building the larger house, the tax reduces the happiness of  homeowners. But my real disagreement is with the claim that the additional savings would stimulate investment. Frank is assuming that everyone will work equally hard in a world where consumption is taxed at very high rates. I doubt it.

Frank goes on to argue for another benefit of high tax rates on consumption:

A progressive consumption tax would also reduce the growing financial pressures confronting middle-class families. Top earners, having received not only the greatest income gains over the last three decades but also substantial tax cuts, have been building larger houses simply because they have more money. Those houses have shifted the frame of reference for people with slightly lower incomes, leading them to build larger as well. The resulting expenditure cascade has affected families at all income levels.

The median new house in the United States, for example, now has over 2,300 square feet, over 40 percent more than in 1979, even though real median family earnings have risen little since then. The problem is not that middle-income families are trying to “keep up with the Gateses.” Rather, these families feel pressure to spend beyond what they can comfortably afford because more expensive neighborhoods tend to have better schools. A family that spends less than its peers on housing must thus send its children to lower-quality schools.

Now it turns out that 1979 was a very good year for family income, but even so, median family income rose 15% between 1979 and 2005 and rose almost 20% between 1980 and 2005. And the way the government measures income doesn't include fringe benefits which are an increasingly important part of compensation. And I don't think the price index that converts nominal into real dollars overstates inflation and understates the growth in real income. So I disagree with Frank that income is up only slightly. So when I see houses getting bigger, I see people spending a larger share of their income on something they care a lot about rather than people keeping up with the Gateses.

I think Frank is right about two things in his article on taxation. One, I think people do spend money on houses trying to get into better school districts and that bids up the price of houses artificially because houses are tied to schools. The way to fix that is to get rid of the connection between houses and schools. The second thing I agree with is that it's better to tax consumption rather than income. But I don't think steeply progressive rates are a good idea. I think they would have strong disincentive effects on productivity, creativity and innovation. I think part of the reason people work long hours and start new businesses and take second jobs is to have more stuff. Taxing the accumulation of stuff at very high rates reduces the incentive to work hard.

Jibbitzing in the Prosperity Pool

Earlier this month, Karol and Thomas and I vacationed at our favorite vacation spot: Cape Cod.

While there, Thomas and I bought our first pairs of Crocs.  They're wonderful shoes for casual wear.  The woman who sold them to us told us about something that we'd never before heard of: Jibbitz.  Jibbitz are little decorations that fit into any one of the many holes featured on each pair of Crocs.  These tiny items are mostly ornamental -- allowing each Croc wearer to express his or her individuality -- but they also are functional, for they can help to identify one pair of Crocs from another.

(Neither Thomas nor I wanted any Jibbitz, by the way.)

The fascinating thing about Jibbitz, though, is that the inventor turned this idea into a business that he and his wife sold for $20 million.  What a  wonderful outcome!

Note that this invention isn't high-tech -- it's about as simple as simple can be.  Yet it is indeed something that enough consumers choose to buy at prices that make the product profitable to produce.

Jibbitz -- another few drops of prosperity in our vast Prosperity Pool.

Tax Burden

My George Mason University colleague, law professor Todd Zywicki, has a wonderful op-ed appearing in today's edition of the Wall Street Journal.  (Unfortunately, a paid subscription to the WSJ is required to access this article.)  In this essay, Todd reports that the data show that the category of expenditure that has risen most, in both percentage terms and in absolute dollar terms, for the average American household over the past 30 years is taxes.

Here are the concluding paragraphs from Todd's not-to-be-missed op-ed:

Although income only rose 75%, and expenditures for the mortgage, car and health insurance rose by even less than that, the tax bill increased by $13,086 -- a whopping 140% increase. The percentage of family income dedicated to health insurance, mortgage and automobiles actually declined between the two periods.

During this period, the figures used by Ms. Warren and Ms. Tyagi [in their book The Two Income Trap: Why Middle Class Mothers and Fathers are Going Broke] indicate that annual mortgage obligations increased by $3,690, automobile obligations by $2,860 and health insurance payments by $620 (a total increase of $7,170). Those increases are not trivial -- but they are swamped by the increase in tax obligations. To put this in perspective, the increase in tax obligations is over three times as large as the increase in the mortgage payments and almost double the increase in the mortgage and automobile payments combined. Even the new expenditure on child care is about a quarter less than the increase in taxes.

Overall, the typical family in the 2000s pays substantially more in taxes than the combined expenses of their mortgage, automobile and health insurance. And the change in the tax obligation between the two periods is substantially greater than the change in mortgage, automobile expenses and health-insurance costs combined.

This suggests that the most important change in the balance sheets of middle-class households over the past three decades is a dramatically higher tax burden caused by the progressive nature of the American tax system. In turn it follows that the most effective way of alleviating the household budget crunch would be to adopt lower and flatter tax rates that would reduce the government's take. Another possibility, advocated by Prof. Edward J. McCaffery of the University of Southern California Law School, would eliminate the "secondary earner bias" in the tax system, which causes all of the wife's income to effectively be taxed at a much higher marginal tax rate than the husband's. Any of these reforms seem sensible.

Lower and flatter marginal tax rates generally are not advocated by those who dominate the American legal academy today. But for those who want to consider serious strategies for preventing bankruptcies, less money in Uncle Sam's pockets may mean more money in ours.

The Politics of Prohibition

Why did the U.S. government prohibit alcohol starting in 1920?  And why did it end this ignoble "experiment" in 1933?  I have a theory.  (Hint: the reason for both the launch and the sinking of alcohol prohibition centers on tax revenue.)

Where Externalities Lie

Here's a letter that I sent today to the Wall Street Journal.

To the Editor:

Like many others, Professor Hendrik Van den Berg insists that "we need to raise the price of gasoline by introducing a tax that reflects the congestion, environmental and national security costs of oil" (Letters, July 3).  I disagree.

First, government already taxes oil production and gasoline.  How does Prof. Van den Berg know that the current level of taxation is inadequate?  Second, government itself is a steamy swamp of negative externalities.  Not only do politicians and bureaucrats spend other people's money, they do so overwhelmingly while under the influence of special-interest groups.  The only tax that we should raise is one that increases the cost of using government.

Sincerely,
Donald J. Boudreaux

I am consistently amazed at the way so many persons -- including (especially?) economists -- cleverly identify real or imagined externalities in private markets and then propose political "solutions" for these alleged problems as if the government officials who will design and implement these "solutions" are wise, well-informed, and pure of motive.

Rabushka on the flat tax

Here is Alvin Rabushka talking about the flat tax, a radical proposal for tax reform that would eliminate all deductions other than the personal exemptions and tax all income at a single rate. I was surprised to learn how popular the idea is around the world. There is little political enthusiasm right now in the United States for fundamental tax reform. Which is a shame. Wouldn't it be wonderful if all the talented people who currently help rich people avoid taxes were instead encouraged to something productive?

Taxing the Rich

The top 1% paid 37% of the income taxes in the latest numbers from 2004.

Ari Fleischer points out other interesting aspects of the US income tax burden and how it has changed over time. The problem with his analysis is that he sort of neglects payroll taxes. Why do I say "sort of?" Because he acknowledges the existence of the payroll tax but misses one key point:

The usual rebuttal made by those who support raising top rates is that lower income Americans pay Social Security and Medicare taxes and therefore need "relief." Of course they pay these taxes. But then, they alone get a good return on their money.

Top earners, on the other hand, pay payroll taxes so their money can be redistributed to others. According to the CBO study, the top 20% of workers, those with incomes over $64,300, pay 44.2% of the payroll tax while the bottom 20%, those who make less than $17,300, pay 4.2%. In return, when it's time to retire, lower-income workers typically receive more in Social Security benefits than they paid in, while the wealthy, who paid the most in taxes, simply can't live long enough to get back what they paid. For much of the middle class and the wealthy, Social Security isn't a retirement program -- it's another program that redistributes their income.

As for Medicare, it doesn't matter that the rich paid far more in taxes; all recipients receive the same benefits. Think of it this way. If Medicare were a car, its price for a low-income worker would be $145 and its price for a millionaire would be $14,500, even though it's the very same car.

Here's why. A taxpayer who makes $1 million a year pays $14,500 in Medicare taxes while a worker who makes $10,000 a year pays $145. But when they retire and visit their doctors or go to the hospital, Medicare reimburses both an equal amount of money. That's a pretty big redistribution of income and a pretty good deal for the low-income worker.

What he misses is that payroll taxes are not user fees. There is a pretense that they fund social security and Medicare. But they don't. They fund everything right now. Right now payroll taxes cover more than the cost of those programs. The difference goes to fund everything else. So to correctly measure the effective tax burden by income, you really should just roll payroll taxes into the income tax collections. Those are the relevant numbers for looking at the political economy of taxation. But Fleischer makes some interesting observations. Just remember he's leaving out the payroll tax.