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| Source: Wall Street Journal |
I buried the lead, which I'll excerpt here:
"...Why is tax reform paralyzed? Because political debate mixes the goal of efficiently raising revenue with so many other objectives. Some want more progressivity or more revenue. Others defend subsidies and transfers for specific activities, groups or businesses. They hold reform hostage.
Wise politicians often bundle dissimilar goals to attract a majority. But when bundling leads to paralysis, progress comes by separating the issues.
Thus, we should agree to first reform the structure of the tax code, leaving the rates blank. We will then separately debate rates, and the consequent overall revenue and progressivity.... we can agree on an efficient, simple and fair tax, and debate revenues and progressivity separately.This is, I think, the most novel idea in the oped. All tax reform packages mix changes to the structure of the tax code with specific rates. Then, the wonkosphere goes on a witch hunt of who pays more and who pays less, and the attempt to fix pathological problems in the structure falls apart.
We should also agree to separate the tax code from the subsidy code. We agree to debate subsidies for mortgage-interest payments, electric cars and the like—transparent and on-budget—but separately from tax reform.
Negotiating such an agreement will be hard. But the ability to achieve grand bargains is the most important characteristic of great political leaders."
I think our politicians really could negotiate a tax code in which all the rates are left blank. Then, we have a separate debate about what those rates will be. In fact, tax rates ought to change a lot more often than the tax code itself.
Similarly, the key to removing the pernicious subsidies in the tax code is again to separate the issues. Taxes are for taxing, then we can debate subsidies.
We need to move from the equilibrium of, I have my subsidy/deduction/credit/special deal, so I won't complain about yours, to the equilibrium of, I gave up my subsidy/deduction/credit special deal, so I'll make darn sure you give up yours too.
Interesting stuff.
ReplyDeleteI would probably propose something more modest, namely: leave the structure of the code as it is (so no-one is better or worse off), but change the accounting, quite fundamentally.
Specifically: 1) all tax deductions are transformed into subsidies (as you propose too), but also 2) all taxes are to be paid by individual people, not at the "group" level. The latter would mean for instance that corporate taxes become individual capital taxes, all employer contributions (e.g. FICA) are paid by employees, health-care employer contributions become subsidies, etc.
Taxing groups of people instead of individuals is one of the best way to obfuscate the burden of taxes.
An important feature of this reform is that it doesn't really change anything, it just leads to greater tax transparency. Lawmakers who oppose it can rightly be accused of sustaining the obscurity of the tax system.
Gideon,
Delete"Taxing groups of people instead of individuals is one of the best way to obfuscate the burden of taxes."
It also places tax compliance on the individual level which is fine unless you are dealing with a couple million pages of tax code.
That is why taxation occurs on the group level, so that group can first hire a tax attorney to read and interpret the existing code and then hire a lobbyist to persuade Congress into adopting a few more thousand pages of new code that benefits that group.
John,
ReplyDelete"In fact, tax rates ought to change a lot more often than the tax code itself."
Tax policy should be time sensitive - there is no doubt in my mind on this, for the same reasons that monetary policy should be time sensitive. 20% interest rates might have made sense in the late 70's / early 80's but it's hard to argue they would make sense today.
But relying on Congress to regularly adjust tax rates on a timely basis asks a lot of an institution that can be dysfunctional at times BY DESIGN. The founding fathers knew what they were doing when they created 3 separate branches of government with a system of checks and balances. If tax rates must be more flexible, don't ask Congress to become more flexible - that's not their job.
What is needed is a independent / semi-independent body that can make tax policy adjustments without having to put every change before a Congressional vote and having to buy those votes with various subsidies / kick backs / and the like.
That power should rest in the Treasury department, but to honestly do it, the Treasury department would need to be unwound from the Executive branch of government.
A couple of ideas:
Election / Constitutional Reform - President and Vice President are elected separately on different schedules. Vice President in addition to casting tying vote in Senate becomes director of the semi-independent Treasury department. Vice President is no longer 2nd in line to become commander and chief. This takes almost a corporate approach - President as CEO, Vice President as CFO - each is elected individually rather than both on a single ticket.
This has several advantages:
1. Tax policy is no longer tied to the Presidential election cycle.
2. Treasury implemented tax policy becomes a counterbalance to Fed monetary policy.
3. Continuity is provided between administrations in the same way that Tim Geithner and Ben Bernanke were retained early on by Obama.
I think we need to never tax working.
ReplyDeleteConsumption, gasoline, Pigou and pollution taxes are good.
Besides, who has the right to pollute someone else's property or the air we breath?
Ben,
Delete"Who has the right to pollute someone else's property or the air we breath?"
By your logic, only tax payers have that right. If you don't / can't pay any taxes, you should be thrown in jail for polluting?
I completely agree with most of this, especially the idea of separating transfers and subsidies from the tax code. I have a hard time seeing how eliminating both the corporate income tax and the capital gains tax could ever be politically realistic, though. I think you'd have a hard enough time getting one or the other. Personally, I would even be okay with taxing capital gains at regular income rates if it meant the complete elimination of the corporate tax.
ReplyDeleteI think we, economists, make a mistake when we always try to modify our advice away from the first best by our unprofessional diagnoses of what is politically realistic. None of this is politically realistic. But someone has to reiterate the ideal once in a while or we forget what it is!
DeleteFrom above:
Delete"I think our politicians really could negotiate a tax code in which all the rates are left blank."
And then:
"None of this is politically realistic."
Above you place faith in the political system, in the next breath you denounce it.
Is "efficiently raising revenue" politically feasible or not?
John,
Delete"But someone has to reiterate the ideal once in a while or we forget what it is!"
Except that your version of the ideal - tax policy that efficiently raises revenues - doesn't match my version of the ideal - tax policy that compliments monetary policy.
If we can't agree on what the ideal tax policy looks like, why should a politician listen to either of us?
I didn't think I had to spell it out quite so much... This is not a "politically realistic" plan, in the sense of having been crafted to satisfy every current interest group, and leaving untouched things like mortgage interest deductions and so forth. I think the second half is very politically realistic as to process: unbundling revenue raising, progressivity, and subsidy is, I think, a good way to negotiate our way to... a politically realistic (and inevitably impure) tax code.
DeleteNot only is Cochrane's suggestion for an "ideal", ideal, it is very good political advice. It's foolhardy to think that any plan isn't debatable, even when Congress is controlled by the same party as the President or the Presidential candidate. Realising this and suggesting a platform for reform by leaving rates debatable would not give the left-leaning staff at the Tax Policy Center the ability to pretend proposed rates are *not* debatable and destroy a candidate's tax reform proposal and negatively affect his or her campaign by publishing fanciful revenue estimates. Case in point: Romney. He was badly served by Mankiw and Feldstein on this issue. It may very likely have cost him the election.
DeleteAnonymous - you are correct.
DeleteI think it is an intellectual trap to think that if only the rules of the game were changed your point of view could somehow stand a better chance. It is like saying that if only the rules of football had been different, the Seahawks would have won the Super Bowl.
ReplyDeleteIt does not matter how complicated a process you set up - the tail cannot wag the dog and in a democracy should not. Any overall tax plan that is not broadly acceptable to the public is not going to work. Any tax reform that increases GDP by 1% but shifts 2% of GDP to the wealthiest 1% of the population (making the poorest 99% of Americans worse off) is not going to be accepted no matter how "efficient" it is.
Better to start trying to chip away at the tax code subsidies than to go tilting at windmills.
The correlation between tax subsidies and financial scams is high enough to be used as an argument in separating taxation from subsidies in any reform:
ReplyDeletehttp://www.theguardian.com/business/2015/dec/14/spain-energy-giant-abengoa-collapse-predicted-by-17-year-old
Literally trillions have been wasted in the US and Europe in "green" subsides - as any financial analysis will show, so I can't understand why this magical thinking continues. Happy New Year prof. Cochrane and everybody else here!
"Literally trillions have been wasted in the US and Europe in 'green' subsides"
Delete"Trillions" seems high but not impossible. Most of that would have been spent in Europe who face a different set of energy concerns than the U.S. does. The money spent in teh U.S. subsidizing ethanol production is pure waste. It is too early to tell if the wind and solar subsidies are a complete waste. Wind and solar may yet save the planet.
A certain blogger (digester, really) likes to employ the aphorism “Insufficient opportunities for graft” whenever an example of public choice theory becomes painfully obvious.
ReplyDeleteBut the saying really does apply in the case of tax reform. What could possibly incentivize politicians to voluntarily relinquish so much power?
"What could possibly incentivize politicians to voluntarily relinquish so much power?"
DeleteSee creation of U. S. Federal Reserve as an example of politicians voluntarily relinquishing power.
https://en.wikipedia.org/wiki/Federal_Reserve_Act
The Democrats at the time (1913-1919) led by Woodrow Wilson - controlled both houses of Congress and the Presidency for the first time since Grover Cleveland (1893-1895).
That is what pushes politicians to cede power - rather than lose it directly in an election after just gaining it - they create committees, advisory boards, lobbying agencies, and the like to retain some power if they are no longer elected.
It is important to keep an ideal world in mind, knowing that is going to be hard to achive. But if one sets out already compromising, than, it is certain he/she will not achieve the ideal, not even close... Good point, Prof. Cochrane.
ReplyDeleteCuriosity,
ReplyDeleteWas looking through the latest Federal Reserve Flow of Funds Report (Z1 Report) here:
http://www.federalreserve.gov/releases/z1/current/z1.pdf
Page 19
F.106 - Federal Government
24 Net Lending (+) or borrowing (-) = -$690.9 Billion
25 Net Acquisition of financial assets = -$176 Billion
40 Net Increase in liabilities = $514.9 Billion
44 Debt Securities = $22.2 Billion
53 Claims of pension fund on sponsor = $470.5 Billion
These same claims appear here:
Page 33
F.119 - Federal Government Employee Retirement Funds
7 - Claims of Pension Fund on Sponsor - $470.5 Billion
What prevents these claims from being converted into federal debt?
Page 94 - L.119 - Federal Government Employee Retirement Funds
$1.3 Trillion in Debt Securities
$2.2 Trillion in Claims of Pension Fund on Sponsor
"Here's what genuine tax reform looks like."
DeleteNo see above. This is what real tax reform looks like - convert debt level claims on future tax revenue to equity level claims.
Hi John!
ReplyDeleteIt's great to read that you are trying to build consensus and reach out across the aisle. At the end of the day, though, what we need to see is how a different tax system and a different set of rates and credits affect effective tax rate across the income spectrum - does it reduce variability in each bucket? does it produce a nice straight line (whose slope we can debate separately)?
The argument that "corporate income taxes are passed to consumers" is like arguing that "individual income taxes are passed to corporations."
ReplyDeleteThe idea that eliminating corporate income taxes and capital gains taxes is somehow not a "subsidy and transfer for specific activities, groups or businesses," is absurd. It is a naked transfer of wealth from the middle class (who earn wages, mostly) to the wealthy (who earn passive income, mostly.)
If you want to encourage people to invest, you need to reduce taxes on wages, because that is the money that normal people USE TO INVEST WITH.
As it stands, your proposal is basically an effort to make the rich richer and the middle class poorer. This is NOT building consensus, and it is ridiculous for you to claim so.
You are referring to this:
Delete"Second, the government should tax consumption, not wages, income or wealth."
One person's consumption is another person's income, so the argument for / against a consumption tax is primarily an argument over who should incur tax incidence - the buyer of goods or the seller of goods.
Now let me explain why tax incidence should not be borne by the purchaser of goods - THE FEDERAL GOVERNMENT WILL ONLY ACCEPT DOLLARS FOR PAYMENT OF TAXES!!! I buy 100 oranges for $100. Will the federal government accept some of my oranges so that I can pay my taxes? No? Then the seller of oranges (having $100) should pay taxes.
Cochrane and company miss the obvious - the recipient of dollars (the seller of goods / services) is in a far better position to pay taxes denominated in dollars than the recipient of goods (seller of dollars) is.
I would have no problem with a consumption tax as long as the federal government is willing to accept purchased goods (or some portion thereof) as sufficient to discharge a tax liability. Otherwise, Cochrane is blowing smoke.
A tax on income, proportional to the amount consumed, i.e. with a full deduction for saving. I hope this clears your smoke.
DeleteSo, as long as I consume more than my income, I ride tax free on my consumption above and beyond my income level? And this dissuades or incentivizes consumption?
DeleteSeems to me that if you actually want to tax my consumption (NOT my income), then the government should take a portion of the good I consume no matter how large it is compared to my income. Also, a significant time can occur between when income is received and when consumption occurs. It is not efficient for a government to assess a tax on income that is received this year and spent on consumption goods four years from now.
And no, it doesn't clear the smoke. You are simply hedging now.
John - We should eliminate all income, savings, investment taxes and only tax consumption
Frank - Fine, then government must accept goods that are consumed as payment for taxes
John - Well I really didn't mean tax consumption, I meant tax income based upon consumption
Deep breath..... Yes I am giving you a hard time here. There are plenty of good reasons why a government taxes income:
1. Income is denominated in dollars, likewise taxes must be paid in dollars
2. Taxes can immediately be assessed and collected on income - not true for a consumption tax proportional to the amount consumed. Government must wait until end of year / quarter to determine tax assessments?
John means proportional to money spent on goods consumed. Eg if I spend $50k on goods in 2016, I pay tax-rate x $50k. He argues that consumers would be more aware of their true tax-burden if directly charged, but it may be administratively easier to collect this directly from retailers (it has no first-order effects on outcome if I spend (1+tax-rate) x $50k and then retailers pay taxes rather than me). The fact that receipt would be slightly deferred under either scheme is of minor significance to a government able to issue bonds to patient financial markets!
DeleteIn either case, you will be unable to consume more than your income without spending your own savings/taking on debt. However, someone able to do this does not 'ride tax free' under John's plan, but simply incurs a tax burden proportional to their annual consumption (which can be set at society's chosen rate).
This program can also be made to be progressive using different marginal consumption bands (eg I pay 20% tax on first $30k consumption, 30% tax on next $70k and so on). This could be implemented at transaction time in a world of digital currency (see Sweden), approximated with different bands of goods (eg high tax on yachts vs low tax on toothpaste) or simply collected at year end by the tax-department.
I don't disagree that there are administrative/enforcement issues with any of these options but struggle to understand any of the other points you made.
"In either case, you will be unable to consume more than your income without spending your own savings/taking on debt."
DeleteOr producing and consuming my own goods. If I want to consume more tomatoes, I just grow more tomatoes.
"I don't disagree that there are administrative/enforcement issues with any of these options but struggle to understand any of the other points you made."
My primary complaint was in regard to phrasing - a government does not and should not tax consumption - meaning government does not accept goods purchased for consumption as sufficient means to discharge a tax liability. A government always and everywhere taxes income denominated in it's preferred currency.
To understand where I am coming from, read John's next article complaining about economists not using repeatable experiments when they publish data either because they don't share the data or they fail to include the software used to create the data. The same is true for economists who use catchy phrases like "government should tax consumption not income" when they don't actually mean taxing consumption.
My secondary complaint was on incentives. It was my understanding that the total amount of annual taxes a person would be required to pay would be limited by the amount of annual income a person collects, irrespective of consumption. You seem to say that there is no such limit on taxation - that creates some severe enforcement issues - you can't squeeze blood from a rock.
So if I take out $100,000 mortgage, and if the tax rate on homes (as consumer goods) is 50%, and if I only have $20,000 of annual income, I must still pay a 50% tax on the purchased house ($50,000) - yes? Where does the extra $30,000 needed to pay the tax come from? As I mentioned above, the person best able to pay a tax denominated in dollars is the seller of goods, not the purchaser of goods.
Or if the tax on tomatoes is 10% and I grow and consume 200% more tomatoes next year, I would owe 20% more in tomato taxes even if my income fell next year.
Presumably there would be no withholding taxes under Cochrane's plan?
DeleteAlso, "..the fact that receipt would be slightly deferred under either scheme is of minor significance to a government able to issue bonds to patient financial markets!"
Do you mean financial markets or do you mean the central bank?
Maybe we don't disagree that much with each other. Personally, I find 'consumption tax' to be transparent (many economists will use and understand this terminology) but he doesn't explicitly state 'tax proportional to the money spent on consumption goods'. A tax requiring you to give to the government a proportion of your consumption goods, rather than paying them with money is clearly a silly idea, but I think he's just using a convenient shorthand rather than trying to pull wool over your eyes!
DeleteYour point about creating an incentive for self-sufficiency is valid but of minor importance (the time you waste fiddling around with tomatoes in your back garden rather than letting a commercial farmer grow them efficiently will outweigh any tax savings). More likely is an increase in black-market trade, but here in the UK we cope with a 20% baseline consumption tax and much higher on cigarettes and alcohol without everything going completely underground.
There are also plenty of examples of exotic evasion/avoidance strategies for capital and income taxes (eg Luxemborg or the Bahamas) and there are good first-order benefits of taxing consumption rather than income and capital in case your interested in reading any optimal taxation literature (roughly, replacing a capital tax with consumption tax of the same burden encourages a shift from present consumption to capital production, increasing future output).
I outlined a few schemes where a lot/all the consumption tax could be collected at point of sale, avoiding your worries about people building up liabilities to the government, but even if the consumption tax is collected at the end of the year, citizens unable to pay immediately could be given credit agreements or be forced to file for bankruptcy and sell assets.
In your example of the bank-mortgage, many tax-codes presently treat houses as investment assets rather than durable consumption goods, but assuming that it is treated as consumption, the bank would need to assess your credit-worthiness to take on $150k of debt and lend you the money needed to pay your tax-liability + the house owner. This could alternatively be levied from the house-seller.
Finally, I mean financial (bond) markets. US presently has no problem borrowing billions at low interest rates by issuing treasuries and so should not worry about a one-one deferral of receipts by a year. There would also be be ways to stagger adoption but again I worry that you're fussing over the implementation details when the current system is already so messy, cumbersome and inefficient.
Personally, I find 'consumption tax' to be transparent (many economists will use and understand this terminology) but he doesn't explicitly state 'tax proportional to the money spent on consumption goods'.
DeleteI find the term "sales tax" to be transparent because most people have paid a sales tax at some point in their lifetime. So why not just call it a sales tax?
"There would also be ways to stagger adoption but again I worry that you're fussing over the implementation details when the current system is already so messy, cumbersome and inefficient."
I would argue that a consumption or sales tax would likely become even more messy, cumbersome, and inefficient because for every new consumption good that is invented, a new tax must be considered and because going to a sales tax does not address the underlying cause of that messiness and inefficiency - Congress.
Take Congress out of the loop and rely on an independent body to set rules based tax policy, and I think you will find that any tax system (income or consumption) works a heck of a lot better than what we currently have.
"There would also be be ways to stagger adoption but again I worry that you're fussing over the implementation details when the current system is already so messy, cumbersome and inefficient."
And I worry that you are not fussing over who implements tax policy.
"US presently has no problem borrowing billions at low interest rates by issuing treasuries."
My concern is term structure, not interest rates. Currently the U. S. Treasury borrows at a range of different maturities from 1 month to 30 years. If all consumption taxes are paid at end of year then it would be next to impossible for the Treasury to borrow and roll over debt at maturities less than one year - yes? For anything less than one year, the Treasury would in essence be doing Ponzi finance - paying back interest and principle with new bond sales until the tax revenue came in at the end of year.
"Finally, I mean financial (bond) markets."
DeleteThe central bank is patient - it does not have to turn a profit, and it is legally precluded from going insolvent. Private banks are not patient - they have shareholders to appease and solvency concerns.
To say that financial markets are patient paints a wide brush over very distinct participants in that market.
'For anything less than one year, the Treasury would in essence be doing Ponzi finance - paying back interest and principle with new bond sales until the tax revenue came in at the end of year.'
DeleteThis doesn't resemble Ponzi finance at all. Providing the government's debt-GDP ratio isn't rising in the long-run, they retain the ability to repay bondholders in full and so are not defrauding these bondholders (whether this is true depends on the debt burden, market interest rate and current account deficit but is independent of the timing of tax receipts).
'Paying back interest and principle with new bond sales until the tax revenue came in at the end of year'.
Is not an issue. Many companies/governments do this at the moment to some extent. At a risk of repeating myself again , you it could be more convenient to collect baseline consumption tax at the point of sale and this would avoid this issue.
'Private banks are not patient - they have shareholders to appease and solvency concerns.To say that financial markets are patient paints a wide brush over very distinct participants in that market.'
You can deduce the patience of financial markets (combined with their fear of inflation) here.
https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield
Many bond investments driven by pension funds, sovereign wealth funds, but the liquid market in US treasuries means that holding US government debt creates no solvency concerns for banks.
'Take Congress out of the loop and rely on an independent body to set rules based tax policy, and I think you will find that any tax system (income or consumption) works a heck of a lot better than what we currently have.'
This sounds sensible, but I separate the two in my mind --> have a sketch taxation plan based on minimising economic distortions for a targeted level of tax receipts --> tweak this to cater for implementation details.
Anonymous,
Delete"This sounds sensible, but I separate the two in my mind --> have a sketch taxation plan based on minimizing economic distortions for a targeted level of tax receipts --> tweak this to cater for implementation details."
As far as eliminating the messiness and cumbersome nature in any tax policy, the WHO in the implementation details must be decided first. The fewer chefs in the kitchen / fingers in the pot, the better.
"...have a sketch taxation plan based on minimizing economic distortions..."
You are switching motivations. A system of taxes can be messy and cumbersome and have few economic distortions or vice versa. A 100% flat income tax rate would neither be messy or cumbersome but would result in a pretty severe economic distortion - yes?
The tax system with the fewest economic distortions is neither a consumption or income tax. It is a totally voluntary system of taxation (if you can call it taxation anymore). Any taxes that are paid are not a legally binding commitment, but rather an individual choice. Under voluntary taxation, it is totally up to the individual what amount (if any) a person pays in taxes.
The whole point of a legally binding system of legally binding taxes IS TO GENERATE AN ECONOMIC DISTORTION. That distortion is for people to accept and use a common currency in their everyday transactions instead of resorting to barter trade or a variety of different private bank notes.
Anonymous,
Delete"US presently has no problem borrowing billions at low interest rates by issuing treasuries and so should not worry about a one-one deferral of receipts by a year."
I believe that the federal government should never borrow irrespective of what interest rates are. I believe that tax policy should be based upon the current economic condition, not where interest rates are set.
Good post. I have long shared this insight. Break the problem into parts, debating each part on its own until a resolution forms. I also agree with the idea that tax rates should be debated and changed more regularly -- down, as well as up -- in response to the prevailing expected cost of borrowing, to manage to the most efficient cost of capital to citizens.
ReplyDeleteBingo,
DeleteI whole heartedly agree with that statement:
"...tax rates should be debated and changed more regularly -- down, as well as up -- in response to the prevailing expected cost of borrowing, to MANAGE TO THE MOST EFFICIENT COST OF CAPITAL TO CITIZENS."
I would add that there should be no debate at all. If we are to adopt pre-agreed upon macro based rules for the central bank when it makes interest rate adjustments, we should likewise adopt pre-agreed upon macro based rules for the Congress / Treasury department when it makes tax rate adjustments.
I think that is the part that John swings and misses on. You cannot rely on Congress facing election cycles to make the proper tax decision based upon the prevailing economy.
If tax policy is to become a rule based economic instrument, then some body outside the sphere of political influence and squabbling must be able to implement it. My inclination would be the Treasury department, but that's just my gut feeling.