Tag Archives: Political Economy

The intersection of markets and politics: fiscal policy, tax structure, regulatory economics, campaign finance, inequality, monetary policy, and the strategic behavior of economic actors in political environments.

Penetrating the Ill Logic of Double Taxation

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Somewhere in the midst of this year’s elections, there is a debate about the structure of the federal government’s tax system.  A common complaint about the system (and, increasingly, the Affordable Care Act) is dubbed “double taxation.”  In this post, I describe the complaint and note its nonsensical nature.

In a nutshell (and framed in terms of corporate taxes, perhaps the most frequent target of this charge), the complaint about double taxation is as follows.  Suppose you own a corporation that earns $100, taxed at 35%.  The corporation’s after tax revenue is $65.  Suppose, as the sole shareholder, you take this income as a dividend.  TO keep things simple, suppose that this dividend income is taxed at the highest personal marginal income tax rate, also 35% (some dividends are currently taxed at lower marginal rates).  Then you end up with $42.25 after both rounds of taxation. In other words, the income was taxed at an effective tax rate of 57.75%.

I have two points.  First, the concept of double taxation by the same government is a red herring.  It is misleading, in the sense that it suggests that you’re paying twice for the same thing.  That is, the implicit claim is that you’re paying twice for that admittedly abstract service, “governance.” But, in reality, since we’re running a deficit, you’re currently not even paying a full “once” for it. Consider first the following example.

Suppose that the government sends you two tax bills, one for “domestic spending,” and another for “defense spending.”  After you pay the first one, the resulting money from which you have to pay the second has already suffered the ignominy of taxation!  The second tax bill is less legitimate, no?  No.

Put another way, suppose that the government outsourced all of defense to Chuck Norris and a band of mercenary zombies (to prepare for the 1000 years of darkness).  Instead of collecting the second tax to pay Chuck and his loyal brain eaters, you are instead directly sent a bill from Chuck for the same amount as you would have paid in taxes.  Is this double taxation?  No, because it’s a bill, not a tax, right?  In other words, is it double taxation whenever someone pays an admission fee to a National Park?  Or how about when you pay for a passport?  In short, the correct answer is “double taxation is a red herring.”

Corporations are a choice. The second point I will make is more specific.  The point of most double taxation arguments these days is that corporate income is double taxed and, essentially, this is unfair.  I am not in the business of saying what is fair, but I am happy to describe my reasoning for why something is reasonable.

A simple argument for why it is reasonable for corporations to pay taxes goes as follows. Corporate taxes are avoidable: simply carry on the same economic activity without a corporate structure. That is, make all of the arrangements using traditional contracts, signed by you as the sole proprietor.

Why don’t corporations do this?  Well, because corporations extract large and real benefits from resource pooling made possible through the provision of limited liability to shareholders.  (There are also tax benefits from incorporating, but I will set this obvious target to the side.  And I won’t touch this one.)

Without going into too much detail about limited liability, suffice it to say that the benefits corporate structure are entirely derived from the state’s role in enforcing contracts and adjudicating liability.  In other words, corporations are ancillary to the rule of law of which the state is the ultimate purveyor.  Accordingly, any constitutional tax structure that the state’s citizens choose to impose on corporate income is reasonable.  (By constitutional, I am waving off tax structures such as those that base tax rates on forbidden criteria such as the race or ethnic origins of the shareholders.)

Note that this point implies that fairness objections to international double taxation (taxation by two nations’ governments) are inconclusive as well.

There are a number of other arguments (e.g., the voluntary nature of dividend distribution, the issue of capital gains and (expected future) taxes being priced into assets), but I will conclude here by pointing out that I am not arguing that the taxation of income necessarily should be differentiated according to the income’s source.  Rather, the argument that it should not should be engaged directly.  Arguing that something is “double taxed” shows that one is either thinking only halfway or telling a half-truth.

As I shake off post-Steelers-disappointment and look forward to the BEST MONDAY NIGHT OF THE YEAR I leave you with this.

 

Regulatory ‘Rithmetic

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A frequent talking point (e.g., like this) in this year’s presidential campaign is about the economic burden of federal regulations.  Given this focus, I thought it might be helpful to wade into the arithmetic behind this burden and the ways in which any president might alleviate it in the coming years.  I focus on the two points in turn.

Question 1: How Much Does Regulation Cost Us?

In general, policymaking through regulation has very small direct costs to taxpayers.  (For example, the total direct federal spending on regulatory agencies in 2012 is estimated to be just shy of $60 billion. To gain some perspective on this (it’s less than 2% of estimated total federal spending in 2012, see my post here.)   The beastly proportion of the burden, then, is through the various individual costs of compliance, foregone economic activity, and misallocation of resources.

Mitt Romney’s campaign has placed an emphasis on regulatory reform.  In fact, his campaign literature (linked above, page 3) states that regulations impose an annual cost burden of $1.75 trillion.

Digression.  The graphic used in the Romney policy brief compares the regulatory cost number with “all income taxes,” but omits payroll and Medicare taxes from this number.  While payroll taxes have an income ceiling (applies only to income up to a little more than than $110K/year), Medicare taxes do not and, more importantly, both are calculated as a percentage of earned income.  Total revenue from these two sources in 2012 is projected to be $779 billion.  Thus, since traditional income taxes and corporate income taxes are projected to total about $1.4 trillion, the total income tax burden is really in the neighborhood of $2.2 trillion.  This reality is indirectly implied, actually, by the source for the Romney’s numbers, a report commissioned by the Small Business Administration which states “…U.S. federal tax receipts, which equaled 21 percent of national income in 2008…” (p.6).

So, where does the astronomical figure of $1.75 trillion come from? As mentioned directly above, the number comes from a report by commissioned by the Small Business Administration and authored by Nicole V. Crain and W. Mark Crain, professors at Lafayette College. (Note: a critique of the methodology and lack of transparency in the Crain & Crain report is presented here. While one can always criticize an empirical study of anything with a scope such as that of the Crain & Crain report, it is safe to presume that federal regulations are in fact costly.  Accordingly, I am interested here only in the applicability of this number to the 2012 elections.)

Total Cost of Regulations

It is important to note at the beginning that the cost estimated by Crain & Crain is an estimate of total annual costs from federal regulations.  That’s a big point.  After all, as the report makes clear, the number includes costs from regulations that were promulgated (i.e., imposed) years and even decades before the current Administration took office.  At one level, who cares…right?  Romney’s campaign is running on a platform of shrinking government, regardless of where it was birthed.  On the other hand, Romney is running against Obama, and the policy piece linked to above directly proposes that a first step toward eliminating this burden is the repeal of various statutes and regulations passed during Obama’s administration.  Here are some quotes (pp.4-5):

  1. Repeal Obamacare. Mitt Romney has laid out a specific plan for dismantling Obamacare even without the congressional majorities required to strike it formally from the books…
  2. Reform Financial Regulation. As president, Mitt Romney will also seek to repeal Dodd-Frank and replace it with a streamlined regulatory framework…
  3. Reform Environmental Regulation. As president, Mitt Romney will eliminate the regulations promulgated in pursuit of the Obama administration’s costly and ineffective anti-carbon agenda…
  4. Review and Eliminate Obama-Era Regulations. One of the greatest problems with the federal bureaucracy is that each incoming presidential administration leaves in place much of what its predecessor constructed. The result is layer upon layer of often unnecessary or inconsistent regulation. Mitt Romney will not allow that practice to continue. On his first day in office, Romney will order all federal agencies to initiate repeal of any regulations issued by the Obama administration that unduly burden the economy or job creation. (Emphasis added.  You know, for emphasis.)

My point is that the Romney campaign is (quite understandably) pointing the anti-regulatory finger at the policies of Romney’s opponent, President Obama.  But, the cost referenced is by no means entirely attributable to his opponent’s policies, a point I return to  below.  Furthermore, if one looks at the source for his data about the annual costs of federal regulations, it is made clear (p.6) that the $1.75 trillion number is for 2008: “The findings in this report indicate that in 2008, U.S. federal government regulations cost an estimated $1.75 trillion…”

Digression. I personally find it odd, in light of the promise to circumvent Congress in “repealing” (or is it “dismantling”?) Obamacare and then to promise (p.5) “to restore a greater degree of congressional control over the agency rulemaking process. Our Constitution calls for our democratically elected Congress to make laws and for the democratically elected president to approve them.”
I will not even go into the arcane aspects of how it is hard (for me at least) to see how one can go beyond the Congressional Review Act in this regard without a dramatic reinterpretation/reversal of Supreme Court precedent established in INS v. Chadha.  Rather, I will simply note that the policy piece explicitly endorses both executive branch circumvention of Congress in pursuit of regulatory reform and promoting the legislative branch’s pride of place in the approval of federal regulations.

 

How Much Has the Cost Increased During the Obama Administration?

Another source of information for the Romney policy piece is the Heritage Foundation. (I think the piece they are referencing is this one, but I’m not sure.  Happy to be corrected, but I think that’s right, even though this is an updated version. To be clear, the two are very similar and I will clarify which one I am quoting from when needed: the earlier one will be called S11 (for Spring 2011) and the updated one will be referred to as F11.)  In the S11 report, the authors state on page 1:

Overall, the Obama Administration imposed 75 new major regulations from January 2009 to mid-FY 2011, with annual costs of $38 billion. There were only six major deregulatory actions during that time, with reported savings of just $1.5 billion.

Okay—to be clear, and comparing apples to apples with respect to the total cost figure of $1.75 trillion, this amounts to an increase in total regulatory costs since 2008 of about 2.2%.  In the F11 report, the authors state (again, on page 1): 

During the first three years of the Obama Administration, 106 new major federal regulations added more than $46 billion per year in new costs for Americans.

With this new data, the percentage increase in annual regulatory costs since 2008 is now a little under 2.7%.  To put this in historical perspective: according to Table 12 of the Crain & Crain report, the estimated per-household cost of federal regulation increased at an annual rate of slightly more than 2.8% between 2000 and 2004. (The Crain & Crain report suggests that its 2008 estimates are hard to compare to those for 2004, 2000, and 1995.  Accordingly, I’ll simply directed interested readers to take the time to look at Table 12 and think for a second about this disclaimer.)

Question 2: Which Regulations Are Costly, and Who is Responsible for Them?

Perhaps even more important for the presidential election than the total economic cost of regulations is the fact that the president is simply one actor in the regulatory drama. Regulations necessarily “fill in the blanks” for statutes passed by Congress.  Thus, it is important to consider where the new estimated costs are coming from in a statutory sense.  What laws are enabling/promoting costly regulation?

The F11 report describes the origins of the most costly regulations:

“The largest proportion of regulations by far stemmed from the 2010 Dodd–Frank financial regulation statute, which was responsible for 12 major rules increasing burdens in 2011, including six from the Securities and Exchange Commission, five from the Commodity Futures Trading Commission, and one from the Federal Reserve.”

Why is this relevant?  Regardless of one’s opinion about Dodd-Frank, it is important to note the following facts:

  • The SEC is an independent regulatory commission and, accordingly, beyond the scope of the president’s direct supervisory authority.
  • 3 of the 5 members of the SEC were appointed by George W. Bush.
  • Similarly, the CFTC is also an independent regulatory commission.
  • Also similarly, 3 of the 4 members of the CFTC were appointed by George W. Bush.
  • Finally, the Federal Reserve is an independent agency.

What this minutiae means in practical terms is that a president from either party has little to no control over these regulations.  Rather, Congressional action precipitated their promulgation and, barring a revision of our Constitutional understanding, similar action would be required to ensure these regulations are repealed.  In fact, this reality is acknowledged in Obama’s Executive Order 13579, which states that independent regulatory agencies

“should consider how best to promote retrospective analysis of rules that may be outmoded, ineffective, insufficient, or excessively burdensome, and to modify, streamline, expand, or repeal them in accordance with what has been learned. … each independent regulatory agency should develop and release to the public a plan, consistent with law and reflecting its resources and regulatory priorities and processes, under which the agency will periodically review its existing significant regulations to determine whether any such regulations should be modified, streamlined, expanded, or repealed so as to make the agency’s regulatory program more effective or less burdensome in achieving the regulatory objectives.” (Emphasis added.)

Regarding the point to which I am speaking (i.e., that the President’s direct authority over independent regulatory agencies is at best constitutionally circumspect), consider the closely related Executive Order 13563, which states that agencies

shall consider how best to promote retrospective analysis of rules that may be outmoded, ineffective, insufficient, or excessively burdensome, and to modify, streamline, expand, or repeal them in accordance with what has been learned. … each agency shall develop and submit to the Office of Information and Regulatory Affairs a preliminary plan, consistent with law and its resources and regulatory priorities, under which the agency will periodically review its existing significant regulations to determine whether any such regulations should be modified, streamlined, expanded, or repealed so as to make the agency’s regulatory program more effective or less burdensome in achieving the regulatory objectives. (Emphasis added.)

The differences between the two orders are minor in appearance, but important in effect.  First, the word “should” is conveying a mere suggestion (as opposed to “shall,” which is a polite command): the president has no authority to direct the internal affairs of an independent agency (this is one of the two principal implications of their independence). Second, executive agencies are, in congruence with previous practice dating back to President Reagan’s Executive Order 12291, directed to forward their plan for regulatory review to the Office of Information and Regulatory Affairs, which is located in the Office of Management and Budget, which (accurately) describes itself as follows:

The core mission of OMB is to serve the President of the United States in implementing his vision across the Executive Branch.  OMB is the largest component of the Executive Office of the President.  It reports directly to the President and helps a wide range of executive departments and agencies across the Federal Government to implement the commitments and priorities of the President.

Thus, the plan submitted by an executive agency is subject to explicit review by an agent of the president.  On the other hand, independent regulatory agencies are merely requested to release their plans “to the public.”

In conclusion, from a very real and long-standing point of the understanding of the separation of powers, the president essentially has no direct supervisory powers over the SEC, the CFTC, or the Federal Reserve. Rather, those who wish to stymie or reverse the regulatory efforts of these entities must look to Congress as well.

Conclusions, or “So what?” 

Federal regulation is a fact of life.  Even if one could contemplate a politically feasible way to eliminate massive swathes of existing regulations, good taste dictates that one should “dance with the one who brung ya.” In this case, that means that the total estimated cost should be compared with the total estimated benefits.  The points I have tried to make is that, relative to the 2012 election, there are two key points to consider:

  1. Even as presented by the Romney campaign, the expansion of the estimated costliness of federal regulations since 2009 has been modest, growing more slowly than during President George W. Bush’s first term.
  2. The president, regardless of party, lacks the authority to directly control the regulatory activity of the independent agencies responsible for the recent regulations estimated to be the most costly.
My goal in making these points is to focus the debate on the costs and benefits of specific regulations.  These are important policies and deserve to be discussed on the merits, as opposed to aggregate estimates that lack context.  With that in mind, I leave you with this.

 

Debits and Credits: Simple Budget Algebra

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The US Federal Government faces a looming “fiscal cliff” as a result of current law calling for a simultaneous set of across-the-board cuts in spending and a rise in various tax rates.

There are many interesting aspects to this scenario, particularly given the divided partisan control of the two chambers of Congress.

Digression. Because Congress must send something to the President’s desk before he can sign it into law, this division is in some ways sufficient. The fact that this is an election year makes it even more interesting, as the collective impact of members’ electoral incentives in the House and Senate are quite different due to the overlapping electoral schedule in the Senate.  One final twist in this saga is the fact that this is the first election after the 2010 reapportionment of the House, meaning that a few members are running against each other and many more members are running for reelection in altered districts.  But much of that is a matter for discussion in a later post.)  

Today, I want to focus on a related question:

How might the federal budget be balanced without increasing revenues?

Before continuing, let me be clear:

  1. I am not arguing in favor of any particular solution (or even that an unbalanced budget is a problem that needs to be solved), but…
  2. I am arguing that balancing the budget without new revenues would require spending cuts that are either
    1. politically impossible (e.g., cutting Social Security without (permanently) cutting payroll taxes; slashing the defense budget),
    2. ridiculous (e.g., eliminating veterans’ benefits; shutting down the FBI), or
    3. both (e.g., eliminating Medicaid).

Digression. Yes, I do believe that the “Norquist Pledge” is incompatible with responsible government and/or the general maxim to not sign a pledge you don’t intend to uphold.

My purpose here is simply to provide a brief introduction to the budget and make the structure/composition of federal spending as clear as possible.  After all, it is not surprising that the federal budget is in some ways complicated and, after all, involve numbers that we rarely use and all rhyme with “Maximilian.”  What is a little surprising is that the federal budget can be described in fairly succinct terms that are also politically meaningful.

Note: All statistics reported here were drawn directly from the various historical tables/projections produced by the Office of Management and Budget. One could do the same thing using numbers from the Congressional Budget Office, too. I have no reason to believe that the differences would be particularly interesting.

Q. What is the size of the budget deficit?This is simultaneously a simple and complicated question.  First, for which year?  I will focus on the projected 2012 budget deficit.  Past budget numbers are obviously less desirable to use, and more distant projections are both (understandably) less reliable and (generally) partisan.  Second, “on-” or “off-budget?”  I will include “off-budget” items, too.  This is a judgment call, as this brings in most notably Social Security, which makes the corresponding budget deficit smaller.  (Precisely, federal trust funds are currently generating a surplus of a hair shy of $100 billion, which is about 7% of the total 2012 deficit. Oops, that gave it away.)

A. The 2012 budget deficit is $1.32 trillion. (The on-budget 2012 deficit is $1.42 trillion.)

Q. How much does the federal government spend?

A. With the caveats discussed above about the definition of the deficit, the federal government is projected to spend $3.8 trillion in 2012.  (Thus, revenues are projected to be $2.48 trillion.)

Q. What are the ten largest categories of spending?This, too, is a complicated question.  While a dollar is a dollar most days of the week, federal spending is famously not so simple.  Broadly speaking, spending comes in two forms: discretionary and non-discretionary.  Non-discretionary spending consists of two main components: “entitlements” and repayment of federal debt.  I will return to these distinctions below.  For now, let’s just treat a dollar as a dollar.

A. The ten largest categories of spending are (I’ll come back to the ones in quotes):

  1. Social security ($778 billion)
  2. Defense ($716 billion)
  3. “Income security” ($580 billion)
  4. Medicare ($484 billion)
  5. Health  ($362 billion) — This is mostly, but not entirely, Medicaid.
  6. Net interest ($225 billion)
  7. Education, Training, Employment, and Social Services ($139 billion)
  8. Veterans benefits and services ($130 billion)
  9. Transportation ($103 billion)
  10. Commerce and Housing Credit ($80 billion)It is useful to note that top top 3 categories account for over 50% of the federal government’s projected spending.  Furthermore, the top 2 categories are larger than the projected deficit.  

Q.What the heck is “Income Security,” and where can I get some?

A. The five largest individual subcategories in this category of federal spending are:

  1. Federal employee retirement and disability ($127 billion)
  2. Food and nutrition assistance ($113 billion)
  3. Unemployment compensation ($108 billion)
  4. Housing assistance ($60 billion)
  5. General retirement and disability insurance (NOT social security) ($8 billion)Thus, if you break these out individually, they would each rank no higher than 8th. As far as getting some of it, clearly the best way is to get a job with the federal government.

Q.What would I have to cut to balance the budget without increasing revenues?

A. Well, this is complicated—what’s fair game?  I will presume that net interest is off the table.  Similarly, though with less conviction, Social Security and Medicare are tough nuts to crack and, at least right now, the true impact of Social Security on the budget is small (regardless of whether positive or negative), unless one thinks that we could cut benefits without cutting the payroll taxes that are deposited into the Social Security trust fund.  First, consider how to answer the question without cutting defense spending (because, among other reasons, defense spending is a very complicated and variegated category).

These add up to about $2.2 trillion, or about 90% of projected 2012 revenues.
This plan leaves approximately $300 billion left to spend….and this is without funding veterans’ benefits, the FBI, federal prisons, the INS, or the federal courts…not to mention food stamps, highways, unemployment insurance, student loans….  In fact, there’s not enough even to fund Medicaid at its current levels.

A2. There’s no simple answer (or, rather, there are lots of simple answers—it’s just not clear what the “right one” is).  But reversing the logic makes clear what is not a very effective approach to balancing the budget: cutting discretionary domestic spending.  For example, suppose that the federal government simply and completely “got out of the business” of things like food assistance, unemployment insurance, pensions for federal employees, transportation projects like the interstate highway system, high speed rail, public transportation grants to state and local governments, higher education, research, and the like.  The total savings of these cuts?  Less than $600 billion. It’s a lot of money, to be sure, but that is less than 50% of the budget deficit.  In other words, even if the federal government eliminated all discretionary spending, we would still be running a deficit of over $700 billion.

In sum, if one believes that the most important priority for the federal government is to balance its budget (and, again, I do not think this should be the most priority to either conservatives or liberals), then you must also believe, as a corollary, that one or more of the following must be done:

  1. social security and/or medicare must be cut (without cutting payroll taxes commensurately),
  2. the defense budget must be slashed, and/or
  3. federal revenues must be raised.
(As a matter of constitutional fidelity and good taste, I withhold the option of defaulting on the debt.  It’s not nearly as effective a deficit cutter as some might think, anyway.  That’s why people still lend us money at interest rates essentially equal to zero.)

Hopefully I’ll find time in the near future to explain the structure of the revenue changes that have been proposed and/or might occur if we fall off the “fiscal cliff.”  In the meantime, I leave you with this.