Sales Tax Hikes During the Recession

Sales taxes have been hiked by several states and localities as their revenues declined with the economy. I estimate that the weighted-average state sales tax rate increased 0.5 percentage points from 2007 to 2010.

When you consider the narrowness of the sales tax base relative to the payroll tax, the state sales tax hikes are equivalent to a 0.2 percentage point payroll tax hike in terms of their national labor market impacts.

Employment Reducing Policy List Updated

This addition comes from MJ Perry:

• Means-tested health insurance benefits
• Extra taxes for multi-national corporations (see Wall Street Journal; HT Greg Mankiw)
• mandating the employers with large payrolls provide health insurance, but that employers with small payrolls do not,
• penalizing employers for providing the type of health insurance they did in the past,
• minimum wage hike
• means-tested mortgage modification (presenting millions of workers with implicit tax rates in excess of 100% (sic)),
• means-tested new home buyer credit,
• mean-tested student loan modification,
• unemployment insurance extensions,
• state income tax hikes,
• IRS means-tested enforcement of prior tax debts,
• planning for new-hiring-tax-credits,
• marginal federal tax rate hikes on the "rich"!

Cartoon About Work Incentives

Here's the serious version.

Employment Reducing Policy List Updated

The list of employment-reducing public policies grows yet again:

• Means-tested health insurance benefits
• Extra taxes for multi-national corporations (see Wall Street Journal; HT Greg Mankiw)
• mandating the employers with large payrolls provide health insurance, but that employers with small payrolls do not,
• minimum wage hike
• means-tested mortgage modification (presenting millions of workers with implicit tax rates in excess of 100% (sic)),
• means-tested new home buyer credit,
• mean-tested student loan modification,
• unemployment insurance extensions,
• state income tax hikes,
• IRS means-tested enforcement of prior tax debts,
• planning for new-hiring-tax-credits,
• marginal federal tax rate hikes on the "rich"!

Addition to the Long List of Employment-Reducing Policies

The list of employment-reducing public policies grows yet again:

• Extra taxes for multi-national corporations (see yesterday's Wall Street Journal; HT Greg Mankiw)
• mandating the employers with large payrolls provide health insurance, but that employers with small payrolls do not,
• minimum wage hike
• means-tested mortgage modification (presenting millions of workers with implicit tax rates in excess of 100% (sic)),
• means-tested new home buyer credit,
• mean-tested student loan modification,
• unemployment insurance extensions,
• state income tax hikes,
• IRS means-tested enforcement of prior tax debts,
• planning for new-hiring-tax-credits,
• marginal federal tax rate hikes on the "rich"!

Another Entry for the Employment-Reducing Policies List

The list of employment-reducing public policies grows yet again:

• mandating the employers with large payrolls provide health insurance, but that employers with small payrolls do not,
• minimum wage hike
• means-tested mortgage modification (presenting millions of workers with implicit tax rates in excess of 100% (sic)),
• means-tested new home buyer credit,
• mean-tested student loan modification,
• unemployment insurance extensions,
• state income tax hikes,
• IRS means-tested enforcement of prior tax debts,
• planning for new-hiring-tax-credits,
• marginal federal tax rate hikes on the "rich"!

Another (40 Percent) Marginal Tax Rate

I have emphasized the large implicit marginal tax rates faced by homeowners (with mortgages under water), but renters face a large implicit marginal tax rate too. Professor Kevin M. Murphy writes me:

"You might want to note that the $8,000 new home buyer tax credit provides an additional 40% marginal tax for single households with between 75K and 95K in income and married households with between $150k and $170K of income."

If you are single and a first time home buyer (thus, single but NOT currently a homeowner), you get the full $8000 if you earn less than $75K but nothing if you earn more than $95K. Thus, by earning $20K beyond $75K this person gives up $8 in tax credits (not to mention paying the usual income and payroll taxes). 40% = 8K/20K.

The list of employment-reducing public policies keeps growing:

• mandating the employers with large payrolls provide health insurance, but that employers with small payrolls do not
• minimum wage hike
• means-tested mortgage modification (presenting millions of workers with implicit tax rates in excess of 100% (sic))
• means-tested new home buyer credit
• mean-tested student loan modification
• unemployment insurance extensions
• state income tax hikes,
• IRS means-tested enforcement of prior tax debts
• marginal federal tax rate hikes on the "rich"!

Terrible Incentives Abound

I have always suspected that this recession has proliferated private-sector-means-testing (and the bad incentives that go with means testing). Now I have proof.

Work Disincentives in the Health Care Bill

As it stands, the health care bill would add to work disincentives. Note specifically the part where health care officials would use tax returns filed with the IRS 'to determine who qualifies for "affordability credits."'

In other words, reporting income to the IRS would not only increase what you pay in federal income tax, and increase how much you pay on your mortgage, and increase how much you pay on your student loan, and increase how much you pay in state income tax, but also increase what you pay for health care.

The Laws of Economics Have Been Suspended

The gurus say that incentives do not matter, at least until this recession is over.

"Traditionally, many economists have been leery of prolonged unemployment benefits because they can reduce the incentive to seek work. But that should not be a concern now because jobs remain so scarce, said Lawrence Katz, a labor economist at Harvard." as quoted by the New York Times.

Professor Krugman is also saying this week that this recession has nothing to do with bad incentives to earn labor income. (Bless him for citing me! When this is all over, I would love to have a monopoly on teaching the "old fashioned" laws of economics.)

I don't quite understand this obsession with UI-apologetics, because UI (unemployment insurance) is just one of many policies that collectively (and some by themselves) create terrible incentives:

• mandating the employers with large payrolls provide health insurance, but that employers with small payrolls do not
• minimum wage hike
• means-tested mortgage modification (presenting millions of workers with implicit tax rates in excess of 100% (sic))
• mean-tested student loan modification
• unemployment insurance extensions
• state income tax hikes,
• IRS means-tested enforcement of prior tax debts
• marginal federal tax rate hikes on the "rich"!

According to Professor Krugman, I am the only one crazy enough to suggest that a list of bad incentives like this might actually show up in the aggregate data!

Government Makes it Worse: Add Minimum Wage Hike to the List

Later this month, the federal government will add to its lists of employment-destroying public policies that have appeared or enlarged since mid-2008:

• minimum wage hike
• means-tested mortgage modification
• mean-tested student loan modification
• unemployment insurance extensions
• state income tax hikes,
• IRS means-tested enforcement of prior tax debts
• marginal federal tax rate hikes on the "rich"!

How long will this list get before more economists recognize that government has done more harm than good during this recession?

Flashback: The Marginal Tax Rate Hike of 2009

As I explained in January, marginal tax rates were increased in 2009:

Today Reuters reports "IRS agents were given more flexibility in their collection actions, including the ability to reduce or suspend monthly payments on back taxes so those hit hard by the financial downturn are not forced to default on their tax payments." In plain language: the IRS will give you a payment reduction ONLY if you demonstrate if your income is low.

I explained in a number of previous posts (here, here, here, here, here, here, here, here, and here) how when mortgage debt collectors offer forgiveness, but only for persons with incomes that are low in comparison with their debts, that creates financial disincentives for working.

You might guess that the economics is much the same for tax debt collectors: when they offer forgiveness, but only for persons with incomes that are low in comparison with their debts, that creates financial disincentives for working. That's why I call that new IRS policy a marginal tax rate hike, even if the result is to reduce tax collections.

Labor Market Distortions are Real

Some of the commenters have put up a "perfectly efficient markets" straw man as an argument against the use of supply and demand to understand today's economy. It is probably my fault for not previously elaborating on this point.

I think there are many distortions in the labor market. See, for example, my A Century of Labor-Leisure Distortions or my Public Policies as Specification Errors. Supply and demand continue to be useful in this setting, as long as you recognize that multiple prices exist in the marketplace.

Suppose, for example, that a distortion existed because of an inefficient intermediary. For example, the price of oil might be $50 in Illinois, but $45 in Texas, because oil comes from the Middle East to Illinois via Texas. We can still talk about supply and demand for oil in Illinois. We just have to be careful that the supply of oil to Illinois embodies more than just the behavior of Middle East oil producers and trans-Atlantic shippers -- it also involves the behavior of the Texas intermediary. Or we might analyze the demand for oil from the Middle East, in which case we have to recognize that it is not just Illinois behavior, but Illinois behavior is intermediated by the Texas middle-men. So the Texas middle man appears on the supply side in one analysis, and on the demand size in the other.

Now back to the labor market. None of my posts refer to "wages" -- that is intentional. I refer to PRODUCTIVITY. This means that a whole bunch of things in the labor market appear on the supply side! That includes everything from sticky wages to employer taxes to (hypothetically -- don't lynch me!) worker laziness. You might say that makes the analysis without content because it has an excessively narrow concept of demand -- it might in principle but in practice it has enabled me to distinguish this recession from several others -- other recessions did have labor demand reductions, even under my narrow definition.

One commenter said that bad employer incentives (I guess an employer tax would fit in that category) have to be considered "demand". That comment is incorrect if the analysis treats, as mine does, the "price" as productivity. In my analysis, a payroll tax owed by employers would properly appear on the supply side of the labor market.

IMPLICATIONS FOR "PRODUCTIVITY WEEK"

Because I have put a variety of behaviors on the supply side of the market, the productivity and employment numbers by themselves do not tell us whether sticky wages, employee preferences, bad working conditions, taxes, or some other factor outside the production process caused the "Labor Supply Shift of 2008." The next phase of the analysis is therefore to investigate some of the specific distortions (get a preview of this here, here, here, here, here, here, here, here, and here.