Monday, November 13, 2017

Low effective rate not an argument against corporate tax cut


President Trump says that U.S. corporations face the highest tax rates in the world, whereas opponents of his tax reform say that “actual” corporate tax rates are in line with other countries. What gives?

The president is referring to the rate that applies to taxable corporate income, known as the “statutory rate.” The federal statutory rate is 35 percent, and the combined federal-state corporate rate is typically about 39 percent. This rate is greater than anywhere in the industrialized world.

But the statutory rate does not apply to all of the income-generating activities of corporations, because some of those activities create deductions that can be subtracted from business income for corporate-tax purposes.

Debt-financed activities are a good example, because the income they generate goes corporate-tax free to the extent that it can be distributed to investors as interest income.
Intellectual property investments are another example, because they are not obviously attached to a physical location, thereby helping accountants assign their returns to Ireland and other low-tax jurisdictions.

As a result, corporations are paying less than 39 percent of their income to state and local treasuries. The Government Accountability Office estimates 17 percent, which it calls the “effective rate.”
It might seem that the 22-percentage-point difference results in a free lunch for corporations at the government’s expense. But the opponents of corporate tax reform are mistaken to ignore the fact that the corporate tax has corporations paying a lot more than the checks they write to government treasuries.

The Internal Revenue Service (under the Obama administration) estimated that corporations and partnerships pay over $100 billion annually in complying with business-tax laws, including their costs of recording, keeping and hiring paid tax professionals. Compliance costs are not checks written to the government, but are real costs nonetheless.

In fact, the high compliance costs are a symptom of the low effective rate because business-tax deductions are a complicated enterprise. Corporations are paying for some of their 22-point savings in terms of the extra compliance costs that come with complicated tax strategies.

More important, our economy is less productive because taxes have induced investors to pursue tax-favored activities beyond what value creation would dictate. The most vivid example is the housing sector, where returns have been depressed by a factor of two or three because those returns are essentially tax free.

In other words, by having so many deductions, the corporate tax involves a substantial hidden tax on businesses beyond what they pay the government, with the extra payment in terms of lost income.

The chart below illustrates by splitting the economy into two kinds of activities: those that pay full tax and those that are tax favored.

If nobody adjusted their investment plans, the tax-favored activities would be a great deal — they would earn the amount up to the dashed line and owe no tax. But there is no free lunch. The tax favors induce investors to engage more in those activities.

Their movement depresses the income accruing there — otherwise nobody would be willing to do the activities subject to full tax. The chart illustrates this by showing how the income ultimately earned has been depressed enough so that the net-of-tax earnings is the same for both types of activities.

The low effective corporate tax rate is therefore not an argument against President Trump’s call for tax reform. That low rate is further evidence of the economic damage done by the tax, as businesses pay to comply and pay by accepting comparatively low-return investments.

Because the effective rate only counts costs in the form of payments to government, a low effective rate is telling us that cutting the corporate tax will benefit economic performance far more than it will cost government treasuries.

Sunday, November 5, 2017

Does Communism have a universal constant? From the October Revolution to Bernie Sanders

To acknowledge the 100th anniversary of the Russian revolution, I have assembled data -- from Holmes (2009), Pipes (2001), Fontova (2013), and others -- on Communist regimes that lasted more than 5 years.
[Communists] openly declare that their ends can be attained only by the forcible overthrow of all existing social conditions. Let the ruling classes tremble at a Communistic revolution. The proletarians have nothing to lose but their chains. They have a world to win. Working men of all countries, unite!

(1) The chart below counts Communist state killings -- war deaths not included -- of its own people by purge, massacre, concentration camp, forced migration, famine, or escape attempt.

The counts are expressed as a percentage of population. 6% is a typical result.

You might say, "94% of people survive Communist regimes." But that's a lot less than the percentage of people who survived history's major tragedies. The U.S. Civil War was especially deadly, but "only" killed 2% of the population and, unlike the 6% above, this counts war deaths (civilian deaths were more like 0.2%). AIDS/HIV killed "only" 2% of Africa's population.

(2) Facts about Communist results are not part of the standard training in economics. Indeed, as recently as 1989, they were denied by some of our best and brightest. E.g., Samuelson and Nordhaus' best-selling textbook asserted "the Soviet economy is proof that, contrary to what many skeptics had earlier believed, a socialist command economy can function and even thrive."

(3) Another example: this year's New York Times commemorated the Russian revolution with fantastic claims such as "Women had better sex under socialism." That article shows a photo of a smiling woman on "a collective farm near Moscow" without mentioning how the Communist system left women and men so malnourished that their bodies no longer functioned normally. Take a look at the birth rate in Ukraine under Stalin:
Click here for a similar picture for China under Mao.

(4) The above are examples of the intellectual class indulging their fantasies about the effects of apparently well-intentioned public policies. But the more general phenomenon was that results were suppressed, both outside and inside the Communist countries, because they were unpleasing to those in power.

(5) Disastrous results can more easily become public when there is competition both in the media and in the public sector. Obviously the Communist regimes operate in a one-party system. But even in our political system, the competition is far from perfect, and both media and state officials sometimes work together to attract attention away from negative results.

It is not so easy to have a government that tightly controls economic resources, but is unable and unwilling to exercise control over ideas. 

Perhaps even Senator Bernie Sanders, who has admired more than one Communist regime and insists that government should freely provide everything from health care to college to housing, might now notice as much: his presidential campaign was one of the most recent victims of the Party Line and political collusion.

Friday, November 3, 2017

Stanford University findings on the ACA and the labor market

Stanford Economics Professor Mark Duggan was quoted as concluding that

"While the Affordable Care Act had a significant effect on health insurance coverage, it did not have a substantial effect on the U.S. labor market as many had expected" and

"the Affordable Care Act has not had the negative effect on jobs the law’s critics claimed it would."

He was referring to a working paper distributed by the National Bureau Economic of Research, which states that

labor market outcomes in the aggregate were not significantly affected.”

Theirs is a working paper and I'm sure that the authors are eager to add data and analysis, so I understand the above conclusions to have been modestly offered. With that said, it is worth recognizing that the above conclusions are not what the working paper shows.

  1. Table 4 (the paper's first table on labor market outcomes) shows that the ACA reduced nationwide labor force participation by 349,190 in 2016, plus however much the ACA reduced labor force participation in a geographic area that was fully insured before the ACA, which I call the HFIA (Hypothetically Fully Insured Area).  This effect is economically significant and, when combined with items (2) and (3) below, is easily in line with "the negative effect on jobs that the law's critics claimed it would be."

    [Admittedly, the 349,190 is probably not statistically significant by the usual criteria, but the quotes above are not claiming that either side could be correct. Rather they claim to decisively reject "critics" who made claims right in line with the Duggan-Goda-Jackson point estimate. See below for the derivation of the 349,190]

  2. The paper assumes, without much explanation, that the HFIA part of the ACA's impact is zero.  But other work has shown that near-elderly insured people were given a tremendous incentive to retire early.  In other words, basic economics tells us that the HFIA part is likely positive (i.e., in the same direction as the 349,190) and we should not assume it to be close to zero until we have further measurement.

  3. The empirical methods in the paper, which emphasize differences among geographic areas such as Medicaid expansion states versus other states, are not designed to detect effects of the employer penalty.  The employer penalty is the same amount throughout the nation.  The penalty creates large labor-market distortions; those distortions that have been measured in other studies have proven to be similar across geographic areas.  Moreover, the employer penalty did not apply until the 2016 coverage year, whereas 8/9 of the working paper's data is before that date. This is an especially serious problem for the low-income population, where the employer penalty in effect has them working 50-60 days per year for the government, on top of the implicit and explicit employment/income taxes they would pay even without the ACA (this fact is nowhere mentioned in the paper). For this reason, the authors' claim than that "lower income individuals were actually incentivized to work more" is especially incredible.

To derive the 349,190, look at the first "Out of the labor force" column of that table.  The first row says that the M variable reduces out of the force by 0.0847 on average for each working-age person in the U.S.  The second row says that the E variable increases out of the labor force by 0.0962.  The mean of the M and E variables are, respectively, 0.073 and 0.086 (p. 11 of the paper). So, relative to the HFIA, their regression says that the U.S. has increased out of the labor force by 0.0021 per working-age person:

0.0021 = 0.073*(-0.0847) + 0.086*(.0962)

To get a number of people, multiply by the number of working age people (difference between these two), and you get 349,190.