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Today’s Economist: Bruce Bartlett: Declining Wealth, Rising Retirement Risk

March 26, 2013 by Leave a Comment

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Bruce Bartlett held senior policy roles in the Reagan and George H.W. Bush administrations and served on the staffs of Representatives Jack Kemp and Ron Paul. He is the author of “The Benefit and the Burden: Tax Reform – Why We Need It and What It Will Take.”

In a recent post, I examined aggregate national wealth from the Federal Reserve Board’s flow of funds statistics. They show that while national wealth is now approximately back to its precrisis level, the composition of it has changed. Much more is now held in the form of such financial assets as stocks and much less in nonfinancial forms such as housing. This is important, economically and distributionally, because the wealthy are much more likely to be invested in stocks and bonds, while the middle class has more of its wealth in home equity.

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Several new studies cast further light on the composition and distribution of wealth, with implications for the ability of millions of Americans to retire and have an adequate retirement income.

On March 21, the Census Bureau published data on median household wealth – the median is the exact middle of the distribution of wealth. It shows that between 2000 and 2005, median wealth increased significantly, to $106,585 from $81,821. It then fell to $68,828 in 2011. Thus, although the stock market is close to its prerecession peak and aggregate national wealth has largely been restored, the median family’s wealth is still considerably below its peak and needs to rise considerably just to get back to where it was in 2000.

The reason, of course, is that the housing market continues to lag. As Figure 1 illustrates, virtually all of the change in wealth since 2000 has been accounted for by the rise and fall of home equity, which closely tracks the price of homes.

Median net worth of households, in 2011 dollars. Median net worth is the sum of the market value of assets owned by every member of the household minus liabilities owed by household members; the Case-Shiller Home Price Index is a measure of home values that tracks home prices in 20 metropolitan regions.United States Census Bureau, Survey of Income and Program Participation, 1996, 2001, 2004 and 2008 Panels Median net worth of households, in 2011 dollars. Median net worth is the sum of the market value of assets owned by every member of the household minus liabilities owed by household members; the Case-Shiller Home Price Index is a measure of home values that tracks home prices in 20 metropolitan regions.

On the other hand, households have grown less dependent on housing wealth over time. In 1984, 41 percent of wealth was held in the form of home equity. By 2000, that percentage had fallen to 30 percent; in 2011 it was 25 percent.

A key reason for this change has been the switch from defined-benefit to defined-contribution pension plans. In the former, workers are promised a specific income at retirement, which the employer provides. The employer bears all the risk of market fluctuations.

Under a defined contribution scheme, such as a 401(k) plan, the worker and the employer jointly contribute to a tax-deductible and tax-deferred account from which the worker will finance retirement. Thus, to a certain extent, the growth of pension wealth is more apparent than real.

The worker always, in effect, owned the assets from which his pension was paid; he just never saw them or benefited when the stock market increased, nor did he suffer when the market fell. With a 401(k) account, the worker knows the present value of his retirement saving at the close of the market every day.

There are several big problems in this shift to defined-contribution pension plans. One is that workers don’t take advantage of them or fail to contribute the maximum contribution they are permitted to make. Another is that they fail to invest in stocks and instead put their money into certificates of deposit or other investments that tend to underperform stocks in the long run. Workers may also be unwise in choosing investment advisers and end up paying a lot in unnecessary fees that can be very costly to returns.

These mistakes are hardly surprising. Under defined-benefit plans, companies hired professional money managers to invest their pension funds. The average worker can hardly be expected to have the same level of expertise, nor do they have the time to investigate their options adequately. They also tend to be excessively risk-averse and invest too conservatively.

Now the first generation of workers who have virtually all their pension saving in defined-contribution plans is nearing retirement, and the news isn’t good. According to a March 19 report from the Employee Benefit Research Institute, only about half of workers nearing retirement have confidence that they have enough money saved for an adequate retirement.

Not surprisingly, retirement saving has taken a back seat to more pressing concerns – coping with unemployment, maintaining standards of living during an era of slow wage growth, putting children through increasingly expensive colleges and so on. People may also have simply underestimated how much money they needed to save in the first place.

This problem is much more severe for black Americans. According to a new study by the Institute on Assets and Social Policy at Brandeis University, black families have considerably less wealth than white families even when their incomes are comparable. Over a 25-year period, a $1 increase in income generated $5.19 in wealth for white families but just 69 cents for black Americans.

The study identified several possible explanations: years of homeownership, household income, spells of unemployment, education, and inheritances from parents. With regard to housing in particular, white families generally bought homes at an earlier age, thus building home equity longer; white families tended to get better mortgages, in part because they made larger down payments. Black Americans bought homes in poorer areas where there was less home price appreciation.

The wealth gap isn’t only racial, it’s generational. According to a March 15 study from the Urban Institute, young people today have considerably less wealth than their parents did at the same stage of life.

Factors include young people buying homes at a market peak and hence suffering disproportionately from the decline in home prices; they also put less money down, making it more likely that they have negative home equity. Younger workers have also tended to marry at a lower rate, have lower incomes than their parents, pay much higher costs for health insurance, and are more likely to graduate with college debts.

What’s really depressing about these studies is the lack of solutions and the likelihood that the problem will only get worse.

Republicans in Congress have pressed for years to convert Social Security, a classic defined-benefit pension, into a defined contribution plan, and also to convert Medicare into a voucher program. These changes would shift even more of the financial risk in retirement onto families that have yet to adapt to fundamental changes in employer pensions and the economy over the last 30 years. The future doesn’t look pretty.

Article source: http://economix.blogs.nytimes.com/2013/03/26/declining-wealth-rising-retirement-risk/?partner=rss&emc=rss

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Today’s Economist: Bruce Bartlett: The Politics of the 14th Amendment and the Debt Limit

March 19, 2013 by Leave a Comment

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Bruce Bartlett held senior policy roles in the Reagan and George H.W. Bush administrations and served on the staffs of Representatives Jack Kemp and Ron Paul. He is the author of “The Benefit and the Burden: Tax Reform – Why We Need It and What It Will Take.”

In 2011, Republicans in Congress drove the nation to the very brink of defaulting on the national debt. During that debate, a number of conservatives argued that default was no big deal — that the debt was so terrible that default was a reasonable option to be considered. Although few Republicans agreed with this position, probably all agreed with Senator Mitch McConnell of Kentucky, the Senate minority leader, that the debt limit was a hostage worth ransoming to force President Obama to surrender to their demands.

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The most recent debt-limit extension was enacted in January and expires on May 19. On March 12, Senator McConnell signaled that he again planned to hold it hostage to Republican demands that programs to aid the poor and elderly be slashed.

In a March 13 interview with the radio host Sean Hannity, the House speaker, John A. Boehner of Ohio, said repeal of the Affordable Care Act might be the ransom that will have to be paid for raising the debt limit. “Do you want to risk the full faith and credit of the United States government over Obamacare?” he said. “That’s a very tough argument to make.”

In 2011, a number of respected legal scholars asserted that a little-known provision of the 14th Amendment to the Constitution essentially invalidated the debt limit. That provision states:

Sec. 4. The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned. But neither the United States nor any State shall assume or pay any debt or obligation incurred in aid of insurrection or rebellion against the United States, or any claim for the loss or emancipation of any slave; but all such debts, obligations and claims shall be held illegal and void.

Other scholars contended that this constitutional provision was archaic, that it related to factors specific to the post-Civil War period and had no present-day relevance. On the contrary, I believe a careful review of the circumstances surrounding enactment of the 14th Amendment shows a great deal of similarity to those today.

Such a review was recently done by Franklin Noll, a historian who is a consultant to the Treasury Department’s Bureau of Engraving and Printing, and posted on the Web site of the Social Science Research Network.

Mr. Noll points out that there was strong support for repudiating the Civil War debt among Democrats, who were closely aligned with the Confederate South. They were angered that Congress had explicitly repudiated all the Confederate debt, and had refused to compensate slave owners for freeing their valuable slaves, and Southerners had no desire to help pay the Union’s debts.

One problem for Republicans was that the 13th Amendment abolished the clause in the Constitution that counted slaves as three-fifths of a man for the purpose of apportioning seats in the House of Representatives. The ironic result was to increase the South’s representation in the House. The 11 states of the Confederacy saw their representatives rise to 73 in 1870 from 61 in 1860. They would also have 22 of the Senate’s 74 seats.

It was feared that readmission of the Southern states, together with Democrats from the north, would provide enough votes to prevent passage of legislation to fund the debt. Hence Republicans believed it was essential to have constitutional protection for the national debt.

The forces of repudiation found strong support in the departing President Andrew Johnson, a Democrat from Tennessee whom Abraham Lincoln put on the Republican ticket in 1864 in a spirit of unity to save the Union. In his last State of the Union address, on Dec. 9, 1868, Johnson contended that the cost of the debt was so high that repudiation was justified. He declared:

This vast debt, if permitted to become permanent and increasing, must eventually be gathered into the hands of a few, and enable them to exert a dangerous and controlling power in the affairs of the government. The borrowers would become servants to the lenders, the lenders the masters of the people. We now pride ourselves upon having given freedom to 4,000,000 of the colored race; it will then be our shame that 40,000,000 of people, by their own toleration of usurpation and profligacy, have suffered themselves to become enslaved, and merely exchanged slave owners for new taskmasters in the shape of bondholders and tax gatherers.

Johnson proposed that the Treasury cease paying interest on a large portion of the debt and instead use that money to retire the debt. “The lessons of the past admonish the lender that it is not well to be over-anxious in exacting from the borrower rigid compliance with the letter of the bond,” he said.

Supporters of repudiation, however, had two big political problems to overcome. First, much of the Civil War debt was owned by average people. Historically, financial institutions had bought almost all the Treasury’s bonds, but the amount of bonds needed to be sold during the war required creation of a mass market for Treasury securities.

Second, the debt was closely identified in the public mind with the war itself. As Mr. Noll explains: “The wartime debt became inextricably entwined with the patriotism and moral purpose of the Civil War. To attack the public debt was therefore an attack on the wartime sacrifices and the righteousness of the war to preserve the Union and abolish slavery.”

For this reason, people were willing to bear a much heavier burden of taxation than existed before the war, making the promises of tax relief from debt repudiation fall on deaf ears.

The purpose of the debt provision of the 14th Amendment was to say that national debt was beyond the realm of politics. In the words Jack Balkin, a Yale law professor: “It was stated in broad terms in order to prevent future majorities in Congress from repudiating the federal debt to gain political advantage, to seek political revenge or to try to disavow previous financial obligations because of changed policy priorities.”

Republican threats to hold the debt limit hostage to their agenda today present precisely the sort of political situation contemplated by the authors of the 14th Amendment.

Article source: http://economix.blogs.nytimes.com/2013/03/19/the-politics-of-the-14th-amendment-and-the-debt-limit/?partner=rss&emc=rss

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Today’s Economist: Bruce Bartlett: The Growing Corporate Cash Hoard

February 12, 2013 by Leave a Comment

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Bruce Bartlett held senior policy roles in the Reagan and George H.W. Bush administrations and served on the staffs of Representatives Jack Kemp and Ron Paul. He is the author of “The Benefit and the Burden: Tax Reform – Why We Need It and What It Will Take.”

Last week, the investor David Einhorn sued Apple, in which his hedge fund is a large shareholder, to prevent it from taking actions that would allow it to continue holding onto its $137 billion in cash, rather than paying it out as dividends.

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Mr. Einhorn’s action highlights a growing problem: many corporations are holding vast amounts of cash and other liquid assets, using them neither for investment nor to benefit shareholders. These assets are largely earned and held overseas, and not subject to American taxes until the money is brought home.

Such tax-avoidance techniques, while legal, have come under increasing political attack. On Thursday, Senator Bernie Sanders of Vermont introduced legislation to end deferral and force multinational companies to pay taxes on their foreign-source income.

According to the Federal Reserve, as of the third quarter of 2012 nonfinancial corporations in the United States held $1.7 trillion of liquid assets – cash and securities that could easily be converted to cash.

By any measure, corporate cash holdings appear to be high and rising.

According to the Federal Reserve, nonfinancial corporations historically held liquid assets of 25 to 30 percent of their short-term liabilities. But this percentage began rising in 2001 and now tends to be in the 45 to 50 percent range. In the third quarter of 2012, it was 44.9 percent.

A recent study by Juan Sánchez and Emircan Yurdagul of the Federal Reserve Bank of St. Louis looked at the ratio of cash to assets at all publicly held nonfinancial, non-utility corporations. They found that, historically, such corporations held cash equal to about 6 percent of their assets, but that began rising in 1995 and is now more than 12 percent, as seen below.

Federal Reserve Bank of St. Louis analysis of Compustat data

One obvious explanation for higher cash holdings by corporations is the uncertainty of the economic environment in the aftermath of the financial crisis. They may also face greater difficulty in getting credit on short notice and need to hold more cash as a precaution.

Another explanation, put forward by the economists Thomas W. Bates, Kathleen M. Kahle and René M. Stulz, is that the growing research-and-development intensity of corporations forces them to hold more cash than they used to. They also note that companies hold fewer inventories and accounts receivable than they used to. And, they say, these factors make corporate cash flow less dependable than previously, thus necessitating the need for higher cash holdings.

A 2011 study by the International Monetary Fund (see Pages 44-49) suggests that higher cash holdings by corporations are simply a sign that they plan new investments in the near future. It says this is a “good omen,” which indicates that “investment could increase substantially over the next year or two.”

However, the dominant explanation for the increased liquidity of nonfinancial corporations appears to be the growing role of multinational corporations and the profits of their foreign operations.

In a 2006 speech, the Federal Reserve Board governor Kevin Warsh noted that higher corporate cash holdings were dominated by those with foreign operations. Between 2001 and 2004, the ratio of cash to assets at domestic-only corporations increased 20 percent, while it increased 50 percent among multinational corporations.

While this may indicate that multinational corporations expect better growth potential among their foreign subsidiaries and plan additional offshore investments, a more likely explanation is tax-based.

Under American tax law, corporate profits generated offshore are taxable, with a tax credit for taxes paid in foreign jurisdictions. But American taxes don’t apply unless and until such profits are repatriated to the United States. Thus, as long as profits are held abroad, United States taxes are deferred indefinitely.

A 2007 study in the Journal of Financial Economics found that among multinational corporations, those facing higher repatriation taxes tended to hold more cash abroad than those facing lower tax burdens. Moreover, cash holdings tend to be higher in countries with low taxes than those with high taxes. Tax sensitivity appears to be more pronounced among technology-based companies.

More recent research published by the National Bureau of Economic Research tested for the impact of taxes on corporate cash holdings by looking at companies that become multinational. They do not tend to increase their cash holdings afterward, thus undermining the tax-based explanation. But the study also finds that research and development intensity is a crucial factor.

The major role of R.D. in large cash holdings may reflect the greater opportunities for tax avoidance among businesses that can easily transfer intangible property abroad without having to move production operations or jobs to other countries. It is a simple matter for companies holding patents, copyrights or trademarks to transfer them to foreign subsidiaries and realize the profits accruing to them in lower-taxed jurisdictions.

I had an experience with this phenomenon just recently. I needed a copy of Microsoft Word for a new computer and went to www.microsoft.com to buy it. But when I tried to pay for it, my credit card was rejected. When I checked with my credit-card company I was told that the charge appeared suspicious because it went to a company based in Luxembourg – a well-known tax haven.

This technique is used by many technology-based companies. For example, The Wall Street Journal reported on Feb. 7 that the patent for the hepatitis C medication produced by California-based Gilead Sciences is domiciled in Ireland, another common tax haven. The home company thus pays royalties to its Irish subsidiary on sales of the drug in the United States, transferring profits from the United States to Ireland.

While the prospects for individual income tax reform appear to be fading, those for corporate tax reform are more positive. The problem of deferral
and the large amount of cash held abroad by multinational corporations based in the United States are key factors driving both parties toward action, possibly this year.

Article source: http://economix.blogs.nytimes.com/2013/02/12/the-growing-corporate-cash-hoard/?partner=rss&emc=rss

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Today’s Economist: Bruce Bartlett: The Debt Limit Is the Real Fiscal Cliff

December 3, 2012 by Leave a Comment

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Bruce Bartlett held senior policy roles in the Reagan and George H.W. Bush administrations and served on the staffs of Representatives Jack Kemp and Ron Paul. He is the author of “The Benefit and the Burden: Tax Reform – Why We Need It and What It Will Take.”

Washington is all abuzz over the impending tax increases and spending cuts referred to as the fiscal cliff, an absurdly inaccurate term that both Democrats and Republicans have unfortunately adopted in order to pursue their own agendas. In truth, it is a nonproblem unless every impending tax increase and spending cut takes effect permanently – something so unlikely as to be effectively impossible.

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In my opinion, the fiscal cliff is akin to the so-called Y2K problem in late 1999, when many people worried that computers would freeze, elevators would stop running and planes would fall from the sky. Of course, nothing of the kind happened.

So if the fiscal cliff is a faux problem, why do we hear that industry and financial markets are deeply fearful of it? The answer is that there is a very real fiscal problem that will occur almost simultaneously – expiration of the debt limit. Much of what passes for fiscal-cliff concern is actually anxiety about whether Republicans in Congress will force a default on the nation’s debt in pursuit of their radical agenda.

No less an authority than the anti-tax activist Grover Norquist, who basically controls the Republican Party’s fiscal policy, has said repeatedly that the debt limit is where the real fight will be over the next several weeks. In a Nov. 28 interview with Politico’s Mike Allen, he was asked about the leverage President Obama has over Republicans in the fiscal-cliff debate. Mr. Norquist replied that Republicans have vastly more leverage when it comes to the debt limit.

MR. NORQUIST: Well, the Republicans also have other leverage, continuing resolutions on spending and the debt ceiling increase. They can give him debt-ceiling increases once a month. They can have him on a rather short leash, on a small – you know, here’s your allowance, come back next month if you’ve behaved.

MR. ALLEN: O.K., O.K., wait. You’re proposing that the debt ceiling be increased month by month?

MR. NORQUIST: Monthly. Monthly. Monthly if he’s good, weekly if he’s not. I mean, look, it’s an accordion, it’s an accordion, because if you’re really – well, that’s what they did – remember the first few months of the Obama – when the Republicans took the House and the Senate – took the House, they said, “O.K., here’s two weeks of continuing resolutions because you have saved $4 billion. Oh, now you’ve agreed to $8 billion in savings, you may have four weeks.” And they basically did – and what happened with the freshmen – remember, the Tea Party guys who just came in said: “This is taking too long. Let’s ask for it all.” And as soon as you asked for it all, you only got half of what you asked for, whereas you were getting everything you wanted. You were doing three yards in a cloud of dust, and you had – now, all those freshmen, newbie Tea Party guys are veterans. They would understand this time around why three yards in a cloud of dust for seven months is winning.

In short, the debt limit is a hostage that Republicans are willing to kill or maim in pursuit of their agenda. They have made this clear ever since the debt ceiling debate in 2011, in which the Treasury came very close to defaulting on the debt.

As Senator Mitch McConnell of Kentucky, the Senate minority leader, explained:

I think some of our members may have thought the default issue was a hostage you might take a chance at shooting. Most of us didn’t think that. What we did learn is this — it’s a hostage that’s worth ransoming.

At the risk of stating the obvious, the debt limit is nuts. It serves no useful purpose to allow members of Congress to vote for vast cuts in taxation and increases in spending and then tell the Treasury it is not permitted to sell bonds to cover the deficits Congress created. To my knowledge, no other nation has such a screwy system.

Nevertheless, we have a debt limit that is denominated in dollar terms; it is breached when the debt subject to limit, which includes bonds the government itself holds in various trust funds, rises above that limit. Currently, it is $16.394 trillion. The Congressional Budget Office estimates that given current spending and revenue trends, that figure will be reached before the end of the year.

At that point, Treasury will have to take extraordinary and costly measures to avoid technically hitting the debt ceiling. But these measures provide only a month or so of breathing room. At some point, Treasury will lack the cash to pay the bills that are due and it will face nothing but unthinkable choices – don’t pay interest to bondholders and default on the debt, don’t pay Social Security benefits, don’t pay our soldiers in the field and so on.

In a new book, “Is U.S. Government Debt Different?,” Howell Jackson, a law professor at Harvard, walks through options for prioritizing government spending in the event that Republicans insist on committing financial suicide. They are all illegal or unconstitutional to one degree or another. They would require the Treasury to either abrogate Congress’s taxing power, spending power or borrowing power.

In the October issue of the Columbia Law Review, Professors Neil H. Buchanan of the George Washington University Law School and Michael C. Dorf of Cornell Law School examine the question of what a president should do when he must act and all his options are unconstitutional. They cite Abraham Lincoln’s July 4, 1861, message to Congress in support of the idea that some laws are more unconstitutional than others and the president is empowered to violate the one that is least unconstitutional when he has no other option.

Said Lincoln, “To state the question more directly, are all the laws, but one, to go unexecuted, and the government itself go to pieces, lest that one be violated?”

In the present case, of course, the one law would be the debt limit, which Professors Buchanan and Dorf say is less binding on the president than unilaterally cutting spending or raising taxes without congressional approval. Hence, if Republicans are truly mad and absolutely refuse to raise the debt limit, thereby risking default or the nonpayment of essential government bills, Professors Buchanan and Dorf believe the president would have the authority to sell bonds over and above the limit.

There are a host of practical problems any time the president is forced into uncharted constitutional territory, as Lincoln so often was. But when faced with an extortion demand from a political party that no longer feels bound by the historical norms of conduct, the president must be willing to do what has to be done.

Article source: http://economix.blogs.nytimes.com/2012/12/03/the-debt-limit-is-the-real-fiscal-cliff/?partner=rss&emc=rss

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Today’s Economist: Bruce Bartlett: Republicans Champion ‘Voluntary Taxes’

September 25, 2012 by Leave a Comment

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Bruce Bartlett held senior policy roles in the Reagan and George H.W. Bush administrations and served on the staffs of Representatives Jack Kemp and Ron Paul. He is the author of “The Benefit and the Burden: Tax Reform — Why We Need It and What It Will Take.”

The Republican-controlled House of Representatives took a break last week from doing nothing to pass a bill to facilitate voluntary taxation. Almost simultaneously, Mitt Romney released his final tax return for 2011, showing that he voluntarily overpaid his taxes by taking less of a deduction for his charitable contributions than he was permitted.

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The legislation was H.R. 6410, “The Buffett Rule Act of 2012.” Those not acquainted with the misleading titles often given to Congressional bills might at first glance think this one has something to do with raising taxes on the ultrawealthy.

Of course, Republicans would never actually raise taxes on the ultrawealthy; they think, or at least assert publicly, that the deficit results from too many poor people not paying taxes. But it would be very helpful to them to have a fig leaf that looks as if they had found a way of getting the rich to pay more. That is by encouraging them to voluntarily pay more, as Mr. Romney did.

Named for the billionaire Warren Buffett, what came to be known as the “Buffett rule” is a proposal by Democrats that all those with incomes of $1 million or more pay at least 30 percent of their income in federal income taxes.

Mr. Romney and his wife had an effective federal income tax rate of just 14 percent, including the voluntary overpayment, on incomes over $13 million in each of the years 2010 and 2011, the only ones for which they have released tax returns.

In April, Senate Republicans filibustered an effort by Democrats to enact a real Buffett rule. Thus there was no chance that Congress would actually legislate higher taxes on the wealthy this year. But apparently, House Republicans feel pressured by voters to respond to the low effective tax rates that many rich people pay, which contribute significantly to historically low federal revenues as a share of the gross domestic product and, hence, to the deficit and the debt.

Republicans recognize that the Buffett rule is politically popular. An April Gallup poll found that Americans favor the Buffett rule by 60 percent to 37 percent, an Ipsos/Reuters poll in March found people supporting it by 64 percent to 30 percent, and a February Associated Press/GfK poll found 65 percent in favor of the Buffett rule and only 26 percent opposed.

H.R. 6410, which was introduced on Sept. 14 and passed the House by voice vote on Sept. 19 with no hearings and just a few minutes of debate, would allow taxpayers to designate on their tax returns a contribution to the federal government, over and above their tax liability, for deficit reduction. Of course, the Treasury has had a fund since 1843 to accept gifts, so the new legislation doesn’t really do anything. So far this year, $7.6 million has been donated.

Representative Chris Van Hollen, Democrat of Maryland, characterized the Republican legislation as a “pretty please” bill. As he put it, “Pretty please, Warren Buffett, pretty please, Mitt Romney, won’t you help contribute a little bit more toward reducing our deficit?”

One could perhaps take the Republican proposal more seriously if it also required a statement on application forms for Social Security and Medicare that those qualified should consider voluntarily forgoing benefits to reduce the deficit. The forms that farmers use to apply for agricultural subsidies could suggest that they put deficit reduction ahead of their personal interest, and so on.

The political reality is that Republicans don’t really support taxation at any level. Of course, none will go on the record saying that they favor abolition of all taxation; they just support every single tax cut and oppose every single tax increase. I have not heard any Republican in recent years acknowledge that the deficit results in any way from lower revenues; rather, they say, the deficit is caused only by excessive spending on everything except the military. Implicitly, therefore, the only kind of taxation a Republican can support is voluntary taxation.

Extreme libertarians, such as the novelist Ayn Rand, have long held that this is the only legitimate form of taxation. As she wrote in a 1964 essay reprinted in her book “The Virtue of Selfishness”:

In a fully free society, taxation – or, to be exact, payment for government services – would be voluntary. Since the proper services of a government – the police, the armed forces, the law courts – are demonstrably needed by individual citizens and affect their interests directly, the citizens would (and should) be willing to pay for such services, as they pay for insurance.

As we know, the Republican vice-presidential nominee Paul D. Ryan has expressed admiration for Rand’s views, and many Republicans in Congress, influenced by the Tea Party movement, support abolition of important government programs along with more tax cuts for the rich.

Interestingly, there actually are instances of voluntary taxation. The New York Times reports that the mayor of Bogotá, Colombia, once asked his citizens to voluntarily pay more taxes and 63,000 of them did. The Times has also reported that cities now often ask tax-exempt organizations to make voluntary payments in lieu of taxes and are turning to parents groups to fill holes in school funding and to community groups to take over park maintenance and other tasks.

Other examples of voluntary methods of financing governmental services include the bond drives of World War II, lotteries, tontines and political campaign contributions. Public universities often solicit private funds to pay for new buildings or programs and remittances by migrants living abroad are a kind of private foreign aid. And of course private charities often engage in social welfare, as well as providing facilities like hospitals and museums (some of which are also provided by government).

While there is no doubt that there are creative methods by which local governments might be able to raise additional revenue and encourage the private sector to take over some of their responsibilities, there is little, if any, scope for this by the federal government. Too much of what it does falls into the category of pure public goods that government must provide, like national defense, or entitlement programs like Social Security and Medicare.

Realistically, voluntary taxation is not a viable alternative to broad-based taxes. Those who oppose raising taxes on the wealthy and are concerned about the number of people exempt from federal income taxes ought to consider a national sales tax, as every other major country has. As Alexander Hamilton explained in Federalist 21, one virtue of consumption taxes is that they are to some extent voluntary.

Article source: http://economix.blogs.nytimes.com/2012/09/25/republicans-champion-voluntary-taxes/?partner=rss&emc=rss

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Economix Blog: Bruce Bartlett: How to Avoid Reinventing the Wheel on Tax Reform

January 24, 2012 by Leave a Comment

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Bruce Bartlett held senior policy roles in the Reagan and George H.W. Bush administrations and served on the staffs of Representatives Jack Kemp and Ron Paul.

An extensive discussion of tax reform is likely to take place over the next couple of years because it’s necessary and long overdue and because both political parties have things they hope to get out of it. Taken together, these suggest that something might actually happen.

That’s the premise of my new book, “The Benefit and the Burden: Tax Reform — Why We Need It and What It Will Take” (published today by Simon Schuster).

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Like many inside-Washington policy debates, much of that involving tax reform is unintelligible except to those who understand the jargon, players, history and unstated assumptions that underlie it. For those interested in following the discussion, which is likely to be protracted, my book is intended as a primer on some of the basic issues and concepts that will inevitably be part of the tax debate.

One of the main points I make is that tax reform is not a new subject, and many issues likely to be in the forefront of the debate have already been pretty thoroughly analyzed in ways that are still relevant.

Here’s one good example: “Blueprints for Basic Tax Reform” is perhaps the most important tax study of the postwar era. It was published 35 years ago this month – in the last weeks of the Ford administration. For many years, it was difficult to find and known only to hard-core tax experts; fortunately, the Treasury Department has made it available on its Web site.

The “Blueprints” study is important because the fundamental debate on tax policy is between two opposing ideas about the tax base – that is, what is taxed.

Historically, the “liberal” idea has been based on a definition of income devised by the economists Robert M. Haig and Henry Simons. It consists of all consumption during a calendar year plus the change in net worth. Thus, it consists of everything a taxpayer takes out of the economy plus the additional amount he or she could have taken out without diminishing her or his net worth.

Under a Haig-Simons definition of income, unrealized capital gains would be taxed as ordinary income, homeowners would be taxed on the imputed rent they pay to themselves by virtue of, in effect, being landlords who rent to themselves, and workers would pay taxes on health and other benefits they receive from their employers over and above their cash wages, among other things.

Almost all discussion of tax policy and tax reform from a liberal point of view assumes that the Haig-Simons definition of income is the correct one. Anything that deviates from it is an unjustified tax loophole, often called a “tax expenditure.”

The contrary “conservative” view is that only consumption should be taxed. This can be done directly, such as through a retail sales tax or value-added tax, or indirectly by exempting all saving from taxation.

Think of it this way. There are only two things one can do with income – save it or consume it. If saving is not taxed, all taxes must necessarily fall on consumption. The idea of taxing only consumption is most associated with the work of the economists John Stuart Mill and Irving Fisher.

During most of the postwar era, virtually all tax reform discussion was premised on the Haig-Simons view, and the Mill-Fisher view was largely forgotten. The tax reform acts of 1969 and 1976 represented efforts by liberals to make the tax code conform as much as possible to their vision. There was essentially no conservative alternative, and both bills were signed into law by Republican presidents.

Treasury Secretary William E. Simon, who served from 1974 to 1977, was disturbed by the lack of a conservative vision of what an ideal tax system should look like, and he recruited the Princeton economist David Bradford to come to Washington and devise one.

“Blueprints” was the result. It proposed two ideal tax systems: one based on a liberal Haig-Simons definition of income and another based on the conservative idea of taxing only consumption.

The liberal alternative in Professor Bradford’s study was largely ignored, because most tax theorists already understood and accepted it. But the conservative option was received as a revelation by conservatives, many of whom didn’t know there was a coherent conservative philosophy of taxation.

Subsequently, the “Blueprints” outline formed the foundation of the flat tax, Fair Tax and just about every other comprehensive conservative tax reform plan.

The reason why the “Blueprints” study remains relevant is that both liberals and conservatives have lost touch with the basics that underpin their respective philosophies of taxation. That is because since the Tax Reform Act of 1986 virtually all tax debate has either been about raising taxes to reduce the deficit or cutting taxes to stimulate growth.

First principles of taxation have been absent or implied rather than stated forthrightly. It would improve the debate on tax reform if each side understood the basics of its own philosophy.

In particular, both have forgotten the importance of defining the tax base properly, and both emphasize the rate schedule far too much. The truth is that statutory tax rates are far less important, either for the economy or fairness, than either side understands.

One goal of my book is to remind people that much of the heavy lifting on tax reform has already been done. The “Blueprints” study is just one example.

Both parties would benefit from better understanding the history and basics of their own tax philosophy. It would both save time and increase the chances that a new tax reform would improve the tax code if they get up to speed before tax reform becomes a partisan political football.

It is not necessary to reinvent the wheel. Policy makers can learn a lot about where we ought to be going from tax reform efforts in the past and the insights of experts whose work is still relevant. And thanks to the Internet, it is easily available.

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Economix Blog: Bruce Bartlett: The True Federal Debt

January 3, 2012 by Leave a Comment

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Bruce Bartlett held senior policy roles in the Reagan and George H.W. Bush administrations and served on the staffs of Representatives Jack Kemp and Ron Paul. He is the author of the coming book “The Benefit and the Burden: Tax Reform – Why We Need It and What It Will Take.”

In our personal lives, we all understand that debts may take different forms. They aren’t limited only to credit cards or loans taken out from banks; they consist of various promises and financial obligations as well.

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These might include commitments to pay for a daughter’s wedding or a child’s graduate school education, to provide the down payment on a sibling’s house or to care for aged parents. While these debts may not show up on anyone’s formal balance sheet, families are well aware of them, and failure to live up to them can be very costly indeed.

So, too, with the federal government. The national debt, which is the object of almost obsessive attention these days, is like a bank loan. It is an important part of national indebtedness, but only a small part. The vast bulk of the true debt is in the form of commitments to pay future benefits to retired federal employees, veterans, and Social Security and Medicare beneficiaries.

These commitments are generally invisible because the federal government operates on a cash basis. The federal budget is concerned only with income and outgo between two points in time — from Oct. 1 to Sept. 30, the fiscal year. Promises to pay benefits in the future generally show up in the budget only when those benefits are actually paid.

For many years, it was almost impossible even to find a list of the federal government’s financial commitments.

In 1949, the Hoover Commission recommended that the government move toward accrual accounting, which corporations are required to use, and book the full cost of programs on an annual basis. It wasn’t until 1966 that Congress required the Treasury Department to publish the data.

But it was available only as an obscure mimeographed document, difficult to obtain, called the Statement of Liabilities and Other Financial Commitments of the United States Government, known only to budget experts.

In 1977, the General Accounting Office and the Treasury published the first consolidated financial statement of the United States government. It was limited in scope, and insufficient data existed to calculate many of the government’s assets and liabilities, but it was an important start to providing a complete picture of federal indebtedness.

The successor to the consolidated financial statement is now called the Financial Report of the United States Government. The edition for the 2011 fiscal year was published on Dec. 23 by the Treasury’s Financial Management Service to no fanfare.

The Obama administration, like previous administrations, had little interest in telling the American people that their debt problem was vastly worse than they thought. It buried the report on a day when most reporters were preparing for the holidays and unlikely to pore through a 254-page document filled with long columns of numbers punctuated with footnotes and accounting jargon.

Predictably, the financial report was ignored. Even The New York Times took no notice of it.

According to the report, the federal debt — simply the cumulative value of all past budget deficits less surpluses — was $10.2 trillion on Sept. 30. But the government also owed $5.8 trillion to federal employees and veterans. Social Security’s unfunded liability — promised benefits over expected Social Security revenues — was $9.2 trillion over the next 75 years, or about 1 percent of the gross domestic product. Medicare’s unfunded liability was $24.6 trillion, or 3 percent of G.D.P.

Altogether, the Treasury reckons the government’s total indebtedness at $51.3 trillion – five times the size of the national debt. This would be an unbearable burden if it had to be paid by the current generation out of current resources, for it approximately equals the entire net worth of American households.

But national debts, of course, will also be paid by future generations out of future output. Those generations will also inherit most of the assets of the current generation, from which future commitments can be financed. For example, future generations will inherit the Treasury’s bonds as well as the responsibility for paying interest on them.

Even so, the Treasury projects that within a generation the federal debt will rise to 100 percent of G.D.P. as future commitments become part of annual spending over and above projected revenues.

Financial Report of the United States Government

Although it is commonly believed that our fiscal problem is purely one of spending, the financial report shows that this is not necessarily the case. The really rapid growth of future spending is not for programs but for interest on the debt.

In other words, it would not be nearly enough just to balance the budget. The federal government would have to begin running a surplus immediately and do so continuously for the next 75 years to prevent the debt/G.D.P. ratio from rising.

Financial Report of the United States Government

The critical point is that interest on the debt is not just another government program that can be cut. It can be reduced only by running a budget surplus, selling assets to reduce principal or reducing the interest paid on the debt.

With interest rates at historical lows and the vast bulk of the debt in the form of short-term securities that roll over rapidly, the figures in the chart above are probably conservative. It is not hard to envision a situation in which interest on the debt rises more quickly than spending can be cut — a problem many European nations are in today.

It’s essential that we strive to overcome budgetary myopia. Our debts are manageable, but only if we take a long-run perspective.

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Economix Blog: Bruce Bartlett: Raising Taxes on the Rich: Not Whether, but How

December 6, 2011 by Leave a Comment

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Bruce Bartlett held senior policy roles in the Reagan and George H.W. Bush administrations and served on the staffs of Representatives Jack Kemp and Ron Paul. He is the author of the forthcoming book “The Benefit and the Burden.”

Last week, the Senate rejected proposals by both Democrats and Republicans to pay for an extension of the 2 percent temporary payroll tax cut enacted a year ago. The Democratic plan to finance it with a 3.25 percent surtax on millionaires garnered significantly more votes than the Republican plan to cut the number of federal jobs and freeze the pay of federal workers.

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This time last year Republicans were insisting that the Bush tax cuts be made permanent without paying for a penny of the cost, even though there is no evidence that they stimulated the economy.

Saying that they are now concerned about the impact of the payroll tax cut on the deficit and its lack of stimulative effect makes Republicans sound a lot like Captain Renault in “Casablanca,” when he said he was shocked to discover gambling going on as he was handed his winnings.

Republicans like to pretend that cutting spending is economically costless, even stimulative, whereas raising taxes in any way whatsoever is so economically debilitating that it dare not be contemplated. This view is complete nonsense.

Careful studies by the Congressional Budget Office and others show that certain spending programs are highly stimulative, whereas tax cuts provide very little bang for the buck.

Congressional Budget Office

Keep in mind that these results are symmetrical. A policy with a high multiplier, such as government purchases, will reduce the gross domestic product by exactly the same amount if it involves spending cuts. A tax cut with a low multiplier will have an equally small negative economic effect if it is instead done as a tax increase.

This would suggest that one of the worst ways to cut spending, from a macroeconomic point of view, would be to do it the way Republicans proposed last week: by cutting government employment. Judging by the table above, cutting taxes for lower- and middle-income people and paying for it with higher taxes for higher-income people, as Democrats have proposed, is unambiguously stimulative.

In any case, the Republican position is politically weak. Polls consistently show that a large majority of Americans favor higher taxes on the rich. For example, the New York Times/CBS News polls in September and October found that about two-thirds of Americans would raise taxes on households earning $1 million or more to reduce the deficit; only 30 percent were opposed.

Growing numbers of millionaires and billionaires have gone on record as favoring higher taxes on the rich, because they can afford them and think they’re necessary to deal with our nation’s fiscal problem, which is largely due to historically low revenues.

These include Warren Buffett, Carlos Slim, Mark Cuban and Nick Hanauer, among others. The group Patriotic Millionaires for Fiscal Strength has been lobbying Congress to raise taxes on people like themselves. A similar movement is under way in Europe as well.

It is no longer possible to deny that there has been a sharp rise in the income and wealth of the ultra-rich while everyone else’s income has stagnated. Authoritative recent studies by the Congressional Budget Office and by Anthony Atkinson, Thomas Piketty and Emmanuel Saez prove that fact beyond question.

The point is not to punish the rich for being rich — Republicans routinely scream “class warfare” whenever anyone suggests higher taxes on the rich — but to raise revenue. If the rich don’t pay more, everyone else will have to.

Recognizing the intellectual and political weakness of their position, Republicans have responded that there is nothing to stop rich people from sending checks to the Treasury Department to reduce the debt. About $3 million is annually donated to the government for this purpose. On Oct. 12, Senator John Thune, Republican of South Dakota, introduced legislation that would add a line on tax returns to make voluntary contributions to the Treasury. It was enthusiastically endorsed by the anti-tax activist Grover Norquist.

Reducing the deficit through voluntary contributions is not a serious idea. It would be a drop in the bucket, such contributions are not sustainable, and it would be unwise to have the government dependent on them because inevitably they would come with strings attached.

Republicans often say that tax evasion and avoidance by the wealthy would cause revenues to fall, rather than rise, if their taxes are raised. But according to the Tax Policy Center, rates higher than the current top rate of 35 percent accounted for 29 percent of individual income tax revenue as recently as 1986, during the Reagan administration.

Recent studies by Peter Diamond and Emmanuel Saez and by A.B. Atkinson and Andrew Leigh find that increasing the top income tax rate would raise net additional revenue at least until it reached 63 percent and probably much higher.

Nor is it correct that low taxes on the rich are essential for economic growth. Recent studies by Dan Andrews, Christopher Jencks and Andrew Leigh and by Thomas Piketty, Emmanuel Saez and Stefanie Stantcheva show that while tax cuts for the rich have raised their share of aggregate income, they have not raised the rate of economic growth.

There are legitimate questions about whether the temporary payroll tax cut stimulated employment or if its expiration will reduce growth, about whether a surtax on millionaires is the best way to pay for it and how much additional revenue can reasonably be expected.

But the idea that the rich cannot or should not pay more should be dismissed out of hand. They can and must pay more; the only question is how best to do it.

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Economix Blog: Bruce Bartlett: The Balanced Budget Amendment Delusion

November 15, 2011 by Leave a Comment

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Bruce Bartlett held senior policy roles in the Reagan and George H.W. Bush administrations and served on the staffs of Representatives Jack Kemp and Ron Paul. He is the author of the coming book “The Benefit and the Burden.”

This week the House of Representatives will take up a balanced budget amendment to the Constitution. An idea that has been kicking around for ages, it has never overcome the hurdle of needing a two-thirds approval vote in both houses of Congress. (After which it would not require the president’s signature but would need to be ratified by three-quarters of the states to take effect.)

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The concept of balancing the budget annually is a bad idea but not an unreasonable one. However, the idea of mandating a balanced budget through the Constitution is dreadful. And the proposal that Republican leaders plan to bring up is, frankly, nuts.

The Founding Fathers took the necessity of balancing the federal budget to be self-evident – with no need to mandate it because economic circumstances severely constrained the government’s ability to spend more than taxes covered.

The memory of the hyperinflation of the War of Independence was fresh, and people were rightly concerned that deficits would lead to the printing of money to cover budgetary shortfalls, restarting inflation. Moreover, the domestic capital market was virtually nonexistent during the early years of the republic, and all Americans were wary of borrowing from abroad unless absolutely necessary.

Consequently, the budget was usually balanced for the nation’s first 150 years, except during wartime, and strenuous efforts were made to pay down the debt as soon as hostilities ended. This budgetary norm didn’t change until the 1930s, when economic stagnation and widespread deprivation made balancing the budget impossible. Also, the economic theories of John Maynard Keynes became popular and argued that large deficits would be necessary to restore growth.

Conservatives view the adoption of Keynesian economics as original sin, opening the door to a vast expansion of government. Instead of being paid for with politically unpopular tax increases or spending cuts, new spending programs were to a large extent financed with seemingly costless deficits. The economist James Buchanan called this “fiscal illusion.”

He had a point. We would have less spending if its tax cost was fully apparent. If people knew their taxes would go up or they would lose government benefits whenever spending increased, we would have a lot less spending.

Unfortunately, conservatives intentionally destroyed the remnants of the implicit balanced budget constraint in the 1970s so they could cut taxes without having to cut spending at the same time. Finding enough spending cuts to pay for big tax cuts would have doomed their efforts, so they concocted a theory, “starve the beast,” to maintain a fig leaf of fiscal responsibility.

Under this theory, deficits are intentionally created by tax cuts, which puts political pressure on Congress to cut spending. Thus, cutting taxes without cutting spending became the epitome of conservative fiscal policy. Unfortunately, it didn’t work.

We gave starve-the-beast theory a test during the Reagan administration, but as I have shown previously, when push came to shove, Reagan was always willing to raise taxes rather than allow deficits to get out of control.

We gave starve-the-beast theory another test during the George H.W. Bush and Clinton administrations. They both raised taxes and, according to the theory, this should have caused spending to rise, because tax increases feed the beast. But they didn’t. Spending as a share of the gross domestic product fell to 18.2 percent in 2000 from 22.3 percent in 1991, according to the Congressional Budget Office.

We gave starve-the-beast theory another test during the George W. Bush administration. Taxes were slashed, but spending rose – again, the exact opposite of what the theory said should have happened. The economist Bill Niskanen asserted that the result was not surprising because the Republican position on taxes effectively reduced the tax cost of spending.

Nevertheless, conservatives like Grover Norquist insist that starve-the-beast theory works, which is why they relentlessly push for still more tax cuts despite the obvious failure of previous tax cuts either to stimulate economic growth or restrain spending, and oppose even the most trivial tax increases no matter how big the deficit.

Historically, one problem conservatives had with a straightforward balanced budget requirement was a concern that it might lead to tax increases. It would also make further tax cuts more difficult to achieve.

Today, most conservatives support a constitutional requirement that will only restrain spending but make tax increases effectively impossible, while continuing to permit tax cuts regardless of the deficit. This is the essence of the “balanced budget” amendment that Republicans plan to vote on.

The amendment reported by the House Judiciary Committee in June would limit federal spending to 18 percent of “economic output” (whatever that is) without a three-fifths vote in both the House and Senate and would require a two-thirds vote to raise taxes. The latter requirement is even more stringent than it appears because it applies to the full membership of both houses, not just the percentage of those present and voting. Taxes, on the other hand, can be cut with a simple majority vote.

Space prohibits a full discussion of all the technical problems with this poorly drafted amendment. A July 8 report from the Congressional Research Service does a good job of going through some of them.

These include the fact that gross domestic product is nowhere defined in law, nor could it be because it is a continually evolving concept; 18 percent of G.D.P. is a totally arbitrary figure that couldn’t be achieved this year even with the abolition of every federal program other than Social Security, Medicare, national defense and interest on the debt, because the deficit is twice as large as total nondefense discretionary spending.

Outlays would actually have to be well below 18 percent of G.D.P. in practice because future spending is held to 18 percent of the previous fiscal year’s G.D.P., and there is no practical way of enforcing the amendment through the federal courts. For more details, see my July 11 article in Tax Notes magazine.

The truth is that Republicans don’t care one whit about actually balancing the budget. If they did, they would want to return to the policies that gave us balanced budgets in the late 1990s.

The crucial one was higher taxes, which virtually all Republicans opposed in 1990 and 1993, and budget controls that prevented tax cuts unless offset dollar-for-dollar with cuts in entitlement programs, which Republicans abandoned in 2002 so they could cut taxes without constraint.

Of course, no Republican favors such policies today. They prefer to delude voters with pie-in-the-sky promises that amending the Constitution will painlessly solve all our budget problems.

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Economix Blog: Bruce Bartlett: Inside the Cain Tax Plan

October 11, 2011 by Leave a Comment

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Bruce Bartlett held senior policy roles in the Reagan and George H.W. Bush administrations and served on the staffs of Representatives Jack Kemp and Ron Paul.

Today’s Economist

Perspectives from expert contributors.

With recent polls showing increased support for Herman Cain as the G.O.P. presidential nominee, attention is being drawn to his platform, especially what he calls the 9-9-9 tax plan. News reports describe it as a 9 percent tax rate on business and personal income, combined with a 9 percent national sales tax.

Little detail has been released by the Cain campaign, so it’s impossible to do a thorough analysis. But using what is available on Mr. Cain’s Web site, I’m taking a stab at estimating its effects.

First, the 9-9-9 plan is actually an intermediate step in Mr. Cain’s plan to overhaul the tax system and jump-start growth. Phase 1 would reduce individual and business taxes to a maximum of 25 percent, which I assume means reducing the top statutory tax rate to 25 percent from 35 percent.

No mention is made on the site of a tax cut for those now in the 10 percent, 15 percent or 25 percent brackets. This means that the only people who would get a tax rate cut are those now in the 28 percent, 33 percent or 35 percent brackets. According to the Joint Committee on Taxation, only 4 percent of taxpayers pay any taxes at those rates.

As for corporations, Mr. Cain’s proposal is primarily going to benefit those with revenues of more than $1 million a year, because they account for 98.7 percent of all receipts by C corporations. (A C corporation is a legal entity separate and distinct from its owners that is taxed as a corporation; its shareholders pay taxes individually on their gains.) Those companies with receipts over $50 million account for 88.8 percent of total receipts.

Other business entities — sole proprietorships, S corporations (which have between 1 and 100 shareholders and pass through net income or losses to shareholders) and partnerships — would not benefit because they are not taxed on the corporate schedule. But they represent 92 percent of all businesses.

Second, Mr. Cain would eliminate all taxes on profits earned by multinational corporations outside the United States. It’s hard to know the impact of this provision, but according to Martin Sullivan, an economist with Tax Analysts, the 50 largest corporations in the United States generated half of their profits in other countries.

The actual benefit of Mr. Cain’s proposal would be much greater to many of them, because, according to Mr. Sullivan, while some of these 50 companies have no foreign operations, others derive 100 percent of their gross profits in foreign countries. In 2010 these included Philip Morris, Pfizer and Abbott Laboratories.

Third, Mr. Cain would abolish all taxes on capital gains. Such taxes typically generate more than $100 billion in federal revenue annually, according to the Tax Policy Center. According to the Joint Committee on Taxation, two-thirds of all capital gains are reported by those with incomes over $1 million.

Mr. Cain says these three proposals, which he would put into effect immediately without offsetting the lost revenue, will jump-start economic growth. He offers no evidence for this assertion; it is simply put forward as self-evident. But the experience of the George W. Bush administration was that cuts in tax rates on the wealthy and on capital gains had no effect whatsoever on growth, according to the Congressional Research Service.

And this is only Phase 1 of the Cain plan. In Phase 2, the payroll tax would be eliminated, causing more than $800 billion in revenue to evaporate. The estate and gift tax would be abolished, further reducing taxes on the wealthy. And the 9-9-9 plan would be implemented.

It’s important to understand that the 9 percent rates on personal and business income would apply to very different tax bases than now exist. For individuals, the tax would apply to gross income less only the deduction for charitable contributions. No mention is made of a personal exemption.

This means that the 47 percent of tax filers who now pay no federal income taxes will pay 9 percent on their total income. And elimination of the payroll tax won’t even help half of them because the earned income tax credit, which Mr. Cain would abolish, offsets both their income tax liability and their payroll tax payment as well.

Additionally, everyone would now pay a 9 percent sales tax on all purchases. No mention is made of any exemptions from this tax, so we may assume that it will apply to food, medical care, rent, home and auto purchases and a wide variety of other expenditures now exempt from state sales taxes. This would increase their cost of living by 9 percent while, at the same time, the poor would pay income taxes.

The business tax in the Cain plan bears no resemblance to the present corporate income tax. The tax would apply to gross sales less dividends paid and all purchases from other companies, including investment goods. Thus, there would be no deduction for wages.

How benefits would be treated is unclear, because purchases of things like health insurance might constitute a purchase from another company and remain deductible. If so, what is to stop a company from paying its employees by leasing their cars and homes for them and even buying their food and clothing? That would reduce their taxable revenue.

The abolition of any deduction for wages is likely to raise the cost of employing workers, even with abolition of the employers’ share of the payroll tax. And since the dividend deduction doesn’t appear to be related to profitability, companies could borrow to pay dividends and still get the deduction. Even a novice tax lawyer could easily make a tax shelter out of that.

And here’s the kicker in the Cain plan. Phase 2 is merely a transition to yet another fundamental tax reform. In Phase 3, the United States would adopt the so-called Fair Tax, which would replace all federal taxes with a 30 percent sales tax on all goods and services. In a previous post, I explained why the Fair Tax is a bad idea. I went into more detail in testimony before the House Ways and Means Committee on July 26.

Whatever one thinks of the Fair Tax, it makes not the slightest bit of sense to have a plan that requires fundamental changes to the federal tax system twice to achieve its objective.

Veterans of tax reform attempts in the United States know reform is very difficult and time-consuming even once. If the Fair Tax is a good idea, Mr. Cain ought to just do it, without confusing the issue with his unnecessary and highly complicated 9-9-9 plan. After all, one of the prime selling points of the Fair Tax is its simplicity, and the 9-9-9 plan is far from that.

Because so little detail exists, it’s hard to do either a proper revenue estimate or distributional analysis of the Cain plan. It’s obvious, however, that Phase 1 would represent a huge tax cut for the wealthy at a time when federal revenues are at a historical low as a share of the gross domestic product and the economy’s fundamental problem is a lack of aggregate demand.

Thus the Cain plan would increase the budget deficit without doing anything to stimulate demand, because rich people can already spend as much as they want and are unlikely to spend more even if their taxes are abolished.

The poor and the middle class might increase their spending if they could keep more of their earnings, but they will unquestionably pay more under Phase 2 of the Cain plan. With no tax on capital gains, the rich would pay almost nothing, while elimination of all deductions and credits, as well as imposition of a national sales tax, must necessarily raise taxes on everyone else, especially those not now paying income taxes.

At a minimum, the Cain plan is a distributional monstrosity. The poor would pay more while the rich would have their taxes cut, with no guarantee that economic growth will increase and good reason to believe that the budget deficit will increase.

Even allowing for the poorly thought through promises routinely made on the campaign trail, Mr. Cain’s tax plan stands out as exceptionally ill conceived.

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