The Economic Impact Of Taxes

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Dr. Garett Jones, Assistant Professor of Economics at George Mason University, presents on the Economic Impact of Taxes.

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The Economic Impact Of Taxes

  1. 1. THE ECONOMICS OF TAXATION Garett Jones BB&T Professor for the Study of Capitalism The Mercatus Center George Mason University [email_address]
  2. 2. Overview <ul><li>The grim future of tax revenues </li></ul><ul><li>Who pays federal taxes? </li></ul><ul><li>Ways to raise taxes </li></ul><ul><li>How citizens will respond to #3 </li></ul><ul><li>Taxes on Capital: A strong result. </li></ul>
  3. 3. Not your usual recession <ul><li>In the aftermath of a typical financial crisis: </li></ul><ul><li>“ Value of government debt tends to explode…an average of 86%.” </li></ul><ul><li>“ The main cause…is the inevitable collapse in tax revenues…” </li></ul>
  4. 4. Source: CBO Director Elmendorf, 2/25/10
  5. 5. Who pays ALL federal taxes? (SS, too) Source: CBO
  6. 6. Who pays federal taxes? (details) Year Lowest Quintile Second Quintile Middle Quintile Fourth Quintile Highest Quintile Top 10% Top 5% Top 1% Average Pre-Tax Income for All Households, by Household Income Category, 2005 2005 15,900 37,400 58,500 85,200 231,300 339,100 520,200 1,558,500 Tax Rates, All Federal Taxes, percent 2005 4.3 9.9 14.2 17.4 25.5 27.4 28.9 31.2 Total Federal Taxes paid, dollars 2005 684 3,703 8,307 14,825 58,982 92,913 150,338 486,252 Source: Congressional Budget Office. Notes: Income equals pretax cash income plus all in-kind benefits (Medicare, Medicaid, food stamps, school lunches and breakfasts, etc.).
  7. 7. Who thinks they pay federal taxes? <ul><li>Gerald Prante, new George Mason Ph.D. </li></ul><ul><li>“ Americans underestimate the share of taxes paid by the rich and overestimate the share paid by middle-income Americans.” </li></ul><ul><ul><li>Prante’s explanation: “pride theory” + “class delusion” </li></ul></ul>
  8. 8. Revenue Raisers: VAT? NRST? <ul><li>Value Added Tax—a consumption tax </li></ul><ul><ul><li>“ If economists were to vote for their favorite tax, the...VAT…would surely be high on the list.” </li></ul></ul><ul><ul><ul><li>-Keen, Journal of Economic Literature, 2009 </li></ul></ul></ul><ul><ul><ul><li>Gets people and businesses to think about future </li></ul></ul></ul><ul><ul><ul><li>Easy to enforce honestly </li></ul></ul></ul><ul><ul><ul><li>BUT: More exceptions=higher rate </li></ul></ul></ul><ul><li>National Retail Sales Tax </li></ul><ul><ul><li>States avoid high sales tax rates: Why? </li></ul></ul><ul><ul><ul><li>My plan for when NRST becomes law. </li></ul></ul></ul>
  9. 9. One revenue raiser: Taxing Sin <ul><li>Excise taxes </li></ul><ul><ul><li>Alcohol, Tobacco, Sugary-soda </li></ul></ul><ul><ul><ul><li>Mercatus brief by Richard Williams/Katelyn Christ </li></ul></ul></ul><ul><li>Young people (12-17) respond more </li></ul><ul><ul><li>10% rise in cigarette price  12% fall in purchases </li></ul></ul><ul><ul><li>But for over-35’s: 10% rise in price  1.5% fall </li></ul></ul><ul><ul><ul><li>(Grossman et al., “Alcohol and Cigarette Taxes,” 1993. </li></ul></ul></ul><ul><ul><li>Discourage consumption by young, raise money from the old? </li></ul></ul>
  10. 10. Tax Expenditures: Loopholes we love <ul><li>Top 5 on personal side: </li></ul><ul><li>Tax-free health, mortgage interest, charitable, state and local taxes, IRA/Pensions: ~$370B per year, ½ of total </li></ul>A must-read: GAO, “Tax expenditures…” 2005
  11. 11. How people respond to tax changes <ul><li>Survey of labor economists: </li></ul><ul><li>Married Women (MW) respond more than men </li></ul><ul><ul><ul><li>MW:10% cut in tax rate  5% more hours </li></ul></ul></ul><ul><ul><ul><li>Men:10% cut in tax rate  1% more hours </li></ul></ul></ul><ul><li>Low-earners respond more: </li></ul><ul><ul><ul><li>about 2X these numbers </li></ul></ul></ul><ul><ul><ul><li>and high-earners respond less . </li></ul></ul></ul><ul><ul><ul><li>Source: Fuchs, Poterba, Kreuger (1997, J. Econ Lit). </li></ul></ul></ul><ul><li>Note: Nobel Laureate Edward Prescott sees 10x bigger responses </li></ul><ul><ul><ul><li>Social forces at work? </li></ul></ul></ul>
  12. 12. Taxes and the Rich: Taxable Income Games <ul><ul><li>For the rich, it’s not about “hours of work” </li></ul></ul><ul><ul><li>There’s taking an easy job (low wage, low stress) vs. taking a harder job (high wage, high stress) </li></ul></ul><ul><ul><li>There’s this year (low tax) vs. next year (high tax) </li></ul></ul><ul><ul><li>Little of this involves “hours of work.” </li></ul></ul>
  13. 13. How much do the rich change their “taxable income” when taxes change? <ul><li>Martin Feldstein (Harvard, former NBER chief) </li></ul><ul><ul><li>2 for 1 </li></ul></ul><ul><ul><li>1% rise in take-home fraction  2% rise in income </li></ul></ul><ul><li>Gruber (MIT) & Saez (Harvard) </li></ul><ul><ul><li>0.6 for 1: Quite a bit smaller. </li></ul></ul><ul><ul><li>1% rise in take-home fraction  0.6% rise in income </li></ul></ul><ul><li>Goolsbee (Chicago, Admin): Looking at 1993 tax increase </li></ul><ul><ul><li>1 for 1 in short run (end-of-year tax games) </li></ul></ul><ul><ul><li>0.1 in long run (they work and work) </li></ul></ul>
  14. 14. How real is the Laffer Curve? <ul><li>Laffer, Time , 12/7/07: </li></ul><ul><li>“ I've never said all tax </li></ul><ul><li>cuts pay for themselves. </li></ul><ul><li>I never even said </li></ul><ul><li>Reagan's tax cuts would </li></ul><ul><li>pay for themselves.” </li></ul><ul><li>Brad Delong, Berkeley & Clinton Treasury: </li></ul><ul><li>“ [R]educing the top tax rate </li></ul><ul><li>from 70% to 50% is probably </li></ul><ul><li>a revenue gainer and surely </li></ul><ul><li>not much of a loser.” </li></ul>
  15. 15. Taxing Capital Income in Theory <ul><li>Shockingly robust: Taxing capital is a bad idea. </li></ul><ul><li>(Chamley/Judd result (1986/1985)) </li></ul><ul><li>(In general, includes corporate income taxes, interest and profit taxes, and capital gains taxes. IRAs and 401K’s get us closer to zero tax.) </li></ul><ul><li>Key point: Capital tax causes lower wages in long run. </li></ul><ul><li>Future-minded workers would vote to tax themselves, not capital. </li></ul>
  16. 16. Really? How? <ul><li>Higher tax on capital  Lower long-term saving </li></ul><ul><li> fewer machines to tax </li></ul><ul><li> (An obvious point) </li></ul><ul><li>The subtle point: Fewer machines  workers produce less  Lower wages </li></ul><ul><li>Even if you take all capital tax revenue and gave it to workers, rational, patient workers would vote against capital tax. </li></ul>
  17. 17. Taxes, Capital, and Growth <ul><li>Survey of top tax economists: </li></ul><ul><ul><li>Shift to pure consumption tax </li></ul></ul><ul><ul><ul><li>Unlimited IRA and/or VAT and/or Sales tax </li></ul></ul></ul><ul><ul><li>avg. answer: 0.2% faster growth  unnoticeable </li></ul></ul><ul><ul><ul><li>10% richer in long run </li></ul></ul></ul><ul><ul><li>optimists: 0.5% faster growth  </li></ul></ul><ul><ul><ul><li>Probably noticeable  25% richer in long run </li></ul></ul></ul>
  18. 18. Who pays the corporate income tax? <ul><li>Answer: Unclear </li></ul><ul><ul><li>Part sales tax </li></ul></ul><ul><ul><li>Part capital tax </li></ul></ul><ul><ul><li>Part labor tax </li></ul></ul><ul><li>Big economic idea: Only humans can pay taxes </li></ul><ul><ul><li>We just don’t know which humans are paying it </li></ul></ul>
  19. 19. Conclusion <ul><li>Revenue will likely be low for years </li></ul><ul><li>Our tax system is progressive. </li></ul><ul><li>Tax rates change amount of work and savings </li></ul><ul><ul><li>And phasing out benefits for high earners raises tax rates </li></ul></ul><ul><li>Capital taxation: Bad in theory. </li></ul>

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