Adventures Near the Inflection Point of the Laffer Curve

First, France: Gerard Depardieu has left the country to avoid paying the new top marginal tax rate of 75%. He's apparently moved to Belgium for now, but Putin has given him a Russian passport and an offer of citizenship just in case he develops a taste for little water.

Second, France again: Nicholas Sarkozy and Carla Bruni are considering doing the same thing, perhaps by moving to London. In a first-as-tragedy-then-as-farce moment, David Cameron is actively recruiting tax exiles. (Remember that in the not-so-distant past tax exiles were leaving Britain for France, among other locales. Here's a 1977 op-ed talking about the phenomenon among musicians. The Rolling Stones wrote and recorded Exile on Main Street as tax refugees. Others included Ringo Starr, Peter Sellers, Sean Connery, and many more. Here's a slideshow of some notable examples.)

Third, California: Phil Mickelson has said that he may leave the state as a result of significant income tax increases at the state and national levels. California's income tax rate is 13.3% for top earners; Texas and Florida don't have a state income tax at all. Mickelson makes upwards of $40mn/year, so moving from CA to FL could net him $5-6mn/year, if he could save the whole 13.3%. In total, Mickelson claims he'll be losing 62-63% of his income to various taxes.

Note that Piketty and Saez estimated the "optimal" top marginal tax rate -- where "optimal" in this case means maximizing public revenue while minimizing income inequality -- as something like 75-80%. (Although it should be noted that this conclusion is based on an assumption that is less likely to hold in Europe as it is in the U.S.) In other words, that's the approximate point where the slope of the Laffer Curve zeroes out and then turns negative. In this case, the anecdotes roughly correspond to the theory: the margin seems to lie at around a 65-75% top tax rate, which can be sustained before avoidance starts becoming widespread.

As a closing aside, in the U.S. state income taxes can be deducted from federal income taxes. As I understand it, there is no limit to the amount of these deductions. This raises an interesting political question: why don't states set their income taxes at exactly the same levels as federal income taxes? Their tax-paying citizens would be no worse off -- they'd pay the same amount of tax, deducting from their federal bill what they pay to their state -- while the state's finances would be significantly better off. The federal government's budget balance would take a hit, but why should state legislatures care about that? Obviously some complications would arise, e.g. everyone would need to itemize deductions, but it seems like these could be fairly easily managed.

Or maybe not. I'm no accountant or lawyer, so its possible that this is completely wrong. But if it isn't why hasn't anybody tried it?

Romney! Obama! Same Effing Difference (?)

Foreword: I have promised a fair few posts on other topics, but I caught the bug for this one and felt like getting it out first. More stuff on finance and politics TK, when I can find the time.

In 2000, in a fit of pique, I briefly became politically active. Disgusted by the cynical triangulations of the Clinton administration, and turned off by Dubya's anti-intellectual populism (and young enough to believe that both were something other than typical), I marched in a few rallies in support of opening up American politics to alternative parties. One of them became a touch violent -- and I was nearly pepper-sprayed by the police, and was nearly impaled by them as well... unfortunately for this story I narrowly escaped all harm -- and it was a great deal of fun.

One of the chants of the day was "Bush! Gore! Same fucking difference!" This was put only slightly less crassly by Ralph Nader, then Green Party candidate for president, as "The only difference between Republicans and Democrats is the speed with which they get on their knees when corporations come calling." Even in my piquedness I cringed at that one, although not as much as I did when my fellow protestors, in violation of multiple laws and menacing in numbers, began bellowing "This is what democracy looks like! That is what a police state looks like!" while gesturing to the men and women in blue who were doing nothing even remotely police-state-ish, but who did intend to maintain rule of law in protection of the actual majority of the population, which we did not represent. The cops did just that, with very little excessive force and that little bit in direct response to intentionally provoked duress. My fellow members of the mob had little sense of irony, apparently. They seldom do. It was more than just a bit off-putting.

(That reminds me to again refer to Milos Forman's surprisingly good essay on how people who lazily make reference to authoritarianism without real knowledge of what actual authoritarian regimes do and have done do a disservice not only to their own reputations but also to wider cultural memory.)

That was when I was a lowly journalism student at a community college. I had never heard of Duverger's law. I had never heard of the median voter theorem even, much less directional models or any further complication. Because things didn't make a ton of sense to me, in my ignorance and at that moment, I thought very much that the forces at work in politics must be sinister. Adbusters made quite a lot of sense, at the time. The WTO was sort of threatening, really, what with its internationalism and its governments and their suits. Who was controlling all of this? Weren't corporations going to profit from all of this? And wasn't that ipso facto a terrible outcome? I'd never heard of comparative advantage, all I know was that people -- people who looked like me -- were pissed right off. Plus we had cool people on our side. Fugazi sang (see above) "Never mind what they're selling... it's what you're buying." All politics is local, man. It starts at home. Far out.

When I was a child I spake as a child, I understood as a child, I reasoned as a child. When I became a man I put away childish things. I'll still consider myself part of the "left", but it's a "left" that mostly only exists in my mind. It's a "left" that believes that the redeemable parts of Marx reveal him as one of the first public choice thinkers; so he's of the "right" too, in his way, in my mind. It's a left that believes that had Marx witnessed the 20th century -- not even the bits of it done in his name -- his writings might have taken a different tone. It's a left that is dedicated to the idea that the best hope for an internationalist emancipatory movement is found in secular capital social democracy. I.e., it's a left that thinks that the Gotha program had something like the right idea after all. It's certainly not a left that is embodied in any actually-existing internationalist political movement of which I'm aware. So I'm not so politically active these days. I'm content to sort of shrug, think that the American "right" and "left" both embody a certain bastardized bit of truth, and take the long view that things in 21st century America are probably gonna end up far better than they generally have in the course of human history.

But. But! What about that "Same fucking difference!"? Well we hear every election that "this election is the most important election since" like 1932, or 1864, or 1776, or something. Every go round we hear it and we're hearing it again. But if Nader was right in 2000, if the only real choice we have is marginal rather than categorical, then we could either agree with my younger self that things are pretty sinister at the moment, or we could take the more restrained view that politics stays fairly close to the median as a matter of necessity. So which is it? Is there a difference between Romney and Obama worth getting up for? Is this election a clash of the mediocre, or will it decide the eternal course of the Republic?

Steven Landsburg provides one answer. He notes that Ezra Klein has published the following picture, purportedly showing the vast differences between the platforms of Obama and Romney on the issue of income taxation:

Leave aside for now the tacky Excel-template graphic... this message has been approved by Krugman and many others across the web. And it looks like a pretty big difference! Except:

What we actually have is an election in which both candidates are proposing massive redistributions from the top downward, one slightly less so than the other. You’d never know this from looking at Klein’s chart because it illustrates changes in rates, whereas what actually matters is the rates themselves. It makes no sense to ask whether any particular group ought to be paying more or less without reference to how much they’re already paying.

Indeed, this is a classic example of what I once called the “Grandfather Fallacy” — by focusing on changes instead of absolutes, Klein’s chart conceals any existing inequities and hence treats them as “grandfathered in”.

Maybe you could quibble with Landburg's use of the word "massive", but he does a quick-and-dirty correction of Klein's graph by plugging in the relevant pre-existing points, and comes up with this (tacky Stata-template) graphic:

Pretty big difference! In the story the graphs are telling, I mean. Not so much in the candidates' plans. Which will be subject to further moderation in both cases, meaning that they are highly likely to move closer together rather than further apart.

Now there's no reason to not consider both changes and levels. I get that both can be meaningful, especially symbolically. But while symbols are important the baseline reality is, unquestionably, even more important. Symbolism is often ephemera, and even if ephemera is often the stuff of politics those of who us who have put childish things behind us might wish to do better. The baseline reality suggests that there really isn't a qualitative difference between the two candidates, at least as it pertains to income taxation. And now that the GOP has made it a huge part of their platform to defend socialized health care at all costs, and that Romney is in favor of keeping the majority of PPACA intact too, I'm not super-clear on how they qualitatively differ on health care reform either. Maybe they'd differ greatly on foreign policy (paging Drezner!), but I can't for the life of me discern what Obama's foreign policy actually is -- "pivot to Asia" and "use drones to blow up whomever we damn well please" notwithstanding -- and Romney stubbornly refuses to even broach the subject*.

The point is that these differences are marginal, not fundamental. The argument is whether that is a good thing or not. And I really don't know... I think the fundamental conservative point -- that stability is ceteris paribus preferable to instability -- is not appreciated nearly enough by the left. At the same time I believe that the fundamental liberal point -- that we can always do better than we have done, and really should try to -- is not appreciated nearly enough by the right.

So score another one for the structuralists I guess. And score one more for the proximity models I guess. And give one more to the marginalists. And get cynical if that's your bag, or sit back and let it all wash all over you and think about how much worse it used to be. But please let's keep the argument running a bit longer. I'm not finished with it just yet.


*The lack of actual foreign policies from either the right or left is a topic for another day. My current thinking is that a) the right adopted the Manichean/Messianic view of the neocons -- most of whom were not Republicans in any other sense -- because it fit in with their Manichean view of foreign policy since World War II; b) Democrats found it tough to oppose because many of the neocons came from their ranks, and also because it was politically popular and because they had no other frame to adopt. Now that the neocons are out of sorts, no one has anything. I think HR Clinton's State -- via Slaughter -- is grasping towards something, but they aren't there yet and Obama hasn't latched onto it.

Real-Life Laffer Curve (or, Arbitraging International Travel)

So, last week I traveled from Chapel Hill to Montreal. But I did not fly to Montreal. I flew to Burlington, VT and then took a Greyhound bus to Montreal. The total cost of the roundtrip, including all fares and taxes, was approximately $290. Why didn't I just fly into Montreal? Because it would've cost around $500-600, or 66-100% more, depending on the days/times we chose to fly. And why is that? Apparently, a big chunk of it is airport fees, traveler's taxes, security taxes, etc. Here is a list of some of them on the Canadian side, but the U.S. has its own "international arrivals" tax, among others. The long and short of it is that it was much cheaper for me to fly domestically and then drive -- even if I'd had to rent a car for a day -- than to simply fly.

Of course, that means that both Canada and the U.S. got zero of these extra taxes from me and my travel companions. We would have been willing to pay some extra to avoid the hassle of a 2-hour bus ride (although, in the end, it was a comfortable trip that allowed us to see some nice landscape that none of us had seen before), and the cost of the bus tickets ($23 per person each way). But by setting the fees so high that the cost of the trip effectively doubled, we were much better off by taking the Burlington-Montreal bus route. The three of us ended up saving nearly $1,000 in aggregate. We were on the wrong side of the Laffer curve: higher taxes drove us out of the market, and Canada and the U.S. got zero extra revenue from our trip.

Now this may not be true for the overall public. My impression from ISA is that most of those traveling from the U.S. flew straight in, and obviously those traveling from Europe or elsewhere did the same. Some of them didn't really care how much it cost, because someone else was paying for it. But many U.S. travelers would have taken the Burlington route if they'd known about it in advance. And if we know anything about arbitrage opportunities, it's that they don't tend to last very long: word gets around. Next time more people will likely choose that option. Of course, if too many people do this the governments may just put a tax on the Greyhounds, but considering that the purposes of the airport taxes -- extra security, airport improvements, etc. -- are airport-specific, such moves may not be politically appealing.

The upshot? If you travel to Montreal, fly into Burlington and take the bus. And if you set tax policy, take incentives into account.

Quote of the Day

M.S.:

What you're seeing in that divergence between the nominal rate corporations are supposed to pay, and the rate they actually pay after loopholes and gimmicks, is institutionalised clientilism and favouritism. In many other countries, the same phenomenon is expressed as corruption, but in America and other advanced economies it's incorporated into the tax code so as to fan away the stench. The problem with trying to get rid of clientilism is that it tends to be supported by the clients.

Rum Diaries

Here's an interesting article on how an obscure provision in the U.S. tax code has caused two U.S. territories to go to the mattresses:

Now the spirit once called Kill-Devil has set off a bitter dispute between two United States islands, Puerto Rico and the Virgin Islands, over a tax that the federal treasury collects on rum.

The fight began when the Virgin Islands persuaded the world’s largest distiller, which said it was leaving Puerto Rico, to move to St. Croix by offering a staggering $2.7 billion in tax incentives. The new distillery, for Captain Morgan spiced rum, will provide no more than 70 permanent jobs on the south shore of St. Croix — but it will entitle the Virgin Islands to collect billions in rum tax revenue from Washington.

That bounty comes at the expense of Puerto Rico, where 90 percent of the revenue from the rum tax had been used for public projects and social services rather than corporate incentives. The Virgin Islands has promised to give nearly half its tax revenue back to the distiller, the British company Diageo, prompting a series of charges and countercharges between neighbors roughly 50 miles apart in the Caribbean. ...

The billions of dollars at stake are the result of a quirk in the tax code that was intended to aid the islands while preventing their offshore distilleries from gaining an unfair advantage over competitors in the states.

Because rum producers in the islands are exempt from federal excise taxes, the government imposed an “equalization tax” on Puerto Rican rum producers in 1917 and gave the money to the commonwealth. In 1954, the United States extended the arrangement to the Virgin Islands.

Now the islands are competing to lure producers with tax incentives. Many are complaining that the tax revenue should go to the people, not the corporations, but if the corporations leave there's no revenue for the people at all. So the islands compete against each other, some of the revenue gets redistributed from Puerto Rican citizens to the corporation, and some other revenue gets redistributed from Puerto Rican citizens to Virgin Islands citizens. Bad for Puerto Ricans, but great for Virgin Islanders.

Of course, absent the equalization tax the corporation would have moved out of the U.S. jurisdiction entirely, likely to Guatemala or Honduras, and both U.S. territories would lose. In any case, tax incentives matter, and they can be very distorting.

U.S. Taxes Are Low Cross-Nationally, Too

(click on image for bigger version)

A few days ago I posted on the recent report that U.S. tax receipts as a percentage of national income are at their lowest point in the past 60 years, although the reason why isn't perfectly clear. I also suggested that this fact may surprise many Americans. Surely this OECD report, showing that the U.S. also has one of the lowest tax burdens among advanced industrialized countries, would be more expected.

I don't have much to add to this, except to note that this gives the U.S. room to move in coming decades. We can afford to raise taxes if needed to balance the budget, pay down debt, or finance welfare programs as the country continues to age. Perhaps that is one reason why U.S. sovereign debt is still so affordable. However, this also may indicate that the country does not have the political will to accept higher taxation in order to finance debt and a larger welfare state.

American Tax Receipts Lowest in 60 Years

As a percentage of income, that is. How many Americans would have guessed this was true?

Federal, state and local taxes — including income, property, sales and other taxes — consumed 9.2% of all personal income in 2009, the lowest rate since 1950, the Bureau of Economic Analysis reports. That rate is far below the historic average of 12% for the last half-century. The overall tax burden hit bottom in December at 8.8.% of income before rising slightly in the first three months of 2010.

I actually don't find it all that surprising. Here's one list of contributing factors:

Three big reasons: The stimulus was in fact a major tax cutter, and increasingly progressive tax rates means that as we've fallen in income, we've fallen into lower tax rates. What's more, we're consuming less, so spending less on taxes.

I don't think these are the best explanations. The stimulus plan did include tax cuts, but they weren't especially large and if the fiscal multiplier is above one then they could have increased tax revenue (because one person's spending is another person's income, which increases income taxes plus sales and other taxes accrued along the way).

Tax rates are not "increasingly progressive" relative to the previous 60 years. In fact, the opposite is true. However the tax structure is still somewhat progressive, and this recession is especially nasty (graph taken from DeLong):



I'm not sure we're consuming less, relative to income. Here's a graph of net national saving from Bloomberg, showing that savings are the lowest since the Great Depression:



I think the best explanation is the simplest: tax receipts have fallen as a percentage of income because this recession has been so severe, and originated in the real estate sector. As house prices have dropped and foreclosures have risen, property tax receipts have fallen. The other explanations may be contributing factors, but are not unique to this recession.

The Perils of Debt

Very interesting column in the New Yorker by UNC-Chapel Hill graduate James Surowiecki on the American tax code and the incentives built into the tax code for individuals and businesses to take on increasing amounts of debt. He runs a blog over at the New Yorker called "The Balance Sheet."Here is an excerpt from the column:

The government doesn’t make people go into debt, of course. It just nudges them in that direction. Individuals are able to write off all their mortgage interest, up to a million dollars, and companies can write off all the interest on their debt, but not things like dividend payments. This gives the system what economists call a “debt bias.” It encourages people to make smaller down payments and to borrow more money than they otherwise would, and to tie up more of their wealth in housing than in other investments. Likewise, the system skews the decisions that companies make about how to fund themselves. Companies can raise money by reinvesting profits, raising equity (selling shares), or borrowing. But only when they borrow do they get the benefit of a “tax shield.” Jason Furman, of the National Economic Council, has estimated that tax breaks make corporate debt as much as forty-two per cent cheaper than corporate equity. So it’s not surprising that many companies prefer to pile on the leverage.

There are a couple of peculiar things about these tax breaks—which have been around as long as the federal income tax. The first is that they’re unnecessary. Few people, after all, can save enough to buy a home with cash, so home buyers naturally gravitate toward mortgages. And businesses like debt because it offers them tremendous leverage, making it possible to put down a little money and potentially reap a huge gain. Even in the absence of the deductions, then, there would be plenty of borrowing. The second thing about these breaks is that their social benefits are pretty much nonexistent. Advocates of the mortgage-interest deduction, for instance, claim that it increases homeownership rates. But it doesn’t: in countries where mortgage deductions have been eliminated, homeownership rates haven’t dropped. Instead, the deduction simply inflates house prices.

Soak the Rich?

So some rich Germans want to pay more taxes:

The group say they have more money than they need, and the extra revenue could fund economic and social programmes to aid Germany's economic recovery.

Germany could raise 100bn euros (£91bn) if the richest people paid a 5% wealth tax for two years, they say.

The petition has 44 signatories so far, and will be presented to newly re-elected Chancellor Angela Merkel.

44 signatories isn't very many, true, but the group held a public gathering to show support and garner publicity:

The group held a demonstration in Berlin on Wednesday to draw attention to their plans, throwing fake banknotes into the air.

Mr Vollmer said it was "really strange that so few people came".

Maybe Western Europeans aren't so different from Americans after all.

(ht: IR Blog)