ataxingmatter

Estonia's Flat Tax System

Please note:  There will be no further updates to this blog until January 3, 2006. Have a happy and safe New Year, one and all! 

There have been a number of articles lately praising Baltic countries in the old "iron curtain"--like Estonia, Latvia, Slovakia and Lithuania--for adopting some version of a "flat" tax.  See, for example, this one by Mark Landler in the San Francisco Chronicle.  It seems clear that the flat tax is currently working well in countries like Estonia, but that success should not be taken as an indicator that countries with highly developed economies should follow the Baltic lead or indeed that the Baltic states can be expected to retain their current tax systems. 

After the fall of the Soviet regime, Estonia began its income tax system in 1990 with a fairly sophisticated progressive tax structure, but with very unsophisticated tax administrators and taxpayers.  See this description of the tax system.  The complexity and lack of administrative expertise created unsurmountable problems, leading Estonia to switch to the current "flat" system in 1994.

Estonia's "flat" system is actually a progressive rate income tax, but with relatively low rates (currently the top rate is 24% and it is scheduled to drop to 20% by 2009) and a broad base (without differentiation between ordinary income and capital gains, and with limited deductions and exemptions permitted).  Id.  There is a standard exemption amount (i.e., a zero rate bracket), but families receive additional exemptions for children.  Certain pensions are excluded.  Various personal expenses--such as mortgage interest--are deductible, but deductions cannot amount to more than 50% of taxable income.  In other words, the Estonian tax system is an income tax with a broad base and flattened (but not flat) rate structure.  There is also an 18% VAT.

An enforced and collected tax creates steady revenue streams that permit government to do the things that must be done to support a stable economy and jumpstart economic growth.  No government can effectively provide public services, including a stable environment for economic growth, without a steady stream of tax revenues.  So getting a tax system off the ground and working would be very important to economic growth in a country that did not have a working tax system.  A simpler and more transparent tax would be especially important in that case, and clearly the system Estonia developed, permitting internet filing of income tax returns (much like the 1040EZ used by many ordinary Americans in the lower four quintiles) has worked to spur Estonia's growth.  It might well be that higher rates and additional rate brackets would work as well (or better), if the country avoided the constant adjustment that was apparently tried in the first few years of Estonia's income tax system and could rely on experienced tax administrators. Consistency and transparency, in other words, may have been much more important for Estonia than reducing to two (three) rates from four rates.

Once revenues are coming in, they can permit governments to create the kind of infrastructure that will drive more growth.  The government of Estonia is clearly paying attention to this issue at this point, by devoting government resources to providing internet access and supporting research on ways to make the internet a productive organ of economic growth.  Many of Estonia's cities have done what Philadelphia is doing (see here)--providing universal wireless access so that citizens can all leap into the information universe. There are 700 public internet access points and 600 free wireless zones in the country, every public school has internet and computer systems, and a majority of the population are internet users.  See this story on Estonia's economy. Estonia is the home of Skype, the "free-to-use internet telephony system" as described here. 

(In the USA, by the way, communications companies have worked to make it illegal for cities to do what Estonia has done--use tax revenues and partnerships with private companies to create public or quasi-public utilities that provide great wireless access cheaply and universally for all citizens.  Verizon spent $3 million lobbying for a Pennsylvania law to prevent cities from offering muni-wireless unless a telecommunications company refuses to do so, and other states are considering such a bill.  See here.)

Having consistent tax collections and an active government that supports markets, as Estonia's government is doing by encouraging internet research and development, is a wonderful driver.  It is especially important when there has been a dearth of such activities. Growth in that context should be meteoric--there is a long way up to go from how far down Estonia was.

There are a number of issues, though, for these new "flat" tax countries, and those issues may become paramount as the heady days of rapid growth wane and the divide between rich and poor becomes more apparent.  For one thing, flattened income tax at lower rates may not generate enough income, even with the critically important equal taxation of capital and labor income.  Funding for the many activities of modern governments--from security to the arts, education to health care--is expensive.  Estonia has so far mimicked the US instead of its European neighbors in providing a very thin social safety net.  Lesser revenues because of the flattened rate structure, however, will make it hard to provide important public goods like  education, health care, assistance for the elderly and other state support that most developed countries think necessary.   As it becomes a more integrated member of the European Union, Estonia's citizens may demand government support for a standard of living similar to their more established Nordic neighbors.

Furthermore, the lower-tax states in Europe are in many cases making gains by undercutting their more established neighbors.  German and French leaders claim that the Baltic states are just grabbing foreign investment from neighboring states by selling their lower tax rates.  See the San Francisco Chronicle story, above.  At the same time, the European Union is still providing financing to its newest members, and that financing supplements the lower tax revenues from the flat tax, providing necessary funds for the countries to continue their modernization drive. Whether Estonia adopts the Euro or not, tensions between European Union countries over tax policies and financing will need to be resolved, perhaps ultimately through some kind of European tax harmonization beyond the general directives currently in force. 

The article on economic indicators for Estonia, cited above, shows that for 2004 Estonia had a growth rate of 7.8% of GDP, mostly through improved productivity.  Job increases were relatively small.  That is what might be expected of an economy that is coming out of a long slump under the Soviet occupation.  Over the long haul, the economy needs to create significant jobs and reduce the unemployment rate below its current level (around 9.5%).

Most problematic for the Baltic states is the impact of the flat tax on already existing inequalities.  Those who came out of the Soviet era with the most assets will carry a relatively light tax burden, while those at the bottom may find the 24% tax rate unbearably steep.  In the United States, for comparison, generally only taxpayers in the top quintile of the income distribution pay an effective tax rate above 25%.  Even assuming continuing economic growth, the higher tax burden on lower-income Estonians may make it hard for them to move forward with the economy. 

Where will the Baltic states be in a decade?  I don't have a crystal ball, but I expect that developed countries will ultimately decide that governments will increasingly emphasize support for quality of life expenditures from education to environment to health care.  Health care and care for the elderly is especially significant as we become more capable of treating disease and prolonging lives.  Education will continue to be the doorway to a better standard of living, and governments will be expected to provide strong educational foundations for all citizens.  As use of carbon products explodes with countries like China and India rapidly adopting Western lifestyles, environmental expenditures will also need to mushroom. Those needs may well require countries like Estonia to move towards a more highly progressive rate structure than the one currently in place.

As Edgar Savisaar, leader of a center-left party in Estonia states (in the San Francisco Chronicle article cited above), "The best societies in the world to live in are the Nordic societies.  [Estonia has] to move in that direction."   

Generosity

Arianna Huffington provides some thoughtful observations about generosity in a posting, linked here,  on the Thinking Peace website.  She reports a debate with Michael Kingsley of Slate about the Slate 60, a charitable contribution rankings list designed to parallel the Forbes 500. 

Her objection--that the people who make the top of the Slate 60 are not often genuinely generous.  Their gifts are to support institutions that are catered by the rich, like symphonies and heavily endowed universities.  Those gifts often carry a quid pro quo, such as memorialization of the donor in huge bronze letters naming a building.   So in her view, those gifts should not be entitled to a full charitable contribution deduction.

Her solution--create a point system that ranks gifts not just by the dollar amount but by the substance of the gifts.  Shame the big givers by pointing out their failure to be genuinely generous. Gifts to programs for the needy (soup kitchens, educational grants to K-12, health care in Africa) count more than gifts to institutions typically supported by the rich.  Anonymous gifts count more than gifts putting the donor's name on a building.   She concludes with this statement:

"Not all generosity is created equal, and so we need to honor those among the generous whose sights extend beyond their own enclaves. Compassion and philanthropy can’t fix America’s problems on their own. But they fill an even smaller portion of the gap between rich and poor when they are directed where they are not urgently needed. " 

It's doubtful whether Huffington's ranking system could be incorporated into the charitable contribution deduction, but it is certainly something to keep in mind whenever someone comes up with the idea of permitting the rich to take into account charitable contributions equal to 100% of their gross income, as in the KETRA bill.  The next time Congress passes such a provision, let's hope the benefit is restricted to donations for charities that direct their aid to the hungry, the homeless and the broken in health. 

Holtz-Eakin Honesty

Congress likes to claim that the series of huge tax cuts, coming at a time of increased military spending to wage war and then fund occupation and reconstruction in Afghanistan and Iraq, deserve the credit for what is described as a booming economy.  The raw facts, however, are more sobering.  While productivity has increased, ordinary Americans have not received much benefit.  Inequality is growing, "Food Banks [are] Leaner  As More In U.S. Are Hungry" and big CEOs are being paid huge multimillion dollar pacakages while their workforces are being outsourced.  Trade imbalances and huge budget deficits will not just fade away or be outgrown because of more tax revenues in a lower taxed economy.  And those deficits will have a long-term impact, especialy if for any reason foreign investors decide to withdraw their funds from the U.S. and invest in other places.  As the Times pointed out today, Congress top economist has been no shrinking violet in trying to help Congress understand the impact of unending deficits.  Holtz-Eakin has in fact opposed tax cuts accompanied by increased spending and provided a clear report of the tax cuts' tilt towards the superrich.  Read the editorial, here.

Our Voices Together

One of the tax professors on our listserve, Ellen Aprill, shared information with us about a foundation established by Gene Steuerle, a senior fellow at the Urban Institute  who lost his wife in the 9/11 attacks.  The foundation was established with monies from the 9/11 victims fund.  It is dedicated to furthering education, tolerance, and social justice throughout the world.  See this description of the mission on the website for "Our Voices Together" and this story in the LA Times about the charity.

Now place that story in juxtaposition with this one.  In this Dec. 26 Chicago Tribune story, Derrick Jackson notes a disheartening piece of data from the Bureau of Labor Statistics' latest report about consumer expenditure patterns. (You can access the 2003 report, here.)  For the top quintile in terms of income, average annual expenditures on entertainment are about $4500.  This compares with about $2000 spent on education and about $250 spent on reading.  Those numbers suggest misguided priorities among the part of the population that can best afford to make a difference.  Especially in a time of war, it is discouraging that "shop til you drop" and "go down to DisneyWorld" have become the expected mode of individual sacrifice.   Just think how much better this world could be if every multimillionaire contributed just one-tenth of his or her assets to organizations such as Our Voices Together! 

The Giving Season

In discussing tax issues, I have frequently called on Congress to consider ordinary Americans, defined loosely as those in the lower four quintiles of the income distribution, in developing tax policies.  I have argued that tax giveaways to the rich cannot be justified when they result in decreased safety nets for lower-income taxpayers or intergenerational transfers through increased debt burdens.   The result is too often an increase in the inequality gap between wealthy owners at the top of the income distribution and those who depend on a wage for a living at the bottom of the distribution.  That inequality gap stifles innovation, as a narrower and narrower band of financially secure individuals at the top remain free to take on entrepreneurial risk.  It also threatens democratic institutions, as oligarchic families aided by lenient estate taxation amass critical concentrations of wealth that carry enormous status and power.  Power captures and corrupts institutions, subverting the political processes and reducing the provision of public goods.   

This holiday season, the New York Times provides two noteworthy perspectives on these issues, as Congress rushes to pass budget measures and tax legislation and as gift-giving  is highlighted in defining the celebrations. 

I.  Questioning the "starve the beast" mantra that tax cuts allocate resources more efficienctly.

The first is Cornell economist Robert Frank's December 22 article "Tax Cuts for the Wealthy:  Waste More, Want More."  Noting the typical tax cut mantra of  "it's your money, and you know how to spend it much better than anyone in Washington," Frank comments that there is more than one way to spend wastefully.  One, for which government is often berated, is to pay more than the market rate for an item that is needed.  Certainly, the federal government has done this at times--especially in issuing big-ticket contracts through the Pentagon.  But Frank notes that another wasteful form of spending is far more common in private than in public spending--the "keep up with the Joneses" rat race of the wealthy which is "made even worse as the chief beneficiaries of the tax cuts race to outdo one another."  Id.  He gives a few real world examples--$700,000 Dunand mechanical watches that are no more accurate than a $30 Timex and a recent $10 million birthday party for the daughter of David Brooks (magnate who manufactures the too scarce body armor for the military in Iraq). 

These keep-up-with-the-Joneses expenditures are economically inefficient.  "[M]ost of the tax cuts financed by recent budget cuts will go to families that already have everything they might reasonably need." Id. The sole objective  of many expenditures is to achieve greater status than a wealthy peer; yet no matter how much is spent, everyone in the peer group spends more and nobody's status is any greater among the peers than it would have been if all had spent less. 

More to the point, Frank notes that dollars used to finance the cuts would in many cases not have been used wastefully by government.  "[E]ven though government does buy some items at inflated prices--body armor whose price includes a profit margin large enough to finance a $10 million birthday party?--many of these items serve vital purposes." Id.  As a result, "there is little reason to expect large tax cuts for wealthy families to have resulted in a more efficient allocation of our nation's scarce resources."  Id.

2.  Questioning the "starve the beast" mantra that we should leave the safety net to the generosity of those who are able to retain more of their own resources.

Frank's piece could have been written as a companion to the  December 19, 2005 New York Times article by David Cay Johnston looking, in this holiday season, at the generosity of the wealthy, "Study Shows the Superrich Are Not the Most Generous."  Johnston reports on New Tithing Group's research based on I.R.S. data on charitable gifts (full report linked here and release linked here).

Johnston notes two particularly unflattering conclusions as to the wealthiest Americans:

• "Working -age Americans who make $50,000 to $100,000 a year are two to six times more generous in the share of their investment assets that they give to charity than those Americans who make more than $10 million."  [emphasis added]
• "The least generous of all working-age Americans in 2003...were ...the 284 taxpayers age 35 and under who made more than $10 million--and the 18,600 taxpayers making $500,000 to $1 million.  The top group had an average $101 million of investment assets while the other group had on average $2.4 million of invetsment assets." [emphasis added]

These statistics on the generosity of the supperrich are particularly interesting in light of the tax cuts provided to the superrich for their donations in KETRA, the Katrina aid bill.  A major provision of KETRA was a tax expenditure resulting from temporary removal of the gross income limitation on charitable contribution deductions and temporary elimination of the phaseout of itemized deductions related to charitable contribution deductions.  Instead of a 50% limitation, taxpayers can make contributions between August 28 and December 31, 2005 that amount to 100% of their adjusted gross income.  Furthermore, the recipient need not be a charity that serves low-income families or Katrina victims.  It need only be a public charity rather than a private foundation or donor-advised fund.  The "extra" contributions can even be provided for designated purposes (e.g., building a concert hall for a symphony orchestra that will carry the donor's name in large gold letters and a plaque at the entrance memorializing the donor's generosity).  The contribution might merely be an acceleration of an additional donation planned to be made in the following year. 

Obviously, this provision only benefits the superrich.  Ordinary taxpayers (those in the lower four quintiles and a good number of those in the upper quintile) cannot afford to give away even half of their income, much less 100%.  The superrich who have excess assets and considerable economic income that is not subject to taxation are the only ones in a position to benefit from the temporary charitable deduction provision. 

It seems a shame that we chose as part of the Katrina emergency aid to provide an indirect benefit to the types of charitable organizations most likely to be supported by wealthy patrons and to the types of donations most likely to involve some kind of status quid pro quo, rather than using federal revenues to provide a direct cash benefit to Katrina evacuees. It seems especially lamentable, in light of the empirical evidence that the wealthiest Americans are in fact less generous than others who can less afford to be so. 

Capital Gains

Even though the holiday season is upon us and Congress is finally calling it quits for the year without the passage of the expected tax giveaway bill for the wealthy, the relentless campaign of conservative think tanks and trickle-down economists to cut taxes on capital gains and other investment income continues. 

The Wall Street Journal's editorial pages provide two recent examples. First there was Martin Felstein's December 8  "Tell Joe It Ain't So" piece arguing for elimination of any tax on capital gains, interest or dividends.  Feldstein, a Harvard professor, member of the Wall Street Journal board of contributors and former chair of the Council of Economic Advisors under President Reagan, purports to care about ordinary Joes, but his arguments apply primarily to the wealthy who can choose to save or work.  His goal is clear--eliminate tax on capital and increase tax on earnings.  He pays little attention to the distributional impact, especially of the proposed increased taxes on wageearners.

Next came Edward Prescott. senior monetary adviser at the Federal Reserve Bank of Minneapolis, an Arizona State professor of economics, and a 2004 Nobel laureate in economics.  His December 20 Op-Ed, "Stop Messing with Federal Tax Rates," appeared to be making an argument for a stable tax system that is not changed on an annual basis, based on the importance of certainty to investors.  He even acknowledged that rates must be "high enough to generate sufficient revenues, but not so high that they choke off growth."  But then the article called the failure to make permanent the temporary tax cuts on capital gains and the temporary change in the taxation of dividends "unfinished business" that needs to be attended to quickly.  In other words, Prescott doesn't really want Congress to follow his advice about not changing the tax law. 

Prescott uses some statistical sleight of hand to claim that his push for low capital gains and dividends taxation isn't just another tax break for the rich.  Why, he says, "nearly 60% of those paying capital gains taxes earn less than $50,000 a year, and 85% of capital gains taxpayers earn less than $100,000."  That statistic--focusing on the fact that some capital gains are enjoyed by taxpayers in lower brackets-- says nothing about the amount of capital gains enjoyed by taxpayers in lower brackets compared to higher brackets.  It disregards the enormous disparities between ordinary taxpayers with a few hundred dollars of capital gains who receive a very small benefit from the rate difference compared to wealthy taxpayers with predominantly capital income.

Like many others arguing for consumption taxation based on efficiency claims, Prescott argues that capital gains taxes are "cumbersome" because they hit at the risk-taking heart of a market economy.  Entrepreneurs who "work their tails off" deserve a tax break. I find that argument unconvincing.  It parallels the argument that CEOs deserve compensation packages 500 times those of ordinary workers because they are the ones that take entrepreneurial risk.  Tell that to the ordinary Enron workers who lost it all when the firm went under. From a fairness perspective, we should ask why owners should receive their compensation at preferential tax rates when workers who "work their tails off for little or no compensation" have to pay higher rates. Workers are as much at the heart of new enterprises as are the capitalists that fund them.  They take great risks by agreeing to work for startups with no guarantees for their futures, and they make the startups possible by doing so.

Prescott then says that the other group of wealthy are those who just "earn more money than the rest of us."  (He disregards the many wealthy who just inherit their wealth.)  He suggests they are doing nothing more than raising their children and pursuing their careers just like the rest of us and should not be "punished" for doing well.  This is of course an argument against a progressive tax system generally rather than an argument merely for reducing tax on capital gains and dividends.  He presents no reason other than encouraging entrepreneurialism (the same argument previously given) for treating the increased investment income (often from passive rather than entrepreneurial activities) of the wealthy preferentially compared to the income of the ordinary worker. 

For all his concern about not talking about the "Bush tax cuts," Prescott's goal is to push forward the Bush agenda to reduce the tax on capital.  He talks about small-time investors saving for retirement, light manufacturers, and hard-working couples across the street, but the true beneficiaries of the tax break he is pushing are the wealthy heiresses and millionaire corporate CEOs.  The small-time investor saving for retirement already has tax-advantaged savings programs that benefit him.  The light manufacturer has numerous expensing provisions to significantly reduce taxable income.  The hard-working couple across the street may well find that the safety net provided by Medicare and Medicaid is no longer there when they need it because of the budget cuts made to fund, among other things, the capital gain and dividend tax break for the wealthy.

Budget Accord?

The House Monday approved the conference agreement on a budget bill that carried out many of this Congress's threats to pull the safety net away from lower-income people in anticipation of tax cuts to come early next year favoring the rich.  See Robert Pear's New York Times story on Budget Accord.

Several of the Senate provisions for imposing tighter regulatory control on payments to pharmaceutical companies and health insurers were eliminated. In fact, new shields for the pharmaceutical industry have been inserted in the military bill, protecting them from even reckless conduct if they are producing vaccines in response to a delared pandemic.

Here are just a few items included in the House-approved budget agreement that purports to reduce the deficit by $39.7 billion over five years (without regard, of course, to the additional tax cuts that Bush and Republican leaders have said they intend to pass early next year).

• Student Loans.  Instead of moving federal money away from subsidies for lenders to real aid for needy students, the budget takes some of current funding out of the student aid program entirely. 
• Child Support Enforcement.  The cutback in enforcement funding was reduced, but still retained in the negotiated provisions.  As noted in prior postings, this is an instance of the federal government cutting its nose to spite its face--child support enforcement spending raises revenue well in excess of costs.  One assumes that the gimmick here is that the budget processes don't appropriately take account of the revenues raised in determining whether the cut in enforcement spending reduces or increases the deficit.  (That, of course, is similar to the reasons for the establishment of the lender-friendly guaranteed loan programs in place of student-friendly direct loans--the expense of the direct loans was dramatically overstated, because payments under the loans were disregarded!)
• Medicaid.  The most onerous provisions here allow states to charge premiums and higher co-payments for medicaid and to cut benefits provided to the poor and elderly.  Recipients of Medicaid can now be required to spend as much as 5% of their family's income on co-payments for medical care for the family.  Higher co-payments are intentionally designed to permit states to discourage emergency room and prescription drug use--i.e., to reduce health care for the poor.  Furthermore, persons who fail to make the increased premium payments can be taken off Medicaid coverage entirely; if they fail to make co-payments, then pharmacists can refuse to fill prescriptions or hospitals can deny services.

The states' governors have argued for this "flexibility" because of a need to cut costs. Representative Joe Barton (Republican of Texas and architect of the Medicaid provisions) claims that these provisions are needed to "encourage personal responsibility" among the poor!  Id.

The harsh truth is that this budget legislation makes a choice to add to the storehouses of the rich in place of providing universal health care for all Americans.  This provision is harshly uncomprehending of the state of many medicaid recipients living on a fixed income.  Increased payments for medical benefits, whether in the form of higher premiums or higher co-payments for services rendered, come at a cost of other basic human needs.

As an aside, consider the Wall Street Journal's Dec. 20, 2005 editorial "Sunshine for Medicaid"  in support of state programs (developed under Medicaid waivers) that purport to use insurers to cut health care costs.  One suspects that what will be cut is health care benefits for the needy.  This looks ominously like a Medicaid equivalent of the guaranteed student loan program--take a functioning government program, insert profit-making financial institutions as middlemen, and ultimately reduce the amount of funding actually going to the intended beneficiaries by letting the financial institutions keep a cut of the taxpayer dollars currently being spent directly on beneficiaries.  The Journal praises the idea as getting rid of the "long-term insurance substitute for the parents of middle-class baby boomers.  Something has to change, or taxes are going to keep rising [sic] everywhere."

• Welfare.  If a state cannot ensure that half of their welfare recipients are engaged in work or searching for work, federal funding can be halted. 

Imagine a state that has worked efficiently and earnestly to ensure that all people are moved off the welfare roles if they are able to work and if there is appropriate work available (and the necessary child care to make sense for work to be required of working parents).  But in that hypothetical state, as in any state, there will undoubtedly remain a core group of welfare recipients who are unable to hold down any kind of real job, whether because of mental or physical handicaps or otherwise.  What happens when the state so effectively reduces its welfare recipients that more than half are members of this core group?

All in all, this budget bill is as expected. Promoters of these provisions in Congress said that their goal  was to limit entitlement spending. It is a chilling example of the current Congressional majority's lack of compassion for the increasing proportion of American families that live below the poverty line and for the working poor who struggle to take care of themselves and their families on inadequate salaries at service jobs in industries like Wal-Mart that provide little or no benefits to most of their workforce.

Miscellany

Today's post will be a departure from my ordinary form, to point out various items worthy of attention. 

More on the Poorly Conceived Jobs Act Repatriation Provision:

A much ballyhooed international tax provision that was the cornerstone of the tax-cuts-create-job-growth platform was a one-time provision for very low taxed (at 5.25%) repatriation of overseas profits that should ordinarily be taxed at the corporate tax rate of 35%. 

As I have written earlier, here, the job stimulus impact of the repatriation of profits was in no way assured.  In fact, the provision ultimately had almost meaningless restrictions on uses of the profits.  Companies can (and do) enjoy the reduced tax incentive for job creation while laying off thousands of their workers!

Note that this need not have been the case.  It would have been relatively simple to condition any tax benefit from repatriation under the special provision to a proven record of adding jobs within the company receiving the tax benefit.  Any company with employee layoffs within a reasonable testing period before and after the repatriation or that could not establish an increase in its permanent employee payroll for the taxable year should not have been permitted to enjoy the benefit.  It would also have been relatively simple to ensure that no company was using cash freed up by repatriation to finance a share buyback or dividend program.

Another flaw in the program is the lack of transparency about the real uses of the funds.  Today's Wall Street Journal reports that firms are bringing back lots of cash under the low-tax scheme, but very few are reporting much at all about their uses of the cash to their shareholders (or, I should add, the public at large that also reads the shareholder reports).  See Michael Rapoport & Steven D. Jones, "Firms Mum on Repatriated Profits," Wall St. J., Dec. 14, 2005, at C3.  According to Rappoport and Jones, many companies like Hewlett-Packard, DuPont, and Intel will use the repatriated billions for capital expenditures and R&D, both of which represent some legal double-dipping, since those uses of cash now benefit from extraordinarily generous expensing provisions. 

One thing we can safely lay odds on--if the international tax provisions are about the same five years from now, there will be another push by corporate lobbyists and their most willing supporters in Congress for another tax break for the companies that have big stashes of deferred profits overseas.  And because of this "one-time" tax break, not nearly so many companies as in the past will repatriate and pay the regular corporate taxes due on their overseas profits. 

Robbing Poor Peter to Benefit Rich Rob?--Student Loans

One of the hurdles slowing down the Republican-led Congress's budget-deficit and tax-cut juggernaut is just how to cut budget numbers while passing even larger amounts of corporate and wealthy investor tax breaks, all without revealing a bankruptcy of both compassion and sound fiscal policy. 

One target of budget cuts is the student loan program.  From my perspective, direct loans to students based on need are incredibly effective uses of tax dollars--they help the country increase its human capital, they help individual Americans rise out of the mire of poverty and into the mainstream of productive work, and they do it in a truly cost-effective way with no middle men taking a cut out of the tax dollars supporting education.  You'd think that kind of a program would be a winner on anybody's agenda.  In fact, the first student loan program providing for direct lending was the National Defense Education Act of 1958.  The first guaranteed programs were established later, in 1965, in part because of the way budgetary rules misrepresented direct loans as costly because they did not at the time take into account the fact that loans would be repaid.  See this history of the loan programs.   

As a significant budget reduction measure, Clinton proposed eliminating guaranteed loans through big lenders and putting all the federal resources behind direct loans administered directly by educational institutions.  When the Republicans took over the House in connection with their 1994 "contract" to re-make the federal government, they targeted the direct loan program for elimination instead!  Id.  When universities complained that direct loans were much more efficient at getting aid dollars where they were needed than the cumbersome, middle man-heavy guaranteed loan apparatus, Congress instead merely refused to permit the Department of Education to encourage universities to move towards direct loan programs.  Id.

The guaranteed loan programs are lush pickings for the big lender financial institutions.  Here is some information from "Robbing Joe College to Pay Sallie Mae", by Anya Kamenetz, in the Dec. 12 New York Times, here.  Lenders get guaranteed profits and they bear almost no risk of loss (98% of principal defaults are paid by guaranty agencies) even though other agencies do most of the actual lending work.  Then there is Sallie Mae, a private company that buys and sells student loans in the secondary market at enormous profits.  Sallie Mae is the biggest contributor to members of the House Education Committee and made the second highest return on revenue in the 2005 Fortune 500. 

Note that the federal direct loan program since 2001 has brought revenue in to the federal government, while the guaranteed loan program with subsidies for big lenders has cost the federal government billions, according to a Government Accountability Office report on federal student loans, GAO 05-874 (at 17-18), here.  The guaranteed loan program has been about 5 times as costly as the direct loan program from 1994-2004.  Yet funding has favored the costlier guaranteed loan program--in fact, financial institutions fought hard against reinstatement of the direct loan program in 1992.  There is an aggregate $396 billion outstanding in guaranteed loans, and only $150 billion in direct loans.  Id. at 18.  The GAO attributes the difference in the costs primarily to the structure of the programs and the fact that the loans through lenders amounts to a government subsidy of the yield rate on the student loans for the benefit of the lenders.  Id.

The House education committee chair, Republican Boehner of Ohio, claims that the proposed budget cut of $14 billion to the student loan program--the largest reduction in history of federal aid to students--makes sense because it mostly reduces the corporate subsidies to lenders.   See Kamenetz, above.   The problem, of course, is that cutting ridiculous subsidies to rich financial institutions shouldn't result in cutting the aid available to students.  That money should be funnelled instead to make direct grants to students (Kamenetz's suggestion) or to increase funding for the efficient direct student loan program.  In other words, if Congress really wants to reduce the budget without sacrificing student access, there's a way to do it.  George Miller estimated that budget reductions could be achieved of $60 billion over ten years just by switching the funds from the giveaway guaranteed loan program to the direct loan program!  Id.  Boehner, on the other hand, told lenders that he had "rabbits up [his] sleeve" to make them happy. Id. So perhaps it is understandable why Kamenetz and this writer consider Boehner's budget cuts more show than substance as far as removing corporate subsidies and more damaging than he admits as far as hurting ordinary Americans' ability to get reasonable federal assistance in going to college.

Budget Cuts, the Alternative Minimum Tax (AMT), again, and the Iraq Occupation

Today's New York Times reports that Congress may not be able to resolve the differences between the House and theSenate over their competing budget plans before the end of the year.  See Carl Hulse, Senate Leader Predicts No Action, New York Times, Dec. 14, 2005, at A31.  As previously discussed, the House tax cut bill extends the capital gains cut for two more years, whereas the Senate bill did not.  The House then passed a second bill patching the AMT for another year with the same exemption levels as currently applicable, in the hopes that a deal with the Senate could include the entire bushel of tax cut goodies.

Another wrench thrown into the budget and tax muddle is the funding for Iraq.  The current bills supposedly reduce the federal budget deficit by about $50 billion (before taking into account the proposed tax cuts, which then "re-increase" the budget deficit).  The White House has now indicated that it will need a slight increase--another $100 billion--for next year.  Remember that all of the House's "deficit reduction" budget cuts to programs primarily benefiting Americans not in the upper quintile amounted only to about $50 billion.  What more proof do we need to see that the military tail is wagging the public goods dog?

One thing is for sure with this Congress and this White House--talk of tax cuts will resurge after the holiday break.  House majority leader Blunt said that "Whatever we don't get done now, it is still going to be there in late January."  Id.

More on KPMG and Tax Shelters

The New York Times also reports here on a captive insurance scam marketed by KPMG, the accounting firm under a deferred prosecution agreement with the Justice Department.  It notes that a senior former KPMG executive described the shelter as generating artificial losses by forming an insurer with assets and contingent liabilities, then selling the stock to a third party in order to claim a loss on the sale (since the liabilities reduce the fair market value).    The transaction also helped in the accounting legerdemain whereby liabilities are transferred "off balance sheet" to make the company look better than it really is. 

Taxing Capital

Feldstein uses a hypothetical Joe Blow to extol the virtues of eliminating all taxes on capital income while instituting a "revenue-neutral rise in the tax on [wage] earnings."  See Martin Feldstein, Raise Taxes on Savings? Tell Joe It Ain't So!, Wall St. J., Dec. 8, 2005, at A16.  David Weisbach and Joseph Bankman have made somewhat similar arguments in support of a consumption tax, here.  Future blog posts will explore the Felstein article specifically to tease out some of the flaws in the current arguments pushing a consumption tax base.

Rohatyn & Rudman's "National Investment Corporation"

One of the most disturbing aspects of the current budget and tax legislation process in Washington is the lack of creative thinking about long term problems.  There is considerable political posturing in the Senate and House budget bills.  Each chamber pretends to pay attention to the ongoing, record-breaking pattern of deficits and accompanying record borrowing that will be repaid by tax increases (or standard of living decreases) for future generations.  They have proposed to cut back on programs like Medicaid, child support enforcement, and student loans--ones that generally have constitutents that are least able to organize to explain to Congress the dramatic impact of small changes in federal funding on their daily lives.  The purported "deficit reduction" legislation, however, exists side-by-side with plans for huge new tax breaks that will reduce government revenues by considerably more billions than the budget legislation accounted for.  In addition to various unneeded tax breaks for business (such as the extension of excess depreciation), the House proposes to extend the millionaires tax break on capital gains and dividend income.  To top it off, the plans disregard the true costs of the continued occupation in Iraq--military/security spending these days is treated as entitlement funding by both the Pentagon and corporate contractors that feed at the Defense trough with the assistance of no-bid contracts and friends in high places. 

All in all, it seems the budget and tax legislation processes as currently practiced are bankrupt of fresh ideas, heavy on short-sighted thinking, captured by special interests, and short on recognition of long-standing problems.   Two issues cry out for government attention:  universal access to education and health care, and infrastructure maintenance and rebuilding.  The first is central to quality of life for all Americans and should be a primary focus of funding with taxpayer dollars.  Without a healthy and educated citizenry, economic growth is unsustainable.  We should be finding a way to endow each and every American with sufficient human capital to function as vigorous, entrepreneurial citizens in the twenty-first century; instead, we are throttling human capital development by funding lenders' huge profits rather than students' direct loans and giving pharmaceutical companies bigger tax cuts through more research and development expensing while providing inadequate funds for independent university research and expecting sick and poor Americans to pay more out of their meager incomes for what little health care we provide.  While Europe and Japan invest in the future, the Bush tax cuts have starved the government of  federal funds for vital infrastructure projects--to (re)build and protect schools and universities, fast intercity rail lines and more secure ports, better bridges and levees, and renewed Gulf marshes and heartland prairies.   

One idea for dealing with the $1.6 trillion of delayed infrastructure projects in this country has been proposed by Warren Rudman and Feliz Rohatyn--a "national investment corporation" that could issue long-term bonds guaranteed by the federal government and oversee expenditures from trust funds for infrastructure projects.  See their description of their proposal here. 

While I think any such proposal would require considerable finetuning to ensure that the entity would not function as a mere conduit of government largesse to big corporate players (as the Defense and Pentagon contracting programs with Halliburton and Shaw have been), it may be that it is time for Congress to consider such an idea.  Creating a longer-term outlook for expenditures and prioritization of needs should help reveal the bankruptcy of the tax-cut, "starve the government" rhetoric of the far right.  As Rohatyn and Rudman note, nobody wants "big government" per se, whether liberal or conservative, but everybody (except the "starve the government" group) wants effective government that provides safety nets for the poor and security and public goods for us all.

We won't get that kind of effective government if we continue to finance it with money borrowed from foreign countries and future generations, in order to provide tax breaks to top quintile individuals and megacorporations.  It's time to stop the giveaways, and start thinking responsibly about the future.  Maybe the "national investment corporation" is one idea that should be considered.

Houses Passes an AMT Bill

The House on Wednesday passed by 414 to 4 a bill that extends the higher AMT exemption amounts for another year.  See this story in the LA Times.   The main beneficiaries of the AMT stop-gap legislation will be taxpayers earning between $200,000 and $500,000.  They make up part of the same group that will benefit most from the capital gains and dividends rate cut.  But without hte extension, considerably more taxpayers in the $75,000 to $100,000 range would also be subject to the tax--increasing from about 1% this year to about 30%.  Id.

The House hopes to take up the rest of its tax cuts later--including the costly capital gains and dividends cuts that will provide an additional windfall for the wealthy.   Stategists had apparently finally realized that it would not go over well at all if Congress passed the tax cut for the superwealthy without even taking care of the AMT hit on the upper-middle class.  Remember that this pressure for the extension of the dividend tax cut comes in the wake of reports that the policy change didn't do much at all to boost economic growth.  Karen Richardson, Did the Dividend-Tax Cut Work?, Wall St. J., Dec. 6, 2005, at C5.

The House also voted separately on a set of tax incentives designed to help businesses in the Gulf area hurt by Katrina and Rita.  The House bill, unlike the Senate bill, excludes businesses that social conservatives don't like--casinos, liquor stores, massage parlors, and similar businesses. 

I have said before that the use of "opportunity zone" credits and other incentives seems like the wrong way to provide federal aid to the areas devastated by the hurricanes.  It seems to make common sense that if money were provided directly to residents on the basis of need and they were able to hire local companies directly to rebuild their homes and clean their businesses, the results would be more localized to the area of need.  More local business would get contracts, and more local residents would have jobs.  The money would circulate in the area, prompting other businesses, like groceries and hardware and clothing stores, to expand.

Our experience with FEMA contracting, on the other hand, suggests that no-bid processes and use of familiar contractors results in most money going to companies far removed from the disaster area.  Of the $3.7 billion in FEMA contracts awarded by late November, only $201 million were for Louisiana companies.  See this story.  Many of those have been no-bid contracts.  Id.  Some of them went to politically connected companies. See this story (wife of Mississippi Governor Haley Barbour's nephew runs company that is 7th out of 88 MIssissippi companies in magnitude of federal contract dollars received, some of them on no-bid basis).

If tax incentives are to be used as the means for aiding the Gulf area, it is hard to see how Congress can justify providing benefits to some legal businesses and not to others.  The discrimination among businesses would have a harsh effect on the owners and employees of the disfavored categories.  The basis of discrimination would not be legality, but this particular Congress' views of moral preferences. Even Republicans such as Thad Cochran from Mississippi have stated that no legal business should be excluded from the Katrina tax breaks. To say the least, it will be interesting to see the outcome of a conference negotiation between the Senate and House on these provisions.