Tax Base Broadening ?

Below Dan pulled a post questioning Jon Chait’s claim that US economist’s generally support a broader tax base and lower rates. I am expert neither on taxes nor economists, but I will write at length on the question after the jump.

Before the jump, I must note that Chait made many of the points I try to make below. His main point is that it is easy to propose base broadening in the abstract but hard to eliminate actual deductions. I slipped into criticizing something he wrote in passing in the post Dan pulled over here, and I do it again after the jump.

First I note that many prominent economists support a sharply higher top marginal income tax rate. The figure 70% is not rare. I am not prominent, but that happens to be the top marginal income tax rate which I support (from nostalgia — that was the rate during my childhood in the 60s a period of notoriously slow economic growth).

Second, I think the consensus is a villager VSP consensus about what economists say (or should say or what economic theory implies or something). Similarly the VSPs are sure that economics tells us that social security pensions should be cut. Oddly many actual economists disagree.

Third, I support gradually eliminating the mortgage interest deduction, so, I personally also support base broadening (in addition to raising the top rate). Here I will generally argue against base broadening, but I stress that I am making a case against it and not totally opposed.

Now for some discussion of actual policy.

I think that it is easy to oppose tax expenditures (deductions, credits, exclusions etc) in the abstract for the same reason it is easy to support lower government spending in the abstract. All are costly, but the justification for each is specific, so when one just thinks of the whole mess, one thinks of the costs and not the benefits.

I don’t think that Chait thinks that most economists want to eliminate the earned income tax credit. I’m sure he doesn’t. That’s a tax credit, but it isn’t what he means at all. Same for the child tax credit.

My guess is that he wants to tax employer provided health insurance as income, but only a part of a transition to single payer. Certainly, he isn’t for repealing the ACA and eliminating the deduction. The logic of a broad tax base is to minimize distortions due to decisions made to avoid taxes. But the huge distortion here is the problem of free riding by the uninsured. Employers who pay for health insurance pay for the care of employees of employers who don’t. Chait supports a mandate — that is an additional tax incentive to get health insurance.

Some economists might want to eliminate tax incentives to save such as IRAs an Keoghs (does anyone remember what Keoghs are ? My dad has one). But wait the problem with running deficits is that is that the illusion of wealth causes higher consumption which crowds out investment (only if the economy is not in a liquidity trap).

Loopholes in the corporate tax code are proportionally much more important than loopholes in the personal income tax code. But many make a whole lot of sense. Surely we prefer corporations to reinvest profits rather than paying dividends (again the problem with just running deficits is crowding out investment). We should especially like investment in R&D since the investing corporation does not capture all of the benefits.

Hmm I think I have covered a significant fraction of total tax expenditures. So what is the cause of the near consensus for a broader tax base and lower rates(among VSPs at least). Clearly a lot of it is that they don’t find the alternative attractive — that is if one is convinced that high tax rates have high dead weight losses, then one is morewilling to eliminate tax expenditures. The alleged costs of high rates include avoiding genuine income to avoid paying taxes — reducing labor supply, reducing human capital investment and reducing saving. The evidence for a large effect on labor supply is miniscule. The human capital argument is that people study less if the increased salary mostly goes to taxes. Again the evidence is very weak. The remaining issue relates specifically to taxation of capital income and capital gains. I think the special low rates are considered loopholes by the critics of loopholes. I know some economists claim to have calculated significant dead weight losses due to genuine avoidance of genuine income. I know how much they had to torture the data too. But I don’t think that anyone is really convinced.

Rather, the problem with high rates is that they encourage tax avoidance for given gross income by making deductions and shelters and such like more valuable. So we are back to deciding if such avoidance (which is often explicitly encouraged) is desirable. It is generally the product of a political choice to encourage something. If this was a mistake, it is a mistake for low tax rates too. If it is a good policy, high rates make it more effective.

In any case, a higher tax rate does not imply that deductions must be more valuable. It is possible to cap deductions (as Obama has repeatedly proposed) so, for income over $250,000 the deduction of x is replaced by a credit of 0.35x. The incentive to find it is the same as now. The new top tax rate can be anything. There is no reason at all taxes have to be calculated by adjusting income then applying the tax function. The almost universal conflation of the marginal tax rate and the marginal benefit to the taxpayer of a tax expenditure is not an error — it is a trick used by those who want low tax rates to suggest that lowering rates is the only way to reduce incentives to find deductions and shelters and such.

OK now for my one field of expertise — lazyness. I am not the world’s top expert, but people even lazier than me are too lazy to type. I suspect that pundits (and some economists) consider the current tax code inefficient, because they personally would have to work rather hard to commment on it intelligently (my solution as seen above is to comment on it based on guesswork). The efficiency is dollars raised per page of tax code. The wasted effort due to complexity is their effort. I think this is a factor.

I think another factor is the desire to find common ground. A compromise based on lower rates and fewer loopholes appeals to lovers of bipartisanship. They have nostalgia for the distant memory of Bill Bradley and Jack Kemp working together. In particular, the argument against high rates based on incentives for tax avoidance leads invevitably to the proposal that the loopholes be eliminated. This is a way to increase revenues which supply siders must embrace if they don’t want to be revealed to be total hypocrites. Decades of experience have not taught many VSPs that supply siders don’t mind broadcasting their total hypocrisy.

Finally, I think advocacy of a simpler tax code appeals to people because it seems more horizontally equitable. The logic is not utilitarian. The idea is that it is fair for people with the same gross income to pay the same amount in taxes. I don’t have any patience for this argument (I don’t care about horizontal equity — I care about equality). It is based on the asusmption that, because it seemed once long ago that income was a good measure of ability to pay taxes, it is the only fair measure. If you think the argument makes sense, think of the marriage penalty. Should the marginal tax rate depend on individual income or family income ? They can’t both have some fundamental link with fairness.

I think the extremely strong appeal is that everyone thinks of the clever sneaks who are paying less than we are (not of those even less sophisticated than ourselves who are paying more). The thought that someone somewhere has more money to spare, yet pays less in taxes, is infuriating. This is not a rational basis for public policy.

But by all means get rid of the mortage interest deduction, slowly, with plenty of warning, when the economy is back to normal.