Taxes and Gimmicks. Antony Davies Duquesne University.

Taxes and Gimmicks Antony Davies Duquesne University www.antonydavies.org

Tax Gimmicks: How government hides what it does

Gimmick #1: Withheld Taxes

Gimmick #1: Withheld Taxes Endowment effect: People value things more once their property rights to those things have been established. The pain of paying $10 is worse than is the pain of not receiving $10.

Gimmick #1: Withheld Taxes 2011: $850 billion in withholdings = 40% of federal revenues How much do you spend a month on gasoline?

Gimmick #2a: Temporary Taxes

Gimmick #2a: Temporary Taxes How they arrive Voters tolerate new taxes that go toward addressing the emergency. Why they don t leave People get used to paying the tax. Government gets used to receiving the revenue.

Gimmick #2b: Temporary Tax Cuts

Gimmick #2b: Temporary Tax Cuts Political benefits Party in power gets credit for cutting taxes, Temporariness mitigates complaints, Cuts expire when the other party is in power. Why they don t work People make long-term decisions based on anticipated longterm income and expenses. Temporary tax cuts don t affect long-term income and expenses.

Payroll tax cut takes effect Average = 9.6% Average = 9.0% 0.6 percentage point decline in unemployment following the payroll tax cut. Source: Bureau of Labor Statistics Produced by: Antony Davies, Duquesne University

Payroll tax cut takes effect No increase in employment following the payroll tax cut. Average = 57.5% Average = 57.5% Source: Bureau of Labor Statistics Produced by: Antony Davies, Duquesne University

Gimmick #3: Statutory vs. Economic Tax Incidence Government only sets the statutory burden of a tax. It has no control over the economic burden. Employer-paid taxes Corporate taxes Luxury taxes

Gimmick #3: Statutory vs. Economic Tax Incidence A buyer and seller are haggling over the price of a used car. $6,500 $7,500

Gimmick #3: Statutory vs. Economic Tax Incidence A buyer and seller are haggling over the price of a used car. $7,000 Buyer pays $7,000 Seller earns $7,000

Gimmick #3: Statutory vs. Economic Tax Incidence Government imposes a $1,000 tax on sales (to be paid by the seller). $7,000 $7,000 $1,000 $6,000 $6,500 $7,500

Gimmick #3: Statutory vs. Economic Tax Incidence $7,500 Buyer pays $7,500 Seller earns $6,500 (after tax)

Gimmick #3: Statutory vs. Economic Tax Incidence No Tax $1,000 Tax on Seller Buyer pays $7,000 Buyer pays $7,500 Seller earns $7,000 Seller earns $6,500 (after tax) Each pays $500 of the tax.

Gimmick #3: Statutory vs. Economic Tax Incidence Government imposes a $1,000 tax on purchases (to be paid by the buyer). $7,000 $7,000 + $1,000 $8,000 $6,500 $7,500

Gimmick #3: Statutory vs. Economic Tax Incidence $6,500 Buyer pays $7,500 (including tax) Seller earns $6,500

Gimmick #3: Statutory vs. Economic Tax Incidence No Tax $1,000 Tax on Buyer Buyer pays $7,000 Buyer pays $7,500 (including tax) Seller earns $7,000 Seller earns $6,500 Each pays $500 of the tax.

Gimmick #3: Statutory vs. Economic Tax Incidence Government cannot control who pays the tax.

Tax Revenues: What does raising taxes get us?

Source: Tax Policy Center (Urban Institute and Brookings Institute), Bureau of Economic Analysis Produced by: Antony Davies, Duquesne University

Source: Tax Policy Center (Urban Institute and Brookings Institute), Bureau of Economic Analysis, Barro and Redlick (2009) Produced by: Antony Davies, Duquesne University

Source: Tax Policy Center (Urban Institute and Brookings Institute), Bureau of Economic Analysis Produced by: Antony Davies, Duquesne University

Fair Shares: Who is paying taxes?

How much government spending do people fund with their tax dollars? Top 1% 56 days 2% to 5% 44 days 5% to 10% 31 days 10% to 20% 41 days 20% to 40% 47 days 40% to 60% 24 days 60% to 80% 10 days 80% to 100% 18 hours Deficit Day Children 112 days

Income Category Income Before Taxes & Transferes (per household) Income After Taxes & Transfers (per household) Average Federal Tax Rate Ignoring Transfers Including Transfers Federal Tax Revenue (billions) Bottom Quintile $15,000 $23,300 1.3% -55.3% $4.5 Second Quintile $28,700 $40,500 10.1% -41.1% $68.4 Middle Quintile $48,900 $57,100 14.7% -16.8% $170.6 Fourth Quintile $79,900 $79,700 17.6% 0.3% $328.5 81% to 90% $120,700 $107,100 20.5% 11.3% $291.5 91% to 95% $164,800 $138,800 22.5% 15.8% $218.3 96% to 99% $262,200 $206,200 25.0% 21.4% $314.9 Top 1% $1,209,200 $866,700 29.2% 28.3% $388.3 Source: Congressional Budget Office Produced by: Antony Davies, Duquesne University

Taxes and Gimmicks Antony Davies Duquesne University www.antonydavies.org

Does Government Have a Revenue Problem?

Source: Bureau of Labor Statistics Produced by: Antony Davies, Duquesne University

Does debt matter?

Dangers of so much debt Too easy to lose track of what s important. $300 million cut in Community Development Block Grants. $300 million = 45 minutes. = 2 days

Dangers of so much debt Too easy to lose track of what s important. Pressure on Federal Reserve to keep interest rates low. +1% =

Since 1962, interest rate on the debt has averaged 6% +/- 2%. The interest rate on the debt was 5% just ten years ago. Source: Bureau of Economic Analysis, US Department of the Treasury

Dangers of so much debt Too easy to lose track of what s important. Pressure on Federal Reserve to keep interest rates low. Quickly approaching a point of no return.

Interest on the debt remains at 2.6% indefinitely. Interest consumes 40% of tax revenue in 2050. Interest consumes 19% of tax revenue in 2012. Assumes growths from 1970 to present continue Annual tax revenue growth is 5.9% Annual non-interest spending growth is 6.7% Source: Bureau of Economic Analysis, US Department of the Treasury

Suppose interest on the debt rises to 5% over the next ten years. Interest consumes 100% of tax revenue in 2046. Interest consumes 19% of tax revenue in 2012. Assumes growths from 1970 to present continue Annual tax revenue growth is 5.9% Annual non-interest spending growth is 6.7% Source: Bureau of Economic Analysis, US Department of the Treasury

Where are we going?

CBO Forecasts CBO (154 forecasts, 1997 2011) Overestimated revenues by 10% four years out. Overestimated revenues by 15% ten years out. Underestimated outlays by 12% four years out. Underestimated outlays by 30% ten years out.

Overestimate Underestimate Source: Congressional Budget Office Produced by: Antony Davies, Duquesne University

Take CBO s 6-year out projection and multiply by 0.87 to get an unbiased forecast. Actual tax revenues are less than CBO projections. Source: Congressional Budget Office Produced by: Antony Davies, Duquesne University

Overestimate Underestimate Actual federal spending is greater than CBO projections. Source: Congressional Budget Office Produced by: Antony Davies, Duquesne University

Overestimate Underestimate Actual debt is significantly higher than CBO projections. Source: Congressional Budget Office Produced by: Antony Davies, Duquesne University

What does this mean? Forecast error correction CBO s current forecast for 2016: Federal Revenue $3.8 trillion x 0.90 = $3.3 trillion Federal Outlays $4.3 trillion x 1.12 = $5.0 trillion Deficit $0.5 trillion $1.7 trillion Public Debt $13.2 trillion x 1.43 = $18.9 trillion Gross Debt $18.4 trillion x 1.17 = $21.5 trillion Public debt will be 102% of GDP. Total debt outstanding will be 116% of GDP.

How about some stimulus!

TARP = $356 b. Federal Reserve = $1,500 b. Stimulus = $578 b. Financial Initiatives = $366 b. Total (net) stimulus = $3 trillion Housing Initiatives = $130 b. Data Source: money.cnn.com/news/storysupplement/economy/bailouttracker/

Total (net) stimulus = $3 trillion Unemployment Rate: 7% 10% 8% 9% 6%

Historically, how has the economy reacted to stimulus spending?

RGDP per Capita Growth More economic activity Stimulus Spending and Economic Growth 4% 3% 2% 1% 0% -6% -4% -2% 0% 2% 4% 6% -1% -2% -3% More government spending -4% Change in Federal Outlays as % of GDP

RGDP per Capita Growth More economic activity Stimulus Spending and Economic Growth 4% 3% 2% If stimulus spending 1% worked, we should see a relationship like this. 0% -6% -4% -2% 0% 2% 4% 6% -1% -2% -3% More government spending -4% Change in Federal Outlays as % of GDP

RGDP per Capita Growth Stimulus Spending and Economic Growth (1954.1 to 2011.1) 4% 3% 2% 1% 0% -6% -4% -2% 0% 2% 4% 6% -1% -2% Data Source: Bureau of Economic Analysis, National Income and Product Accounts -3% Increased government spending does not -4% appear to increase economic activity. Change in Federal Outlays as % of GDP

Maybe stimulus spending doesn t have an immediate effect. What is the effect over time?

RGDP per Capita Growth 1 Year Later Stimulus Spending and Economic Growth (1954.1 to 2011.1) 4% 3% 2% 1% 0% -6% -4% -2% 0% 2% 4% 6% -1% -2% -3% -4% Change in Federal Outlays as % of GDP Data Source: Bureau of Economic Analysis, National Income and Product Accounts Increased government spending does not appear to increase economic activity one year in the future.

Maybe stimulus spending s effects are cumulative. What is the cumulative effect?

RGDP per Capita Growth (4QMA) Stimulus Spending and Economic Growth (1954.1 to 2011.1) 3% 2% 2% 1% 1% Increased government spending appears to have a negative cumulative effect over 4 quarters. 0% -1.0% -0.5% 0.0% 0.5% 1.0% 1.5% 2.0% -1% -1% -2% Change in Federal Outlays as % of GDP (4Q Moving Average) Data Source: Bureau of Economic Analysis, National Income and Product Accounts