Friday, April 23, 2010

Summer here kids

The title of this post is taken from that of a 1998 song by Grandaddy. Perhaps not the aptest reference I could have chosen - certainly I hope not - as the oft-repeated theme of that song is "I'm not having a good time." Whereas I personally love the summer, both the weather and the freedom. But the song has been running through my head this morning because the title applies.

Summer's here for me, even if the weather is still a bit back and forth, as yesterday I co-taught my last classes of the semester (and indeed the academic year, as I'm on sabbatical in the fall). That's as good a definition of summer as you can get in the academic world.

It was a pretty long day, as I first spoke at an international tax panel and then did 4 hours of classes (per the usual Tax Policy Colloquium "super Thursday"). But it was reasonably lively throughout.

From 9 to 9:45 am, I led a tax policy panel discussion at an NYU-KPMG event held here at the law school. Perhaps loosely in the spirit of Passover and the "four questions," I offered 4 statements that I described as mistaken but widely accepted. To wit:

"(1) U.S. international tax policy is or should be based on maximizing worldwide welfare.
"(2) The basic policy choice we face is between (a) an exemption system for U.S. taxpayers’ foreign source income, and (b) a worldwide system with foreign tax credits.
"(3) It makes no real difference that corporations, rather than individuals, are the main U.S. taxpayers subject to our rules for foreign source active business income.
"(4) The debate should focus purely on existing U.S. companies – or alternatively, should forget about them altogether."

Given 20 minutes to explain why all 4 of these statements are wrong, I finished in 15, followed by discussion with panelists David Rosenbloom, Mihir Desai, and Charles Kingson, none of whom disagreed enormously with any of my points although their own views are not exactly identical.

Then it was off to an AM colloquium class at 10 am to discuss with the students a new (though it's been around for a while) paper by Ed McCaffery and Jim Hines, "The Last Best Hope for Progressivity in Tax." I share the authors' belief that it would be desirable to shift from the existing income tax to a reasonably well-designed progressive consumption tax. The model they (or at least McCaffery) may prefer is an individual "consumed income tax," looking a bit like a standard income tax on individuals but with all saving being deducted and all dissaving included. In my view, about equally as good would be the use of an X-tax (like the flat tax but with more rate bracket graduation).

One big theme McCaffery has had in his past writing, reflected to a degree in the paper, is that he regards a post-paid consumption tax as greatly superior to a prepaid wage tax - even though, as he recognizes, if you build in a certain number of assumptions and design features, the two would be long-term economically equivalent.

The paper calls the flat tax, and thus equivalently the David Bradford X-tax, a prepaid wage tax. However, I explained at the 4 pm session, and Hines agreed - McCaffery, alas, could not come to New York for the day - that this is incorrect. The flat tax and X-tax superficially look like wage taxes because, in fact, the workers' wages are taxed under the applicable rate structure (e.g., 0%, then 15%, then 25%, then 35%).

Given the explicit tax on wages, how could these not be wage taxes? Ah, but you need to look a bit further. Let's illustrate using the flat tax, since its having only two brackets (0% and the single rate applying above that) makes the exposition simpler. To create a flat tax, you effectively start with a VAT, in which all inter-business sales are taxable to the seller but deductible or creditable by the buyer, leading to a net tax on those transactions of zero. Only sales to retail customers are taxable on the seller side without being refundable on the buyer side. Hence, a VAT is simply a retail sales tax (RST) plus paperwork for the preceding inter-business sales - which generate a positive tax plus an offsetting negative tax, rather than simply no tax like the RST, in order to generate a paper trail for auditors.

All you need do to convert the VAT into a flat tax is make wage payments deductible by the business and includable by the worker. This, too, would make no difference whatsoever if workers were taxed from the first dollar on at the business rate. The only reason it matters under the flat tax is that workers have a zero rate bracket.

Thus, suppose the flat tax is at 25%, except for a zero bracket on the first $20,000 of wages. It is economically equivalent to the sum of (1) a 25% VAT (which McCaffery and all others would agree is a "post-paid consumption tax," not a "prepaid wage tax"), plus (2) a cash payment of up to $5,000 per worker, under which the amount you get equals 25% of your wages up to $20,000.

In short, the flat tax is simply a post-paid consumption tax plus a wage SUBSIDY (you can call it a "VAT rebate" if you like) for the first $20,000 earned. Case closed, unless one wants to classify based on optics rather than economic reality (which I suppose one could try to defend on behavioral economics grounds).

Hines and McCaffery are both enormously entertaining speakers. (I thought of the phrase describing Jeff Goldblum's Ian Malcolm character in the first Jurassic Park movie: "a deplorable excess of personality"). It would have been great to see both of them, but it was nice to at least see one of them.

The paper appears to have more McCaffery than Hines content, but Jim was game in defending most of the views expressed therein (although, again, he agreed with my analysis of the above). I myself tend to agree more with Ed's bottom lines than with the details of his analysis, such as a seeming tendency to like "work" and "saving" as ends in themselves while criticizing excess "consumption," whereas I might say one works and saves in order to be able to consume.

To Jim, the key takeaway from the paper is that the reason one can be more progressive in a consumption tax than an income tax is that everyone recognizes the optimal tax rate on saving can't (for efficiency reasons) be as high as it might be on work / consumption. So decoupling the two rates means that a high marginal rate becomes more sensible and more politically feasible. But all one needs to achieve this decoupling is a "dual income tax," such as those that have existed in various Scandinavian countries, in which the tax rate on the normal return to saving is determined separately from that on other income. Jim agreed with this as well, and noted that he also thinks the tax rate on that normal return should be zero (as it is under a consumption tax). But he agreed that decoupling the two rates takes care of his critique and that it's a separate question whether the tax on the normal return to saving should be zero, rather than simply lower than the higher plausible rates on everything else.

I suppose this post is getting more than long enough. So I'll close by noting with pleasure that I will be co-teaching the Tax Policy Colloquium with Mihir Desai again next year, and that we were both delighted to have great students.