Wrong again, Doug

Doug Holtz-Eakin, pooh-poohing an extended payroll tax holiday that might provide needed stimulus (though admittedly a very ninetieth-best way of doing this) says that, as a matter of economics, it doesn't matter whether you do it on the employer or the employee side. As a matter of economics, this is incorrect.

Standard economic models of tax incidence show that, at equilibrium, it doesn't matter whether you change the tax hit on the employer side or the employee side, because that only affects legal incidence, without transforming the factors that determine economic incidence. But in the short run (i.e, in transition to the equilibrium), it unmistakably DOES matter which side you do it on.

Suppose wages are sticky in the short run, whether for psychological reasons reflecting nominal prices or simply because people have existing short-term contracts. For example, suppose I have a contract with my employer specifying that it will pay me $12 per hour through the end of the year. This is undoubtedly an incomplete contract - it doesn't provide, for example, that this is conditioned on assuming continuation of current payroll tax policy, such that we will agree to the same "true" after-tax wage no matter which side Congress might pick for a payroll tax holiday. If the payroll tax is cut on the employee side, I pocket the increased after-tax income. No renegotiation until the next go-round (where it would more likely occur if the holiday were ongoing or expected to recur) Likewise, if the payroll tax is suspended on the employer side, it pcokets the extra change.

True, supply and demand are going to be affected, but the point is that to a considerable degree all this takes time to unfold.

So while Doug is likely right about permanently changing the payroll tax on one side or the other (leaving aside details such as the fact that minimum wage laws don't adjust for payroll tax nominal incidence), he is clearly wrong about the economics of, say, another one-year payroll tax holiday that is enacted with little advance notice and great uncertainty in advance about whether it would in fact happen.

There's a distributional difference in who pockets the money, and also a stimulative difference since the workers may on average have higher marginal propensity to consume than the owners of the businesses that would pocket the transition gain the other way around.

To be sure, it's still a far-from-great stimulus choice, given that even the richest workers get the payroll tax holiday as to their wages up to the Social Security tax cap, plus the fact that high-earners get more than those earning less than the cap amount.

I also realize that it's not going to happen, as the Republicans have finally located a class of tax cuts that they don't like - those that would be potentially stimulative in the run-up to 2012.

But nonetheless, let's try to discuss it honestly without misapplying standard economics truisms (about long-term incidence) outside their proper realm of application.

A site for sore eyes on vacation

Same species as a much-beloved pet I had some 40 years ago (not being allowed a cat or dog). OK, he wasn't quite equivalent, but nonetheless preferable to nearly all possible alternatives to those two supremely pet-adapted species.

I read recently that iguanas are no longer a legal pet in NYC, but that they are considered surprisingly intelligent and with distinctive personalities (which fits my memory). Don Ig Juan, as my father named him, was easygoing and friendly. He loved tuna cat food most of all, blueberries second, and would wait eagerly for me to finish my own breakfast and come to hand-feed him. It's true that he would rather pompously nod his head up and down, dewlap under the neck extended out, when he saw his reflection (another male iguana) in the mirror. But then he would lose interest, apparently realizing that the mirror rival wasn't real.

We ended up giving him to the Staten Island Zoo, leaving me a lifelong fan of this attractive and interesting species, although the fella or gal in this photo skittered off into the canopy below, having no reason to appreciate my bona fides.

A bit of unintended tax history on vacation

I am currently on vacation for a week in the delightful Caribbean island of St. Martin (for the French part) and St. Maartin (for the Dutch part). This is apparently the world's smallest island to have two separate sovereigns, as the French vs. Dutch division remains operative to this day (and dates back continuously to 1648).

It turns out that the Dutch part of the island (we are staying in the French part but plan to go to a beach on the Dutch part tomorrow) used to be part of the Netherlands Antilles, which is famous in U.S. tax planning history as, in effect, the Cayman Islands of an earlier era.

Until the late 1980s, and thus overlapping with my earliest professional years, the Netherlands Antilles was THE place of choice to have a tax haven affiliate for U.S. international tax planning purposes. As it happens, the reason had to do with the application of a U.S.-Dutch tax treaty, whereas the Caymans often "works" today for entirely non-treaty reasons. But still, the word "Netherlands-Antilles" means something to me that it probably wouldn't if I were 10 years younger.

Banana republic watch

Today's New York Times article about the push for another repatriation tax holiday shows how ill-functioning our political system is. Tax holidays work best if they are credibly "once and once only" offers. The last tax holiday was only 6 years ago, and we are already potentially doing it again?

As the article mentions, the predominant academic consensus from last time around is that it mainly led to dividends and share buybacks, not extra jobs et al. Money is fungible. And while in principle even the shareholder payouts might be considered stimulative, one would not expect the recipients to have a very high marginal propensity to consume.

Another banana republic aspect to this is the emphasis being placed on the point that the taxes raised by the dividend tax holiday would lower the budget deficit. Yes, but in expected present value terms they would increase the long-term U.S. fiscal gap, as to a considerable degree companies would simply take a small hit today (including a potential accounting hit for supposedly "permanently reinvested foreign earnings") on the view that it was cheaper than paying the full tax in the future.

For this reason, enacting the dividend tax holiday as a way of lowering the current year budget deficit is like improving your current cash flow by going to the local pawnbroker who charges 20% a month, or like a farmer selling the seed corn to raise extra funds. From a budgetary standpoint it is childish, shortsighted, and irresponsible.

Compare to all this the idea that we might shift to an exemption system for U.S. companies' foreign source active business income, but accompanied by (a) greatly improving the source rules so that they apply to all multinationals (taking account of all their affiliates around the world) on a unitary, residence-neutral basis and (b) enacting a one-time transition tax for U.S. companies' pre-effective date unrepatriated foreign source income, with payment of this tax perhaps to be deferrable but effectively with interest. A well-functioning political system would be considering changes like that instead of replicating the behavior pattern of an impatient toddler.

Casey Mulligan follow-up

Casey Mulligan complains that, in my preceding post, I misread his article because the first and last paragraphs mention the nontaxation of imputed rent point. The references are perhaps a bit oblique, but I take his point and apologize for the snark.

That said, I still find his analysis inadequate because I really don't think one can assess the home mortgage interest deduction independently of the imputed rent issue. Denying the interest deduction would be an indirect partial repeal of the exclusion, partly reducing its scope (good) but also potentially creating fresh distortions that would not follow from a more direct, even partial, repeal (bad).

I think the good from denying the deduction would outweigh the bad. I would merely have disagreed with Mulligan, rather than finding his analysis as snark-worthy as I did, had he addressed this issue. But, in my view, treating the under-taxation of home ownership in other respects as effectively irrelevant to analysis of the home mortgage interest deduction was a disservice to the readers of his NYT blog entry.

UPDATE: To put it another way, Mulligan says that the Treasury doesn't lose revenue from the mortgage interest deduction as such, assuming deduction and inclusion by the borrower and lender at the same marginal tax rate. OK, fine. But the Treasury does lose an opportunity to recoup some of its losses from the imputed rental exclusion, and that's the whole point of the argument for mortgage interest disallowance.

There is no joy in Mudville - Casey Mulligan has struck out

Thanks again to a link in the Tax Prof Blog, I see that Casey Mulligan of the University of Chicago Econ Department is saying that the home mortgage interest deduction is no big deal, hence no particular reason to repeal it. He focuses mainly on the point that "one person’s mortgage interest payment produces interest income for another person or a business. The lender may well owe taxes on the interest income."

My god, but Mulligan has missed the boat on this one. William Turnier pretty much makes the point, back in the Tax Prof blog link, by referencing the Haig-Simons definition of income and calling the home mortgage interest payment consumption-related.

But I would make it a bit clearer still. The problem isn't really the home mortgage interest deduction as such, although it may encourage the sort of excessive home leverage that helped contribute to the 2008 financial crisis. The real problem is the fact that homeowners get to exclude imputed rental income because it isn't derived from an observable market transaction. The home mortgage interest deduction merely builds off that. Its allowance would be uncontroversial if imputed rental income were included.

One can't seriously discuss the home mortgage interest deduction without understanding its relationship to the underlying imputed rent exclusion. This is really basic stuff. Mulligan ought to know, not just before he blogs about the issue in the New York Times, but as a supposedly informed professional in the field of public economics.

He further embarrasses himself by adding the following: "In contrast, consumer durable goods do not enjoy the interest deductions that housing and business capital do. Someone who takes out a car loan to purchase a personal automobile cannot deduct the interest payments from her taxable income, even while the Internal Revenue Service may be collecting taxes on the interest income of the lender. In this regard, tax policy discourages investment in consumer durable goods relative to investment in housing and businesses."

Mulligan apparently is unaware that the personal use of a car generates an economic return that the tax system excludes from income, whereas returns to business investment are at least in principle taxed. Again, this is really elementary stuff. Anyone who purports to do public economics and to have opinions about the tax system ought to know it.

The University of Chicago Law School has a pretty good tax faculty, whose members I am sure would have been happy to bring Mulligan up to speed. But if you don't know that you don't know, I guess it's hard to find out.

Very interesting fight among Senate Republicans

With thanks to Tax Prof Blog for the link, I note with considerable interest a current battle in the Senate, in which I gather Republicans' votes will be front and center. Senator Tom Coburn is seeking the elimination of ethanol subsidies that include income tax expenditures, but is being opposed by Grover Norquist due to the no-new-taxes pledge, signed by 40 of the Senate's 47 Republicans and constituting, in my view, a tourniquet around the throat of long-term (and perhaps even short-term) U.S. fiscal sustainability.

Oh, yes. Norquist is on board with eliminating tax expenditures for ethanol, but only so long as Congress ALSO repeals the estate tax. Good one, you Lenin-lover, you.

Coburn's view, which is unambiguously logically correct, is that, even if you are categorically opposed to "tax increases," this has to be defined with at least some modicum of intellectual coherence, such that repealing what are effectively "spending" provisions smuggled into the tax code won't count as tax increases for this purpose. (See more on this point in my recent Tax Notes article, which is available here.)

An alternative view to the one that both Coburn and I take would mean one only cared about the form of particular policies on the books, not about actual economic substance.

I gather that Coburn's plan is not expected to pass. Indeed, the Obama Administration, earning a profiles-in-courage award as usual, apparently opposes the elimination of ethanol subsidies. Nonetheless, it would be a huge positive step if more Republicans adopted the Coburn view (which also was discernible in Congressman Ryan's budget document). Coburn thus deserves great praise on this score, even apart from the ethanol subsidies issue itself (on which he likewise is siding with the angels).

UPDATE: The Coburn amendment failed by one vote. That is, it won (under majoritarian rules) by 59-40, but this left it one vote short of the threshold needed to permit closure and thus avoid filibuster. And of course the Senate these days codes it as a loss if you merely win by a borderline landslide.

I wonder, however, if the amendment was guaranteed to lose by one vote no matter what. The Democratic and/or Republican leaderships may have decided (perhaps even cooperatively) to let as many people as possible vote for it, so they could score a good-guys stance with the voters, so long as it didn't actually prevail. This once happened with the balanced budget amendment in the 1990s - it lost by one vote, but reportedly would have lost by one vote even if it had attracted 10 more "true" supporters.

Pawlenty's tax cut proposal in perspective

The best available revenue estimate for Tim Pawlenty's crazy proposal to enact massive tax cuts, with only minimal specified financing, places the revenue cost at more than $1 trillion per year by 2014, the second year when it would be fully in place. The estimated annual cost would be more than $1.6 trillion by 2021.

Among other changes, Pawlenty would repeal the AMT and the estate tax, lower the top individual rate to 25% and the corporate rate to 15%, and eliminate the tax on interest, dividends, and capital gains. The main pay-for appears to be as follows: "Let’s grow the economy by 5%, instead of the anemic 2% currently envisioned."

This reminds me of the line from Shakespeare's Henry IV, Part I, where Glendower says "I can call spirits from the vasty deep," and Hotspur replies "Why, so can I, and so can any man / But will they come when you do call for them?"

If Pawlenty wants to dream, then I say why not call for 40% annual economic growth? Or perhaps 325%? If we're talking magical wish lists, why stop at so measly a number as 5%? Pawlenty evidently lacks the true courage of his claimed convictions.

On a more serious note, Economy Watch estimates that U.S. GDP in 2014 might be just over $17 trillion. While this obviously doesn't count the Pawlenty tax cut (which presumably would raise GDP if people were sufficiently myopic not to worry about future tax levels or default risks), it's worth noting, just for rough back-of-the-envelope purposes, that the revenue cost of the projected Pawlenty tax cut for 2014 is more than 6% of that amount. And the annual revenue-cost-to-GDP ratio very likely would stay at that level if we myopically ran forward the projections without taking into account the catastrophic budgetary effects that it would very swiftly have. So the infinite horizon estimate might also be in the neighborhood of 6% or more of GDP.

Just for comparison purposes, according to the most recent study by Alan Auerbach and William Gale, the most likely estimate of the long-term U.S. fiscal gap (under optimistic assumptions about healthcare growth) places it at between 6 and 7 percent of GDP.

So we are currently on a disastrous fiscal path, which everyone agrees cannot be permitted to continue, and at a very rough estimate Pawlenty, bottom-feeding for votes in the Republican nominating process, proposes roughly to double the size of the problem.

Personally I find his recklessness and irresponsibility thoroughly despicable, and all the more so because it is likely to prove politically contagious.

Yuval Levin wants tax rates to be both high and low

I've seen several references today to an article in National Affairs called "Beyond the Welfare State," by Yuval Levin, who appears to be a relatively thoughtful conservative with actual interest in ideas. So I decided to give it a glance.

Not to be too critical, but I did notice this bit from his recommendations near the end of the piece:

What he calls the "conservative vision" would "begin with a simple and predictable tax system, with a broad base and low rates ....

"Second, essentially all government benefits — including benefits for the elderly — should be means-tested so that those in greater need receive more help and those who are not needy do not become dependent on public support." Etcetera.

Not to say one couldn't support both of these ideas. But does Levin realize that means-testing benefits is economically equivalent to raising (perhaps significantly) people's marginal tax rates in the benefits phase-out range?

Utterly astounding, and indeed nauseating

Nobel Laureate economist Peter Diamond has withdrawn his candidacy to be a member of the Federal Reserve Board of Governors, a victim of Republican obstructionism. Apart from the fact that he is a great economist, whose work (for example, on Social Security) I personally have benefited from reading, his expertise on labor markets could not possibly be more central to the Fed's mission of stabilizing the economy by addressing both inflation and unemployment.

The Republican Senators who blocked his candidacy apparently claim that labor market expertise (and by extension, unemployment) is irrelevant to the Fed's mission. I hope they will have the honesty to campaign for public office, in 2012 and thereafter, on the basis of this view of unemployment's policy irrelevance. No one who is even minimally economically literate could deny the Fed's vital role in addressing business cycle-related unemployment. In many people's view (including mine), the Fed has been doing far too little on this score. The blocking of Diamond's appointment follows a broader pattern that raises serious questions about the Republicans' good faith interest in permitting the state of the U.S. economy to improve.

Book report

I've been greatly enjoying Evan Connell's "Mr. Bridge" (when I was in Singapore) and now "Mrs. Bridge." The odd thing about these novels is that, on the surface, they are exactly the sort of thing that would be (and was) made into a Merchant-Ivory movie. They bring to mind Updike territory, although they read as if they were written earlier (reflecting that they are set 30 years earlier and in a much more conservative time, albeit one that is already changing).

Yet underneath and in truth, "Mr. Bridge" and "Mrs. Bridge" are savage and pitiless (albeit empathetic), offering exceptionally dark comedy.

Summer weather

Today's weather in NYC is more or less perfect - summer-like but not too hot - and I would certainly sign up for it 365 days a year (leaving aside the drought issue if it never rained). Unfortunately, as it happens I will have to be indoors working most of the day (a rarity for me on weekends).

People here sometimes say (be it rationalization or Stockholm syndrome) that they prefer the Northeast's varying seasonal weather to constant daily perfection. In response, I will generally dial up the sarcasm module and say yes, I agree, and for the same reason I find it so BORING if I'm healthy all the time. Isn't it more fascinating to get the flu occasionally for a couple of months, throw in back spasms and broken bones every now and then, break out in an itchy rash if everything is getting too comfortable, and perhaps even have the occasional digestive meltdown? That way, there's never a dull moment.

Perfect health and perfect weather are nonetheless just fine for me. There are plenty of other means out there for keeping one's life interesting.

Debt ceiling solution?

The Fourteenth Amendment to the U.S. Constitution states that '[t]he validity of the public debt of the United States, authorized by law ... shall not be questioned." I recently read something on-line suggesting that President Obama interpret this clause, when the crunch hits, as giving him the power to avoid a default by authorizing debt issuance in excess of the statutory ceiling. And I suppose he could throw in national security powers amid the threat of a national disaster as an extra justification for acting.

If I were in the White House and wearing a political rather than a legal hat, I would definitely recommend that this be done at the right time - not too far in advance, which would be a political disaster, but just at the crunch point, when it could be described as vital for U.S. national security, etcetera. This might then get all the pundits salivating about bold and decisive leadership. And after everything else we have seen from the Executive Branch in the last decade, or maybe I should say the last 50 to 60 years (the brief early 1970s retrenchment aside), it would hardly be discordant with the fundamentals of how our government now operates. After all, if the president can wage an undeclared war in Libya without Congressional authorization, as everyone seems to think he can, then, although these are separate legal questions, it's hardly an unprecedented power grab.

Would the action be constitutionally correct? I am admittedly skeptical. But the above clause was apparently adopted in anticipation of the concern that members of Congress from the ex-Confederate states would seek to compel default on U.S. public debt, or at least Civil War veterans' pensions (expressly mentioned in text from the clause that I skipped). So we are back in a recognizable scenario of concern that Congress will deliberately default, although to be sure the amendment doesn't mention delegating powers to the President to avoid questioning of the debt.

Constitutionally correct or not - and in the context of a potentially disastrous global and national economic crisis I think there is a colorable claim here - I can't see that anyone would have standing to contest it. The House, which presumably would not be joined by the Senate, seems unlikely to have standing or to be able to avoid "political question" problems, although with 5 hardcore Republicans on the Supreme Court who knows. But even if the House could get an injunction, Boehner et al would have to think twice about seeking to enjoin debt issuance and thereby directly triggering not just a global economic catastrophe but (as the White House could spin it) non-payment of our troops and needy seniors.

While there could subsequently be a legal issue concerning the enforceability of the debt issued at the President's say-so in excess of the statutory ceiling, one would probably expect that by then the debt would have been retrospectively validated.

If I were President Obama, I would not use the threat of doing this as leverage in the debt negotiations. Rather, I would spring it as a surprise at the last moment, in effect after baiting the trap. Dramatic 9 pm EST speech from the Oval Office with all the trimmings. Mention not just default and its consequences but the need to pay our troops, keep Social Security and Medicare operating, etcetera. Make the issue one of whether our troops and seniors should be paid or not.

Again, I am speaking here to what I would recommend as a political advisor. As a legal advisor, if asked to opine on what is the best view of the law, not what's the most that one could get away with, I would have a much harder time recommending this. But how many political actors in Washington do business this way any more? Even Supreme Court Justices all too often clearly don't. It's hard to play by different rules than everyone else without seriously handicapping yourself. And also I think a voluntary U.S. debt default is potentially a true global calamity. Being a bit tricky with one's legal interpretations in a true ticking time bomb scenario is a lot more justifiable than doing so just for political gain.