The current recession derives from two sources: demand and supply. On the demand side, consumers are purchasing fewer durable goods (e.g., automobiles) and spending much less on services, such as all forms of transportation. On the supply side, there has been a massive decline in supply of goods and services as workers stay home and supply chains break, leading to a collapse of trade networks, further disrupting firms that can’t get the physical or worker inputs they need to produce their own output. Accordingly, some writers, including my colleague Howard Gleckman, have criticized the extent to which stimulus packages so far have emphasized the demand side of the market, particularly with rebate payments to almost everyone, regardless of need. My purpose here isn’t to measure the extent to which that criticism applies to all the provisions enacted so far, but rather to ask how future legislation can better be oriented toward increasing supply and demand at the same time and, thereby, increasing employment.
The short answer: increase government purchases.
Basic economic theory teaches that under certain conditions government purchases do more than tax cuts or increases in transfers to stimulate the economy. That’s because a dollar of purchases effectively creates a demand for that purchase, leads to an increased supply of labor to fulfill that purchase, and then leaves a dollar of income in the hands of the those who supply the goods and services purchased. This is especially relevant in today’s economic downturn. When government simply puts a dollar of tax cut or transfer increase in our hands, but without purchasing anything, we often simply tuck that dollar under the mattress, so to speak, in which case there is no increase either in demand or supply.
Consistent with health concerns, therefore, Congress should strongly consider which types of stimuli are most likely to help minimize supply disruptions and more immediately increase employment.
You can see such concerns expressed partly in the efforts of Congress to keep people on the payrolls of existing firms. Along the same lines, the President and others have also suggested ramping up spending on infrastructure.
Of course, implementing this type of response requires some thought as to what can or must be produced, consistent with minimizing additional health threats to those involved. Here are a few examples.
We will need many additional healthcare workers who, with minimal training, could perform routine functions, whether testing for the coronavirus in the tens of millions rather than tens of thousands, as now, or giving tens of millions of vaccine shots when they become available. Government should start training more people to perform those functions now. Bill Gates has already suggested that we need to build the facilities now that will be able to generate billions of vaccines worldwide when that opportunity becomes available. Those production efforts and the training of health care workers are complementary actions.
Among the hardest hit of all sectors, restaurants deserve special attention. If we want to keep more of them viable, the government could give people vouchers that can be spent on take-out restaurant meals. Normally this would be quite inefficient, but it’s probably more efficient than simply paying restaurants to hang onto staff who have few functions to perform.
More educators could be hired now to develop better online tools for teaching, not just for the short-term needs arising from social isolation, but for the longer-term opportunities that information technology provides.
State and local governments clearly have rising needs to serve their citizens even as their revenues start to plummet. Congress should ensure, to the extent possible, that much of the federal support given to those governments goes toward currently purchasing additional goods and services, as opposed to being saved to offset the tax increases or transfer cuts these governments may need to impose down the road.
Even independently of federal help, states facing balanced budget constitutional restrictions should realize that additional state and local purchases, even if offset by temporary tax increases or cuts in salaries, still increase output in times of high unemployment.
Charities need resources to deal with increased demands. The recently enacted $300 tax deduction for charitable contributions offered to non-itemizers in the CARES Act probably won’t increase either charitable giving or charitable output by much at all. Government instead could take steps to purchase more services from charities. Every dollar spent that way will increase charitable output by roughly the same amount, a much more efficient result.
Infrastructure may be hard to begin immediately; “shovel-ready” projects were hard to find in the Great Recession. However, the ramp up could start now, particularly if the longer-term financing needed to support these projects was put into place when the projects were authorized.
While none of this is easy and certainly doesn’t address health and other welfare issues, the next tranches of Congressional legislation should increasingly give due consideration to the stimulative impact of additional purchases of goods and services in bringing workers back into the productive economy.
This column originally appeared on TaxVox on April 20, 2020.
For both social and economic reasons, people will soon begin to re-congregate even while awaiting the availability of a vaccine that itself may be less than foolproof. In fact, if estimates of a 15 or 20 percent unemployment rate prove correct, that means that still over 80 percent of workers have remained employed, often in groups and factories that provide the vital goods and services we need. Meanwhile, families increasingly will do what they have to do: gather to solve such problems as child and elderly care, food purchases, and shared rent. These social and economic demands increasingly will force physical contacts to expand.
Clearly, “bending the curve” on the rate of new infections and demands on hospitals only begins to deal with the crisis. Health experts tell us we seem far from a science-based plan for reopening the country. Nonetheless, individual needs and demands for increased production of vital goods and services made scarce by trade disruptions will lead to further opening up social and economic life even in absence of vital information on the risks entailed.
Accordingly, the debate over testing, its funding and expansion, has itself started to ramp up, but it must move way beyond considering what a medical model centered in the doctor’s office or hospital requires, what South Korea or China achieved when, even by late March, they had tested far less than one percent of the population, and even beyond the phase of extensive testing and surveillance, as suggested separately in roadmaps by Ezekiel Emanuel and Mark McClellan and colleagues.
Instead, I’m referring to the need to reinforce a top-down medical model with a bottom-up economic model that informs the billions of associational decisions that are being made daily by households and businesses with whatever information they have on who is infected, recovered, immune, or currently virus-free. Even while awaiting a vaccine, or even after a far-from-foolproof one is developed, very broad expansion of testing can inform almost all of us better on how to limit the extraordinary social and economic costs of isolation.
Policymakers are starting to pay attention to his issue. Recent late-in-the game efforts include Medicare’s recent decision to double to $100 what it pays for a test derived through high throughput technologies and a $30 billion testing subsidy that Congress is only now considering after already passing a $2 trillion plus package. Yet even these only touch on what is required to ramp up production, distribution, information networks, potential patent purchases, and, perhaps, use of wartime production powers.
To see what I mean, suppose ideally that testing was widely and easily available for everyone and on a frequent basis regardless of symptoms. Think of some of the inventive ways that individuals and businesses might make use of knowledge that they, along with family members, coworkers, and other parties, are free from the virus or had developed immunities to it.
An immediate gain, of course, will be the reduced stress and anxiety of hundreds of millions.
At the same time, social isolation can be reduced by making it much easier to move from individual isolation to what I will call “group isolation.” Access to testing with quick results could enable a tested child to take a tested elderly parent out of the nursing home. Extended families could more easily visit among themselves to deal with family needs. Childcare can more safely be employed for millions who have to work. Families could more readily combine to care for children, the impaired, and those most isolated.
Poorer and newly immigrant families for millennia have dealt with their economic needs by clustering together, and, indeed, many do so now—one likely reason, along with the need to work, for their higher death rates. Lack of adequate testing deters these social opportunities and reduces avoidable costs where clustering already occurs.
If serology or other testing gave us a better handle on who had immunity and the extent of that immunity, including many who didn’t even know they had been infected, these individuals could make a better risk assessment of whether to return to work or volunteer to fill in for economic functions increasingly found vital.
On-site work becomes a more extensive and safer opportunity. As already noted, employment rates tell us that most businesses still operate. Workers live together at New York utilities and dorm together in Chinese factories. AngelSoft brags that its factories hum day and night, partly to deal with our fetish on hoarding toilet paper.
Such practices could be made more extensive more quickly, as well as safer. Creative restaurant entrepreneurs might find new ways to keep their staffs safely employed, perhaps rotated in combined work and living arrangements for, say, weeks on and then weeks off. The temporary closing of factories, such as has occurred with meat-processing plants, would more easily be avoided. Protections would expand for truck and bus drivers delivering the goods and transportation that people need, grocery clerks selling needed food, equipment repair experts who keep homes functioning, health scientists working around the clock, and so many others. With safer conditions, these workers might also be less likely to quit or go on strike.
Don’t get me wrong, my focus is long-term. Even with recent improvements in testing, doctors still have to go through bureaucratic hurdles to get tests and, when made, still have to wait for results. While people without major symptoms today should be discouraged from competing for scarce test kits, the opposite should hold as near in the future as possible.
The focus up to now has been on limiting numbers initially affected and flattening the curve so that our hospitals are not overwhelmed. But the threats to both our health and the economy in all likelihood will remain for months or years, depending partly upon when a vaccine is developed, how fast it can be manufactured and deployed, and the continuing power of the virus to spread. Recognizing these extraordinary costs and the possible world-wide need for billions of vaccines, Bill Gates recently suggested that we start now to gear up manufacturing facilities even for promising vaccines that might not prove efficacious.
I’m suggesting similarly that now is the time to ramp very large interventions for testing. Its invention and improvements don’t seem to face the same hurdles as does a vaccine. Abbott Laboratories alone claims that it expects monthly to produce 5 million point-of-care tests that can detect the novel coronavirus in as little as five minutes. Yet, with a U.S. population of about 330 million and a world population of 8 billion, we’re still talking about allocating a very scarce resource. Mologic works on developing a one-dollar, 10-minute home test, primarily for Africa, that would not require labs, electricity or sourcing supplies from global manufacturers.
Invention is only part of the battle. Government must immediately plan for and finance much broader production and distribution systems for whatever might come along. The health system will need to adapt to new, as not-yet-fully-understood, opportunities, while supporting testing and information systems that don’t rely excessively on doctors, nurses or other trained officials. Their numbers simply are too small to provide one-on-one testing, much less advice, to tens or hundreds of millions of people regularly being tested. Lesser developed nations with limited health providers and weak supply systems already are forced to think this way. And the U.S. recovery depends in no small part on recovery abroad, as well.
There is no doubt that richer firms and organizations will not await government actions. What tests Stanford and Apple are now providing for local first responders, you can be sure at some point they will be giving to their own workers and staffs, even if they individually have to expand or create their own laboratory facilities or use less reliable tests when better ones are too scarce. But only the government can achieve the breadth and scale required for millions of households and businesses.
Obviously, the adaptations themselves will depend upon the types, qualities, and levels of testing made possible, especially should at-home or on-site tests be able to provide timely results.
As Bill Gates discussed with vaccines, multiple systems likely will be required, should periodic improvements make obsolete more expensive, less reliable, tests. The imperfection of tests and their processing requires dealing with liability laws that could slow down improvements and recovery itself. Patent law must also be tackled, and government must decide whether, as Burt Weisbrod from Northwestern University suggested long before this outbreak, whether up-front government purchases of patents will be more efficient than depending upon firm decisions over production, distribution, and price. As with ventilators, the Defense Production Act may need to be invoked.
A simple back-of-the-envelope calculation suggests that if at peak the virus reduces total U.S. economic activity by one quarter, that adds up to about $100 billion less in U.S. output and income per week. Double that amount to account for foregone nonmarket production and the unmeasured cost of social isolation and its attendant health costs. The cost of a vastly expanded system of testing seems minor by comparison to advancing the recovery phase by even one week.
So, yes, first focus on expanding testing so that the healthcare system can readily test those with symptoms and then track down and isolate those with whom they have had contact. That discussion is already underway. But recognize, finance and organize now for how a greatly expanded system can further inform the billions of social and economic associational decisions that households and businesses will and often must make every day.
As Republicans and Democrats joined hands to provide the most recent of what might be several stages of relief from our national pandemic crisis, almost everyone—fiscal hawks and doves alike—agrees that this isn’t the time to think about who should pay for the recovery.
The conclusion may be correct as a political matter but not as an economic one. The payoff from these rescue packages likely will be high, just as might your borrowing to finance additional education or simply to shelter and feed your family. But even worthwhile debt-financed investments eventually must be covered. While this may not be the time to make those judgments about payments, holding off determining who pays has little or nothing to do with the timing of when they pay.
The economic argument against paying some of the cost for the relief package now goes something like this. Enacting immediate tax increases or spending cuts would be counterproductive and dampen or negate the stimulus provided by tax cuts and spending increases. Policymakers say let’s put our attention to the problems at hand.
The politics behind this approach are clear, even if not explicitly stated. Elected officials like to give away money. They particularly like to spend money and call it a tax cut; that makes government, measured by the size of spending and taxes, look smaller. On the flip side, elected officials don’t like to explain who should pay for government. It’s easier to pass that problem onto some future Congress, which, by the way, will be even less inclined to mandate additional payments from future taxpayers for past benefits for which it can’t even claim credit.
Given those incentives and Congress’ modern inability to deal with the cost side of government, worrying now about who pays makes it very hard to garner consensus on actions that must be taken immediately. So, yes, politically, it was probably the right solution to not specify the source of these future payments. But this approach does have negative consequences that shouldn’t be ignored.
Simply as a matter of fairness, delay on specifying the payment mechanisms weakens the message that “we’re all in this together.” Many are already contributing extraordinarily to dealing with the crisis. We ask a lot from those on the front line in hospitals, nursing homes, prisons, and homeless shelters, as well as both those businesses that were asked to close and those deemed essential that must stay open. We also ask many workers to put themselves at risk by selling us groceries and drugs, delivering needed supplies, fixing our broken utilities, policing our streets, even producing toilet paper and otherwise maintaining a base economy on which we can survive and hopefully soon thrive. Some commentators already ask whether the burden of this recession isn’t being borne disproportionately among less advantaged groups.
Can we really say that those of us who end up well protected and lucky enough to have current income from our jobs, Social Security checks, or other sources, have paid a fair share of the total burden to society from this crisis? If my income doesn’t fall, and I get some additional grants or subsidized loans from government, I may even come out ahead by that narrow economic standard.
To be clear, if Congress had required individuals to contribute, say, an average of $100 more in taxes for each of the next ten years, it would have had little or no effect on the stimulative or incentive impact of giving them $1,000 today. Unfortunately, it is not possible to make detailed distinctions among who already contributed or lost the most from the pandemic and the resulting recession. But, future tax contributions, averaged across all taxpayers, would provide greater relief to those with the greatest loss in income in 2020 if assessed through a progressive surtax on existing income and profits. Under this formulation, those whose incomes fell below existing tax-exempt levels of income would pay nothing while those whose incomes rebounded mightily would pay the most.
Without taking a single dime out of the economy today, Congress could act now to strengthen the economic recovery itself by reducing investors’ worry about government’s long-term fiscal trajectory. This may seem less worrisome in the U.S. than countries already facing sovereign debt crises, but we have our own fiscal issues, not the least of which is that the rising ratio of debt to national income weakens our ability to respond to future crises. And these prudent fiscal steps might even give the American people greater faith that the federal government at long last was beginning to act in their long-term, not just short-term, interest.
This column originally appeared on TaxVox on Monday, April 13, 2020.
On March 3, the Treasury Department put out a press release saying that 2018’s charitable giving “appeared largely unchanged from previous years,” despite a “concern that … TCJA [the Tax Cuts and Jobs Act of 2017] reforms would lead to less charitable giving.”
The TCJA had a substantial impact on tax benefits for giving because it increased the standard deduction and made other changes that made it less likely that taxpayers would itemize deductions on their individual income tax returns. It also lowered individual income tax rates. The open question was and still is: Will the decline in tax subsidies and the higher after-tax cost of giving result in less giving?
The Treasury release is misleading because it is based on the relatively constant amount of nominal giving, before taking inflation and economic growth into account. Constant nominal giving means that real inflation-adjusted giving dropped and the rate of giving did, in fact, decline.
Think of it this way: Any other sector of the economy, such as manufacturing, would be considered in decline if both its real income and share of total output fell over time. So, too, for charities. The formal statistical report from the IRS Statistics of Income Division accurately details, at least from returns of charitable organizations received to date, the amount of their nominal charitable gift receipts in 2017 to 2018. But the statistical report makes no claims that charitable giving remained “unchanged,” though you wouldn’t know it the Treasury press release.
Amid all the world’s troubles, you may think I am quibbling. I am not naïve: Politicians, and even political appointees, spin the facts. But it is troubling when releases imply the Treasury Department, writ large, including its public servants, comes to misleading conclusions. No matter which political party is in power, the long-run trust of the public in the integrity of its government institutions is an asset vital to the nation’s well-being.
A misleading conclusion also put civil servants and well-meaning political appointees in a bind, even if they do nothing more than type up and distribute bad information. It encourages sycophancy among both career staff and political appointees, whose careers then become tied to their loyalty to the Administration in power, not the American public. Think about it: somebody had to write the words to this release.
What really happened to charitable giving in 2018? When Congress passed the TCJA, TPC projected that giving as a share of income would decline by roughly 4 to 5.5 percentage points. Why? The government subsidy to the average dollar of giving declined by a bit less than 7 percentage points.
Treasury estimated that adjusted gross income rose by between 5 and 6 percentage points from 2017 to 2018. Thus, for people’s rate of giving to remain constant, total giving would have had to increase by roughly the same percentage. But it did not.
While the limited data released available so far are consistent with TPC’s interpretation, the jury still is out on the overall effects of TCJA on charitable giving. We’ll only know better when we get a longer-run picture. Sadly, Treasury seems more focused on spin than objective analysis.
This column originally appeared on TaxVox on March 6, 2020.
Social Security is back in the headlines. Democratic presidential hopeful Bernie Sanders attacked his rival for the nomination, former Vice-President Joe Biden, for his past support of some relatively small cuts in Social Security’s growing long-term costs. Then, President Donald Trump hinted that he might back some unspecified changes in entitlements, perhaps including Social Security. At the same time, almost every candidate, including the president in his State of the Union address and Biden, in his pledge to older Americans, promise to “protect” Social Security.
You may think that “protect” is a weasel word. But I like it. Like the animal itself, it can be quite adaptive.
But who and what would be protected? And from what threats? Let’s look at what “protect” can and cannot mean.
Does “protect” mean current law must remain unchanged? No. Otherwise, according to the latest estimates, elderly and disabled beneficiaries will lose close to 20 percent of their benefits starting in 2035when the Social Security trust funds run out of assets. At that point, Social Security payroll taxes will be sufficient to support about 4/5 of the expected benefit claims.
Even before that day of reckoning, every year that Social Security spends more than it collects in taxes, it shifts unfunded costs to future taxpayers and beneficiaries, either within Social Security, or outside of it through higher federal debt, lower non-Social Security spending, or higher other federal taxes like the income tax. There are no other options.
Does “protect” mean that Social Security reform will exempt current beneficiaries from covering any of the shortfall? Almost certainly. The only exception might be revising annual cost of living adjustments to reflect what many believe is a more accurate measure of inflation (the so-called “Chain CPI”). This switch sometimes has been supported by both Democrats and Republicans, including at one time President Obamaand members of a bipartisan commission.
Does “protect” mean that the scheduled rate of growth in benefits will be maintained for all? Unlikely. The number of payroll tax-paying workers will decline rapidly as the baby boomers retire. But scheduled benefit growth means a currently retired couple with average earnings will receive about $650,000 over their lifetime while a millennial couple is due to receive about $1 million. For many, benefits still exceed the taxes paid by the couple during their working years.
Does “protect” mean that future beneficiaries will receive real inflation-adjusted benefits that are at least as high as today’s beneficiaries? Probably, since there’s a lot of room between no real growth and the growth in benefits that is already scheduled under current law.
Does “protect” mean sparing lower earners from sharing in the costs of reform? Possibly, as some proposals would add additional protections and higher minimum benefits for lower earners. However, lower lifetime earners already share in the burden of financing Social Security now, since the growth in Social Security and health costs, along with higher interest costs, has been squeezing out almost all other programs, including those federal programs that support working families.
Does “protect” mean sparing those with above-median earnings from sharing in the burden? Forget it. The higher one’s earnings, the higher the payroll taxes paid and the higher the benefits received, and reform will be paid for largely by those who pay most of the taxes and get most of the benefits. So, the real fight over Social Security reform boils down to how much to raise taxes and/or reduce benefits for these earners.
Does “protect” mean maintaining the retirement age so Social Security pays for more years of benefits as older people live longer? Perhaps, though it is getting harder and harder to define Social Security as an “old age” program. Today, individuals who retire can expect close to two decades of benefits and couples who retire can expect close to three decades of benefits. The financial aspects of this trend accrue largely to the richest households for at least two reasons. Not only have their years of remaining life expectancy been increasing the most, but the highest-income households have avoided much of a hopefully brief recent increase in middle-age mortality associated with opioids, obesity, and suicide that has increased the share of the population who don’t even reach the prescribed retirement age.
Does “protect” guarantee that we won’t have more near-poor elderly in the future? No, though it certainly could. Urban Institute research soon to be published will show that the share of the elderly receiving very low benefits may increase under today’s scheduled benefits and even under some reforms.
Does “protect” mean that Congress will adopt a well-defined process to reform Social Security? At least so far, the evidence is weak. Many recent Congressional proposals are framed around political rhetoric such as “no new taxes” or “no cuts in benefits” with little regard for the need to target future resources more equitably and efficiently as would be done in a true reform effort.
So, what should “protect” mean? Reforms should help lower-to-median-earning households, remove almost all poverty among the elderly, concentrate benefits more in older age, and better encourage work by older adults. A reformed Social Security system should be more equitable and establish a sustainable rate of growth in lifetime benefits relative to lifetime earnings for middle-income households. Reforms also should take into account other government benefits and private sources of income of seniors and people with disabilities, partly by attacking rising Medicare costs and strengthening private pensions.
But the bottom line is: “protect” cannot possibly mean that nobody pays for what everybody gets.
This column originally appeared in TaxVox on February 14, 2020.
The current debate over wealth taxes mostly focuses on whether the very rich are undertaxed, but gives little attention to the most efficient and fairest ways to tax them and capital income more generally. Here are three specific questions that any well-designed effort aimed at raising taxes on the wealthy should answer:
- How do the changes address double taxation?
- Is there any reason why gains unrealized by time of death should be subject to income tax, as under current law, only for heirs of decedents who die with money in retirement accounts?
- When is the best time to tax wealth and/or returns from capital?
Double Tax Issues
The wealthy already may be taxed through corporate income taxes, individual income taxes, and estate taxes. Few believe these taxes combine efficiently to raise revenue or that the burdens are distributed fairly. Some individuals are subject to all of these taxes on their capital income, some none. These double tax issues could become magnified should a new wealth tax simply be grafted onto the existing tax structure.
Consider how the corporate tax can combine with the individual income tax (both statutory income tax rates and a “net investment income tax”) to create a double tax. For now, I’m ignoring the estate tax. A new wealth tax can create a triple tax for the stock owner of a corporation that recognizes its income currently and then pays the remaining income (after corporate income tax) out as dividends. Suppose the return on capital is 6 percent, then a 2 percent wealth tax is roughly equivalent to a 33 percent income tax rate on that capital income. However, that wealth tax can combine with a 21 percent corporate income tax rate and a potential individual income tax rate of 23.8 percent (the 20 percent tax on qualified dividends plus the 3.8 percent net investment income tax). After taking into account interactions, the total tax rate on that return is still over 70 percent, well above the current nearly 40 percent potential combined corporate and individual income tax rates.
By contrast, the partnership owner of real estate who uses interest and other costs to completely offset rent revenues, while earning a 6 percent net return entirely in the form of capital gains on the property, owes no corporate or individual income tax currently, and simply pays the 2 percent wealth tax, for a combined tax rate of 33 percent on the income generated by this property.
Double taxes (or triple taxes) aren’t new by any means. What to do about them depends upon the purpose of those taxes. But at very high levels of assessment, where the effective income tax rate can approach or exceed 100 percent, this issue becomes a lot more important. And, as far as I can tell, almost none of the proponents of a wealth tax have dealt with or even discussed it.
Taxation of Gains Accrued at Death
Among the issues that arise in assessing higher taxes on the wealthy is whether Congress should continue to forgive income taxes on gains accrued but not yet taxed by time of death because the underlying assets have not been sold. Both the holder of a regular IRA account and the owner of corporate stock with accrued capital gains have income earned during their lifetime but not yet taxed by time of death. Yet only the latter gets permanent forgiveness of the tax, because the heir’s basis in the asset is “stepped up” to the value at the time of the original owner’s death. In contrast, heirs of an IRA or other retirement account must over their lifetimes pay tax on all gains accrued by their deceased benefactors. (In fact, Congress just passed a new law requiring heirs to recognize income and pay income tax over ten years on inherited retirement accounts.) Now I recognize that the two cases are not exactly equivalent when IRA owners get an extra tax break by deferral of taxes on their wages (because the contribution to a traditional IRA is deductible). But I suggest that the same holds for many wealthy taxpayers for whom the returns to wealth often derive from returns to labor and entrepreneurship for which tax was also deferred. Why not create greater parity between households with IRAs and more wealthy households who accrue their untaxed capital income outside of retirement accounts?
Timing of Taxation on Returns from Wealth
Regardless of the level of tax assessed on the wealthy, when to tax them raises very important efficiency issues. See my earlier two-part discussion here and here. Among the concerns that carry over to wealth taxation, successful entrepreneurs become wealthy mainly by earning a very high rate of return on their business assets and human capital, then saving most of those returns within the business. Because the societal returns to most great entrepreneurial ideas dissipate as the new idea ages, and the skills of the entrepreneurs often don’t pass onto their children, rich heirs tend to generate lower rates of return for society, not just themselves, than their entrepreneurial forebears. Thus, it may be better for society to collect tax on the accumulated unrealized gains at death rather than taxing them during life and reducing the entrepreneur’s wealth accumulation. As Winston Churchill once stated, “The process of creation of new wealth is beneficial to the whole community. The process of squatting on old wealth though valuable is a far less lively agent.”
Answering the three questions raised at the beginning of this post can help channel efforts to raise—or for that matter, lower—taxes on the wealthy more efficiently and equitably.
This column first appeared on TaxVox on January 8, 2020.
I must confess my misgivings about much that surrounds Christmas, Hanukkah, Kwanzaa and other celebrations near the Winter Solstice. I certainly applaud and am rejuvenated by the spiritual preparation, gathering of family and friends, and joy in a season that extends from Thanksgiving through the New Year. Most of all, hope rises as our souls reflect on how powers far beyond our own mortal beings have made us not only beloved, but capable of holiness. As one song reminds us, “the weary world rejoices, for yonder breaks a new and glorious morn.”
But has the soul really “felt its worth?” Or has it been overwhelmed by the commercialism that has increasingly dominated the season, from the first Black Friday offerings that begin on Thanksgiving evening? Is that what our prayers of thanks that day have come to? A curious order surrounds those first days of this extended season: first, Black Friday, then Cyber Monday, then Giving Tuesday—the last fairly new, and certainly last chronologically and monetarily in the pecking order. Getting comes before giving.
As wonderful as the outreach efforts of our churches and synagogues can be in this holy season, and our mosques and temples in their own seasons of hope, in some ways getting before giving still applies even there. No matter how rich our place of worship and its members, the collections throughout the year almost always go first and first and foremost to our internal needs, our club membership, and, then and only on occasion to needs other than our own. The first collection is for us, the second—if it occurs—for them. The poor box usually sits at the back of the church. Twice during my life, I offered two different churches a guarantee that money for their internal needs would not go wanting or decline for a couple of years if they would experiment with putting the needs of others on a par with our own. Good people, the members of the church councils couldn’t figure out how to reset priorities that much; they found few or no models to follow.
While our religions teach us that all seasons are holy, the data don’t support that recognition. No matter how much richer we become than previous generations, we in the U.S. don’t give away more than about 2 percent of our income; most other nations give even less. Similarly, when my co-authors and I look at data on giving by those with significant amounts of wealth, none—not even those with more than $100 million of wealth—gives away more than half of 1 percent of its wealth each year, though some do become more generous at time of death, when the hearse lacks a luggage rack.
Why such reluctance to give up some significant share of our wealth no matter how much we have? I have become convinced that doing so threatens our options in life in ways that modest giving out of income usually does not. We can get a warm glow feeling by participating in giving rituals, as during the holiday season, but very few of those rituals ask us to change our basic way of living.
Since this column regularly centers on public policy, I can’t help but relate this imbalance between getting and giving to our political debates. World War II left in its aftermath appreciation for sacrifice, perhaps symbolized most by John Kennedy inaugural claim in 1961 to “pay any price, bear any burden, meet any hardship” for the cause of liberty. Even by then, however, we had begun our long slide downward from the peak Marshall plan years, when we contributed about four percent of our national income for foreign aid, to a level today only about one-eighth that size, measured relative to our income.
More than a Trumpian phenomenon, politics in the modern age has long centered on what we get. Candidates tell us that we represent suffering, oppressed, citizens who must be favored with more benefits or fewer taxes. Occasionally we might have to pay a bit more to get a lot more, but usually not even that will be required. Anyway, fortunately, money grows on fiscal trees or within fertile Federal Reserve vaults. Mainly, however, we don’t get enough because of, you know, them. Some claim our society’s problems derive from immigrants from “shithole countries” or billionaires in “wine caves,” and others who align themselves against us by joining with liberals or conservatives intent upon destroying our democracy. So, when bad things happen, “they,” not “we,” bear no responsibility for their happening, much less for fixing them.
As voters, we know that any politician who lays out any sense of shared responsibility for giving, not just getting, cannot get elected. Salvation for true believers in one political party or another lies simply in blaming those outside our self-righteous clan. The rest of us simply hold our noses and try to figure out which candidates might do the right thing despite their campaign rhetoric.
Still, life stirs beneath the frozen ground, and soon new growth offers wonders and opportunities never before seen. My prayer is that we and our neighbors become twice blest, as givers and receivers, as we find new ways to give and build on that new life in all our holy seasons to come.
The recent passing of former Federal Reserve Chair Paul Volcker serves as an important reminder of his critical role in ending stagflation in the late 1970s and early 1980s. But while most attention is being paid to how his aggressive efforts to raise interest rates broke the back of accelerating inflation, Volcker’s interest rate hikes served another key purpose: by restoring positive costs for borrowing, they helped channel funds away from investments that produced low or even negative economic returns to society. In most of the 1980s and 1990s, as inflation fell and Congress reduced marginal tax rates, the economy began a period of significant productivity growth.
Volcker’s experience serves as an important reminder that monetary and fiscal or tax policy can do more than provide stimulus and at times help avoid recession. These policies often subsidize investors who use borrowed dollars and may distort investment incentives. In particular, monetary policy can lower borrowing costs (and lower interest rates can disadvantage savers), while tax policy can encourage leverage and discourage equity investment by allowing borrowers to deduct from their income more than the real cost of interest payments.
Here’s a simple example of how monetary and tax policy work in combination: Imagine a world where the interest rate is equal to the inflation rate. The real or inflation-adjusted interest cost for borrowing is then zero, yet the borrower gets to deduct full nominal interest costs, so the after-tax real cost of borrowing would be negative. (Technically, net after-tax, after-inflation borrowing costs become negative when the interest rate is less than the inflation rate divided by one minus the tax rate.)
Such was the case in the late 1970s and early 1980s, when top corporate income tax rates and top individual tax rates on capital income were about 50 percent and annual inflation exceeded 10 percent. Approximately speaking, if a corporation borrowed at 20-percent nominal interest rate and took a tax deduction at a 50 percent tax rate and adjusted for inflation, its real after-tax interest rate would be below zero. Since interest rates faced by actual corporate borrowers were often well below 20 percent, tax shelters of all sorts proliferated. Investments in unproductive capital became profitable. Stagnation then accompanied high inflation during those years, as I described in a book on the topic. Whatever cash flow problems Volcker’s interest rate policies temporarily caused to businesses and individuals, they also forced investors to rethink investments in tax shelters and to make productive investments that would earn positive real private returns.
What about today? Even though inflation remains low, businesses still get a tax subsidy for borrowing. If the annual inflation rate is 2 percent and a corporation’s borrowing cost is 4 percent, for instance, the corporation still can deduct twice its real interest costs. But in this example, corporate income tax rates would have to be above 50 percent for the real after-tax borrowing cost for the firm to be negative. However, in some foreign countries, nominal interest rates have turned negative, while in the U.S. the federal funds rate—the cost of borrowing by banks—is much closer to zero, after inflation. This means that some borrowers already may be facing negative real interest rates.
As for today’s tax policy, whatever its defects, the Tax Cut and Jobs Act (TCJA) sharply cut corporate income tax rates and effectively reduced the tax subsidy for corporate borrowing.
This feature strengthens monetary policy. If inflation accelerates in the future, the Fed won’t need to increase interest rates as much to dampen that inflation because the real after-tax cost of borrowing will remain positive. Volcker’s interest rate adjustments, for instance, could have been smaller and achieved much the same results had tax rates then been lower in the late 1970s.
That doesn’t mean that the U.S. has completely removed distortions created by our tax and financial systems. Under TCJA, borrowing by noncorporate businesses remains more subsidized than for corporations (because top individual income tax rates are higher than the corporate income tax rate). This means that the noncorporate share of business borrowing is likely to rise as the corporate share falls, all other things being equal.
Of course, high corporate tax rates and low real interest rates are not the only ways that government policies encourage excessive borrowing. Bankruptcy law protects individuals and business owners from bearing the full costs of their mistakes, not only for all assets they own, but often for each individual business. Banking laws, deposit guarantees, and implicit promises to limit bank failures further protect banks and their borrowers, while encouraging leverage. In combination with today’s low interest rates, these various policies help create negative expected real interest costs for many borrowers.
Thus, while some of these policies may encourage investment and capital formation and help the economy grow, over the long run they still can fuel excess leverage, consolidation of industries, tax sheltering, and (still) too big-to-fail banks.
Bottom line: despite lower rates of inflation today, we need to take seriously the public finance lessons from the Volcker era. While recent corporate tax rate cuts will reduce subsidies for borrowing and have some significant positive impacts on corporate finance, the nation’s borrowing juggernaut will remain well fueled and continue to weaken future economic growth by encouraging investments with low or negative real private economic returns.
This column first appeared on TaxVox on December 16, 2019.