New proposed tax on income from interest/dividends

[samclem]

I think even the folks at Brooking would agree that they don't really know how much the folks at various income levels would wind up paying. Their work looks like it depends on fairly static analysis--is there maybe a chance that people might modify their behavior based on the new tax rules?
At any rate, if we don't like the way the burden is distributed, it's simple enough to shift the curve by modifying the top rate by a few points and changing the income level of the rate change. That's simple (but important) stuff. The more fundamental questions:
- Does the plan get the "big stuff" (e.g. what counts as taxable income?) right?
- Does simplification of the tax code have inherent benefits as a standalone goal? I think it does. It enhances flow of capital to where it can be most efficiently utilized (which increases productivity/GDP), it increases transparency and it increases faith in the fairness of our tax system.

 

[Gone4Good]

I think even the folks at Brooking would agree that they don't really know how much the folks at various income levels would wind up paying.

They do agree with that. Here's what they say . . .

Dynamic versus static estimates. [FONT=Times New Roman,Times New Roman][FONT=Times New Roman,Times New Roman]The Tax Policy Center typically incorporates a microdynamic response into its revenue estimates, based on a large economics literature that has examined the change in reported income in response to tax changes.[/FONT][/FONT][FONT=Times New Roman,Times New Roman][FONT=Times New Roman,Times New Roman]6 [/FONT][/FONT][FONT=Times New Roman,Times New Roman][FONT=Times New Roman,Times New Roman]All else equal, we would expect the reduction in marginal tax rates under the Roadmap to increase taxable income. However, other aspects of the reform complicate using estimates based on previous (much smaller) tax changes. The BCT adds a layer of tax that would lower the after-tax value of work and thus at least partially offset any real labor supply response. In addition, the Roadmap’s elimination of exclusions, deductions, and credits would remove another important source of income change. Most important, exempting capital income gives taxpayers a large incentive to reclassify income into these nontaxable forms. The combination of these and other factors make it difficult to quantify the magnitude of the behavioral response. It is likely, however, that behavioral change would lead to lower revenues. [/FONT]
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So in a dynamic analysis, the tax could actually be more regressive as upper income individuals twist themselves in knots to reclassify income as dividends, interest and gains. And because these types of income are taxed at zero, any reclassification lowers both the effective rate and total revenue (i.e. you can't "make it up on volume"). Besides, providing huge incentives to shift income from "earned" to "unearned" creates market distortions of their own. I'm not sure why anyone thinks that is a good thing.

 

[clifp]

- Does simplification of the tax code have inherent benefits as a standalone goal? I think it does. It enhances flow of capital to where it can be most efficiently utilized (which increases productivity/GDP), it increases transparency and it increases faith in the fairness of our tax system.

I really think it does. In other thread I suggested using a stock options to help transform a large 10x run up in a stock from short term gains into long term capital gains. I am quite sure when I first learned about this perhaps 15 -20 years ago this was a viable strategy. Since then the IRS has understandably plugged the loophole. It made me realize how many scores of loopholes I had heard of (and even used) over the last 25 years. The only reasons these and thousands of other loophole, past present and future exist is because of the mind numbing complexity of the tax code. In the race between creative accountants and tax attorney to make loopholes, and the IRS to get rid of them in a whack a mole like fashion, the only true losers are the American people. There has to be a more productive use of their brains and energy.

 

[samclem]

So in a dynamic analysis, the tax could actually be more regressive as upper income individuals twist themselves in knots to reclassify income as dividends, interest and gains. And because these types of income are taxed at zero, any reclassification lowers both the effective rate and total revenue (i.e. you can't "make it up on volume"). .

But, of course there's no "fixed pie" of income. Missing in the quoted section was any indication of the impact of the overall growth in national income that would likely result from simplification of the tax code (through more efficient utilization of labor and capital when it is directed by market forces rather than legislative whim). A bigger "pie" of income, even when taxed at a lower rate, can increase tax revenues (as previous tax cuts have often shown).
That type of dynamic analysis is tough to do.

Besides, providing huge incentives to shift income from "earned" to "unearned" creates market distortions of their own.

Agreed.

Taxes are a fact of life. How they are imposed will impact behavior. There are lots of options. Which should we, by policy, discourage through taxation:
Labor? Saving/investing? Spending?
Hmmm . . .

 

[samclem]

In the race between creative accountants and tax attorney to make loopholes, and the IRS to get rid of them in a whack a mole like fashion, the only true losers are the American people. There has to be a more productive use of their brains and energy.

Right. And the accounting/compliance costs are just the tip of the iceberg. Every time an individual chooses to invest in a particular way due to the tax laws rather than the expected "before tax" gain, the market and the entire economy loses. Everyone is made poorer.

 

[haha]

It takes both capital and labor to have the kind of economy we want. I don't see any reason to favor one over the other in the tax code.

OK, I'll give you one. Labor gets hungry and must eat regularly. Capital has more flexibility.

Ha

 

[Gone4Good]

But, of course there's no "fixed pie" of income.

True, but even the great Laffer Curve shows that a zero tax rate results in zero revenue.

 

[Gone4Good]

Every time an individual chooses to invest in a particular way due to the tax laws rather than the expected "before tax" gain, the market and the entire economy loses. Everyone is made poorer.

And those are exactly the kind of non-economic decisions that you encourage when you tax different kinds of income at different rates. (and especially so when the rate differences are as large as 2,500bp)

 

[ERD50]

I don't understand how anything is rigged. It's his plan.

...

But my real objective in posting the Brookings analysis is to show how a tax scheme like this really works. This kind of plan (no taxes on capital and flatish taxes on income) is very popular among a certain group. So its worthwhile to look at what that would mean in practice.

BTW - I'm a big fan of simplification.

I wasn't saying that the numbers were 'rigged', but that perhaps your argument was 'rigged' (realize that I may have simply missed your point).

What I'm saying is you cannot dismiss an entire concept because a single implementation of that concept did not appear to meet the requirements.

1) A two-rate tax structure of 10% (up to $100K) and 25% above $100K.
2) Eliminate all current deductions and credits
3) No tax on interest, dividens and capital gains
4) No estate tax
5) No AMT tax

I'm in agreement with some of that, but that doesn't mean that some mix/match and adjustments aren't required to maintain revenue.

-ERD50

 

[samclem]

OK, I'll give you one. Labor gets hungry and must eat regularly. Capital has more flexibility.

Ha

Here's another difference: Labor markets are relatively fixed within borders, there's considerable "friction" involved in moving one's home and family to seek out a lower tax rate in another country.

Capital, on the other hand, is very fluid. People can choose to put their money to work in virtually any national economy in the world with a few mouse clicks. Foreigners who invest in US companies must pay taxes to the US on their "unearned" income. So, a foreigner has a disincentive to invest in the US compared to putting his money to work in such well-known bastions of right-wing laissez faire capitalism as Belgium, New Zealand, Germany, China (and a bunch of other nations in Asia)--all countries with no capital gains taxes.

Do we want US business to pay more for capital than businesses in other countries? Is this likely to make the US more productive and competitive? Remember, too, that the US already has one of the highest corporate tax rates of any industrialized nation.

The miracle is that we have any jobs and growth at all.

 

[FIRE'd@51]

It takes both capital and labor to have the kind of economy we want. I don't see any reason to favor one over the other in the tax code.

If you really believed this, you would be arguing for zero tax on capital gains and dividends (or the elimination of the corporate income tax), since they have already been taxed at the corporate level. Labor, on the other hand, is a deduction to the corporation for tax purposes.

 

[chinaco]

No problem here. Tax 'em.

 

[Gone4Good]

If you really believed this, you would be arguing for zero tax on capital gains and dividends (or the elimination of the corporate income tax), since they have already been taxed at the corporate level. Labor, on the other hand, is a deduction to the corporation for tax purposes.

No I wouldn't. Because the better alternative is to completely eliminate the the corporate tax while taxing labor and capital the same. Not only does that eliminate the huge difference in tax treatment between a small business owner filing a Form SE and a corporate shareholder but also eliminates our current tax code's subsidy for debt capital (someone here will have to explain to me why taxing small business owners at more than double the rate of shareowners makes sense, or what the argument is for further reducing the tax to shareowners when small businesses create most new jobs and innovation). It also gets rid of the huge incentive to enter into uneconomic tax dodges designed to reclassify ordinary earnings as gains.

But none of this matters, really. Because the argument isn't actually about having a tax code that makes economic sense (massive differences in rates will never make economic sense). The deliberately narrow economic arguments are rolled out as cover for the real purpose . . . to bestow tax cuts on wealthy political patrons. (psst . . . small business owners don't write as big of checks)