Econ 101: What is a free market? (it’s obvious, isn’t it?) – a short quiz

Econ 101: What is a free market? (it’s obvious, isn’t it?) – a short quiz.

Econ 101: What is a free market? (it’s obvious, isn’t it?) – a short quiz

We all know free markets when we see them, don’t we?  Lets’ see how reliable our vision is.  Here is a short, fun quiz on the definition and properties of free markets:

1. What is a “free” market (select all that apply – “all” and “none” are time savers)?
   1. A place where I can get all the free stuff I want.
   2. A place where I can buy stuff without having to pay for admission to it
   3. A place where I can buy any anything I want without government interference
   4. A place where I can sell any anything I want without government interference
   5. All of the above
   6. None of the above
   7. What is a perfectly competitive market (select all that apply)?
      1. A free market
      2. A place where the winner takes all or almost all, like a golf or tennis tournament or the Super Bowl
      3. A place where no buyer or seller can set prices as they see fit, but, must take the price they find there.
      4. A place where there are very many sellers and just as many sellers
      5. A place where the price of everything equals its economic cost (which includes a competitively determined level of profit)
      6. A place where everybody knows everything that everybody else knows and knows that everybody knows it.
      7. None of the above
      8. All of the above
      9. Which of the markets listed below are perfectly competitive (select all that apply – “all” and “none” are time savers)?
         1. Health care products
         2. Health care services
         3. Personal computers
         4. Software operating systems
         5. Transportation
         6. Petroleum products (oil, gasoline, plastics)
         7. Firearms
         8. Labor (including professional services)
         9. Chinese food
         10. Prescription drugs
         11. Over-the-counter drugs
         12. Insurance (any kind, such as flood or medical insurance)
         13. Toys
         14. Database software
         15. Accounting software
         16. Internet search engines
         17. Broccoli
         18. Beef
         19. Beans
         20. Barley
         21. Beer
         22. None of the above
         23. All of the above
         24. Free response:  If you can name a perfectly competitive or free market,
             1. Name it here:__________________________
             2. Is it free or perfectly competitive (select one or both choices)?

i.     Free

ii.     Perfectly competitive

iii.     Both free and perfectly competitive.

1. I can’t think of one right now
2. There are none

Answers:

1. d
2. c, d, e, f
3. v
4. d

The notion of a “free” market is nonsensical; “free” is a misnomer designed to persuade us that there is such a thing.  It isn’t even a useful fiction.  It’s used, like “unicorn”, as a rhetorical or storytelling device.  Like “the second king Charles of France”, the phrase, “perfectly competitive market” denotes nothing.  The notion of a “perfectly competitive market” is, while not nonsensical, a fiction that is used to tell a story of human behavior.  It appears to be useful because it involves mathematics and has a mathematical apparatus.  This apparatus is supposed to express our intuitions about perfectly competitive markets precisely.  It reminds me of the (apocryphal) story of a doctoral student in Mathematics who proved a theorem using functions the domains of which were empty.  The theorem had, therefore, no range of application; it was related to nothing.  The idea of “perfectly competitive markets” has no range of application because its domain of human behaviors is empty.  People and markets just aren’t as the theory presupposes; it fails to explain any human behavior, either individually or aggregated.  This inference is evident from the fact that the predictive record of economic theory and economists is terrible.

 

It’s obvious: “Guns don’t kill people; people kill

It’s obvious:

1. “Guns don’t kill people; people kill people.”  And
2. “If guns are outlawed, only outlaws will have guns.”

Let me say, first, that both of these claims are slogans.  They are simplistic, conceal assumptions critical to understanding them and are intended to appeal to our emotions, in part by concealing such assumptions.  This much is obvious.  But, although they are simplistic, I’ve seen a lot of car bumpers and windows carrying them around for everyone’s reading pleasure.  To many people, they must be meaningful and important and must express some core belief succinctly.  Our first task, then, is to discover this meaning.

Statement A points out that guns, being material objects, don’t “intend” anything; people, being conscious and purposeful by nature (a discussion for another context), do “intend” specific outcomes.  Statement A would be clearer, if written, “Guns don’t intend to kill people; people intend to kill people.”  Still, this says nothing about accidental (unintentional) deaths due to gunfire or about gunfire wounds that aren’t fatal.

Statement B, as written, is meaningless and owes its impact to the ambiguity and connotation of the term, “outlaws.”  Prescription drugs are “outlawed”, yet, if I take a Percocet for pain after surgery, I am not an outlaw (I have permission from a registered, licensed physician).  Am I an “outlaw” when I exceed the speed limit or “roll through” a “stop” sign?  Are your sixteen-year-old children outlaws, if they see an R-rated film in the theater (or in your house, for that matter)?  Would law enforcement, the military, the National Guard, the Coast Guard or your bodyguard (including the not-so-Secret Service) be outlaws if they owned or carried guns?  When an American gives his 18-year-old son a glass of wine in a restaurant, are he and the son outlaws?  When a Frenchman gives his 18-year-old son a glass of wine in a restaurant, they are not outlaws.  In France, there is no age requirement to drink wine—outlaw in the U.S., law-abiding citizen in France.  Obviously, Statement B uses “outlaw” in two ways.  This use is intentional and is to good effect on those who are disposed to agree with it.  Let’s scrutinize these claims further.

Statement A, while true, is silly.  It builds and knocks down the straw man argument that guns are evil because they can kill people.  Nobody believes that argument.  Substitute “strawberries” for “guns” in it.  The result, “Strawberries don’t kill people; people kill people” is comical (to me, anyway).  Or, use “poisons” or “cars” or try “Yorkshire Terriers” or “Bad breath and acne” or, well, anything in that sentence.  The best reply to Statement A is, “So what?”  It can be read as supporting gun control as easily as protesting it.  Should we monitor and proscribe the usage of guns by people, then, instead of guns?  After all, monitoring and proscribing behavior or the use of objects by people is not new.  We have traffic laws and manufacturing standards for cars.  We have building codes.  Even law enforcement behavior is monitored and proscribed.  In fact, virtually every other aspect of human behavior is monitored and proscribed by the societies in which we live.  In some societies, raping, killing or beating disobedient wives are accepted; yet, oral or written expressions of discontent with authorities or institutions are not.

Statement B was constructed to exploit the connotation of “outlaws” as “evil people” in the service of resisting firearms regulation.  It’s meaningless because the middle term is undistributed (by changing its meaning, you change the term).  For example,

All trees have leaves.  This plant has leaves.  Therefore, this plant is a tree.

All criminals have guns.  I have a gun.  Therefore, I am a criminal.

Or, Statement B is a tautology.

If owning guns violates the law and all violators of the law are outlaws, then all gun owners are outlaws (i. e., violators of the law).

To get an idea where you stand on gun control, try this short quiz:

Why is gun regulation bad?  (Choose all that apply)

a)    It violates the second amendment to the Constitution of the United States.

b)    Being shot is so unlikely that I don’t need to know who probably didn’t shoot me.  Neither do the cops.  32,000 deaths is only 0.01% of the U. S. population.  That one of them is mine is too improbable to care about.  I wouldn’t care about anyone else’s even if the probability were 0.1%–maybe at 1%.  Now, if I lived in El Salvador, I might feel differently about this issue and get myself a gun, even if I had to register it.

c)     I want to be able to defend myself against attack, but I don’t want the gun I used traced back to me.

d)    I want to be able to shoot someone who looks like he’s going to rob or hurt me, and I don’t want the gun I used traced back to me.

e)    It makes it too easy for law enforcement to arrest and convict me for a crime I committed while using a gun.  It’s like hide-and-seek with breadcrumbs for the seeker, which is unfair to the hider.

f)     It would make it too easy for law enforcement to find out that I bought a gun for my cousin, who can’t buy his own gun because he’s a convicted felon, so he could defend himself from his competitors, witnesses of his crimes, or other enemies.  If they catch him and he keeps his mouth shut, they may not catch me.

g)    The (federal, state, local, circle all that apply) government would know exactly how much and what kinds of firepower I’ve accumulated in the event that I need to participate in or lead an armed insurrection against it.  They could use this knowledge to make their overthrow more challenging (and cost more lives) by reducing my advantage from the element of surprise.

h)    The cops could be prepared to defend themselves against or anticipate my possession of firearms when they come to my house.  I would have no advantage in case I wanted to resist whatever purpose I thought they might be there to achieve or in case I want to scare the hell out them so they’ll shoot me and I can sue the department.

i)     I don’t want the cops to know and find the guy who murdered my daughter while attempting to shoot someone else.  Why punish incompetence?  It was just an accident.

j)      Just in case I’m able to shoot 26 other students at my school without being identified by -witnesses (eye-, ear-, tongue- or finger-, your choice), I can leave my gun behind and go about my business as usual without fear of arrest or reprisal.

k)    All of the above.

l)     None of the above.

m)  Some reason not listed above.  Please provide it here:_____________________________________________________________
__________________________________________________________________.

Don’t tax Business

It’s obvious:  Businesses should pay their fair share of taxes, after all, they use public resources and benefit from government activities.

Why do we tax business income?  A business is not a person, or hasn’t been until recently when the SCOTUS awarded limited “personhood” to certain legal entities in the Citizens United case ruling.  We seem to regard them as different from people in that the federal and state business taxes are, for all practical purposes, flat, while individual federal taxes are progressive.  Revenues from taxes on businesses comprise about 18% of total tax revenues collected by the federal government and smaller portions of state and local tax revenues.  These revenues can and should be replaced by other taxation.

Nevertheless, there are at least four arguments for taxing businesses:

1. They use shared resources that are developed or maintained (or both) by the public through the use of government funds;
2. They need to be regulated because we cannot trust them to behave in the public interest only when they view it as the same as their interest, at least, and effective regulation costs money;
3. They rely on a work force that is educated at the expense of taxpayers at every level of government; this reliance is critical to their survival;
4. The federal government funds a large portion of the research and development conducted by private and public educational, research and commercial institutions,

Three of these arguments are arguments for a use/benefit tax, i. e., which businesses use and benefit from public resources.  Thus, it resembles a highway toll or a “student activity fee” or a parking meter.  The second argument appears to be a psycho-sociological and based on assumptions about how people are likely to behave in commercial contexts, but, is, indeed, a use tax: incentives to misbehave are strong enough for individual companies to persuade management to misbehave, thereby, creating monitoring and enforcement costs to society.  By misbehaving (breaking the rules), such companies cause society to incur costs they would not incur otherwise by requiring the use.

These are my eight arguments against taxing business.  Eliminating taxes on commerce would:

1. Obviate the need of businesses to lobby Congress and the White House on tax policy, thereby, reducing or eliminating their impact on tax policy formation;
2. Remove tax considerations from investment decisions by corporations, thereby, liberating economists and financial/economic analysts to evaluate cash flows resulting from investment within an economic framework tainted less by government policy considerations than with such taxes in effect;
3. Eliminate the need to monitor business economic behavior with respect to the tax code and enforce compliance with it;
4. Release into the workforce a large number of very skilled individuals who apply their skills and aptitudes to productive activities;
5. Provide resources companies use to invest in tax optimizing behavior to invest in economic optimizing behavior;
6. Attract more business investment by foreign companies in the U. S.;
7. Reduce the value of corporate perquisites and reduce incentives to use corporate resources as a form of tax-subsidized compensation to employees (primarily executives);
8. Reduce of operating the IRS.

I need to elaborate each of these reasons.

First, I acknowledge that businesses lobby Congress and the White House on many other issues that may consume more of their resources than lobbying on tax issues.  Nevertheless, enormous amounts of time and money are invested in tax lobbying.  Congressmen and women insert provisions that favor industries, states, localities and specific companies with regard to taxation; in many instances such insertions function as “trading cards”(although less so these days).  Not only must companies pay for their influence, but our elected officials must invest time in responding to it.  This time and money could be deployed more effectively.  Such lobbying also skews political behavior in favor of the “special” interests of individual companies, frequently at a meaningful cost to other constituencies and with no larger benefit to those constituencies taken as a whole.  Examples of this lobbying include opposition to carbon taxes, support for accelerated depletion allowances for extraction companies (oil, gas, copper, coal, iron ore, etc.), exemptions on income earned and taxed in foreign countries, reduced taxes on income earned from exports and capital gains treatment of carried interest in private companies owned and realized by investors.  Such lobbying consumes enormous resources, skews economic behavior and is inequitable.

Second, companies base investment decisions on their estimates of the future net cash flows from future projects, adjusted for perceived risks.  Differences in tax rates, deductions and credits can determine the outcomes of such decisions at the margin (where all decisions are made).  Such decisions include whether to build, lease or buy plant or equipment, which equipment to build, lease or buy and how to pay for it; whether to acquire a company (competitor, customer, vendor or unrelated), which parts of that company to buy, what part of the balance sheet to acquire (assets or stock) and how to pay for it (debt or equity or some other form such as royalties).  Ex post facto, many corporate investment decisions would have different, if taxes incurred or reduced had not been a factor in estimating cash flow; “go” decisions would have “no” decisions and vice versa.  Let’s reduce the impact of political decisions on investment decisions.

Third, there is an enormous professional structure devoted to reducing, avoiding, deferring, or “managing”, the amount of taxes companies incur.  These professionals are largely very capable people whose capabilities could be put to more productive use.  The direct cost of supporting this industry could be deployed in research, training, product development, project management, education or any large number of other value-adding fields.  The opportunity cost of not deploying these people and the funds used to support their industry is even greater.  Consider the opportunities never considered, missed or delayed as a result of the need to focus time, attention and money on managing corporate taxes.  In addition to the costs of companies’ self-monitoring, there is the cost of monitoring and acting (legal action, civil or criminal, say) by such external groups as accountants, lawyers and the Internal Revenues Service.  All of these assets could be deployed more productively elsewhere.

Fourth, eliminating taxes on business would release the professionals into the work force where their talents, knowledge and skills could be employed more productively, say, in the production of real goods or of knowledge services.

Fifth, instead of using the staff of the accounting department, or, in the case of larger companies, having a tax accounting department, and paying for this human capacity, that money could be applied to designing new products, improving factory floor layout, improving customer service, or any number of other activities.

Sixth, foreign companies would have greater incentive to locate operations in the U. S.  The increment in the cost of labor in the U. S. would be a smaller factor in such investment decisions and, in some cases, the tax saving of building a facility in the U. S. might exceed the higher cost of labor.  At the margin, this factor could alter the decision whether to build in Mexico or the U. S. or even to build at all.

Seventh, the current tax code subsidizes corporate and personal ownership of private airplanes, corporate retreats, corporate apartments, other travel, entertainment, meal and lodging costs.  Monitoring abuses of these subsidies is costly to the IRS and managing these deductions is costly to the company.  In addition, such subsidies provide incentives for companies to invest in abusive practices, as the cost of protecting them is far less than the cost of investigating them.

Eighth, it would reduce the operating expenses of the IRS.  The IRS is already efficient, very efficient.  But, it could reduce its resources or use them to monitor behavior and enforce tax law still more efficiently and more effectively under tax code that has been simplified and automated greatly.

Many of the benefits of this change would be amplified by other changes to business law.  For example, if we eliminate all deductions (including charitable deductions) and preferential treatment of so-called capital gains for individuals, all of the 18% of revenues forgone by this change would be recaptured without changing tax rates appreciably.  This calculation is a simple back-of-the envelope calculation based on income data from FRED, the database of the St. Louis Federal Reserve Bank and the US Census Bureau and tax “expenditure” data from the White House Office of Management and Budget.

Another change that would improve the effectiveness and efficiency of the tax code and its administrative structure is to eliminate the many types of legal entities available to businesses.  When an individual starts a business, he or she may choose its legal structure from among several legal entities:  “C” Corporation, “Subchapter S” Corporation, partnership, limited partnership, professional association, sole proprietorship or limited liability company.  In limited liability companies and “Subchapter S” corporations, the shareholders may choose to have the profits of the company to be taxed as if the company were a C corporation  (at corporate tax rates) or have those profits divided among the shareholders and taxed at individual income rates.  Each business type serves different purposes with respect to taxation and legal protection from liabilities incurred by the company in the course of its operations.  By eliminating tax considerations, such structures need only address the question of personal liability of the owners of the business.  This question is simple.  The owners are liable or they are not, therefore, only one legal distinction is required.  Either the structure protects the owners or it doesn’t.  Therefore, we need only one such structure that protects the owners and one that does not.  But, who would choose one that doesn’t?  No one, thus, we need only one legal structure for business entities.  Which structure we choose or what we call it is irrelevant, as long as the owners are protected from civil liabilities incurred by their companies (except in cases of gross negligence or direct violations of law).

Think about it.  Imagine an economy and a government, in which businesses don’t lobby Congress or state legislatures for tax breaks, investments would be made on the economic merits and risks of opportunities only, companies wouldn’t gain economic benefit from maintaining a staff of tax accountants and lawyers as well as use outside tax counsel, foreign companies could locate facilities in the U. S. without regard to corporate taxes, fewer resources would be devoted to minimizing, deferring or avoiding taxes due and resources devoted to litigation that results from differences of opinion about taxes, legal structures and criminal or civil liabilities would be significantly less.  Indeed, a few other changes to the tax code for individuals and corporations would transform revenue collection at every government level into an equitable, efficient, equitable and enforceable endeavor.

Gun control/registration/removal: Which is it?

It’s obvious:  “Guns don’t kill people; people kill people.”

Language matters.  Legislation and policy debate and discussion related to firearms regulation appears to be influenced unduly by the language adopted by the participants.  The greatest offender is the National Rifle Association (NRA) and supporters of its point of view.  An obvious example is the accusation that proponents of universal firearms registration actually mean “universal gun removal”.  Another example is the slogan above.

Let’s experiment with this slogan by substituting some other terms for “guns”.

• Poisons don’t kill people; people kill people.
• Cocaine doesn’t kill people; people kill people.
• Cars don’t kill people; people kill people.
• Drugs don’t kill people; people kill people.

Talking about drug “control“ is acceptable, but, to those same people, talking about firearms “control” is not.  As long as we conflate “control” with “registration” or “removal” with “regulation”, no progress will be made in this discussion.  Universal registration of drug sellers and users is instituted with nary a peep of protest from all but the beneficiaries and their representatives of unregulated or weakly regulated distribution of dangerous drugs.  Automobiles are registered, regulated and, in many ways, “controlled”—you can’t drive an unregistered vehicle.  Yet, we accept this situation without reflection, unless circumventing this information system is somehow beneficial to us.  Poisons are regulated.  Many require government-issued permits to buy and use.  All transactions of such regulated poisons are supposed to be recorded and their purchasers identified.  Individual food items are tracked from the grower/rancher through the processor to the consumer by bar coded identification codes.  Purchases and sales of alcoholic beverages are recorded; inventories are reported at all levels except among private citizens, who have no permit to resell their inventories.  Private sales of wine, beer and spirits are illegal in every state.  Not only do we accept this regulation, we are grateful for it.

In the case of universal automobile registration, the benefits are many and obvious, including:  locating stolen vehicles, identifying vehicles that pollute excessively, are unsafe or are involved in accidents or crimes, finding and capturing criminals or suspected criminals who’ve used cars to commit their crimes and enforcing traffic laws.  In the case of food, the benefits are, again, many and obvious:  tracking that batch of contaminated peanut butter or that batch of cafeteria food that was contaminated by peanut oil or parts when it was not supposed to be, locating the source of horsemeat sold as beef hamburger, preventing spoilage or botulism or locating the sources of it.  The State of Florida (in the U. S.), despite loud and well-funded objections, started a database that tracks all pharmacy, clinic and physician transactions involving controlled substances.  Participation is not mandatory and, within one year, the information provided by and inferred from it has led to major arrests and convictions of doctors and other criminals who have sold millions of dollars of dangerous prescription drugs with prescriptions, but, illegally for other reasons.

Registering all firearms and recording all transactions involving firearms is no different from registering and recording all vehicles and transactions involving them.  The benefits are many and obvious.  Yet, we resist this minimal attempt at managing the deployment and use of dangerous tools.  Why?  Why do we conflate registration with removal and information with control?  Why is such paranoia seated so deeply in so many and why are they so passionate about protecting their paranoia?  Don’t we want to find our guns after they’re stolen?  Don’t we want to prevent them from being used in a crime, especially a crime that results in a fatality?  Don’t we want to find and prosecute firearms dealers who traffic in guns used by murderers, terrorists or private armies and who fund such other illegal activities as drug or slave trafficking?

Universal registration of firearms, their owners and their dealers is the minimum, yet, most important condition of responsible gun usage for this and all nations, each nation taken as a whole.  The United States trails all other developed nations in this matter, while it should lead them.  A recent Pew Institute poll found that 92% of Americans and 74% of NRA members support universal firearms registration.  This means that approximately 138 million voters and 3 million NRA members support it.  Passing and implementing legislation by federal and state governments that requires registration of all firearms and all transactions as well as extensive criminal background checks should be a slam dunk.  Yet, it isn’t.  The loudest voices, which are well funded, have cowed a significant number of congressional representatives (especially) and senators into opposing this legislation.  It may not pass.  We’re lucky to see a vote.  Yet, registering all of our firearms is simply common sense; opposing it is unreasonable.

Proposal for an Ideal Tax Code – 1

It’s obvious:  We need taxes and the current tax code needs to be changed.

Why do we need taxes?  How should we change the tax code?  We need taxes at all levels of government to fund government activities.  We, the citizenry, need to pay taxes to fund government activities.  Government entities need a reliable, predictable source of revenues to fund their activities, so they can provide reliable, predictable services.  Every tax code should be Equitable, Effective, Efficient and Enforceable.  I refer to these criteria as the “four E’s” (which I discussed in the previous post).  To recap:

• “Equitable” means “fair” in the sense that it “recognizes that some dollars are worth more than others to individual taxpayers, if not to the tax collector, but does not values dollars differently by their sources”.  The dollars we earn to buy shelter, food, clothing, transportation and security are more valuable to us taxpayers than the dollars we earn to buy restaurant dinners, cruises and theater tickets; the dollars earned from dividends or capital gains, whether from the sale of real or financial assets are no more or less valuable than the dollars received from building machines or selling wine.  Each unit of currency with a given denomination has a different value according to its use, but, not according to its source.
• “Effective” means “tax codes enable governments to collect enough money to provide the services that it’s citizens ask it to provide”.
• “Efficient” means “the tax code enables governments to minimize the cost of managing the code, viz., identifying the taxpayer economic activities to tax, determining equitable rates or amounts of taxation, calculating taxes owed by taxpayers, collecting taxes due, and accounting for and administering all of these activities.
• “Enforceable” means “enables the identification of all taxable revenues and the collection of the taxes due on them”.

Our current federal tax code is deficient on three of four counts.  Surprise, surprise, the IRS is efficient!  State and local tax codes are deficient, as well, on the same three counts.  Again, although their results vary widely, they tend to be efficient.

First, it’s not equitable. While it’s progressive and, thereby, recognizes that the first dollars earned are more valuable to us than the last dollars earned, it distinguishes their values according their sources, too, by taxing capital gains and dividends at lower maximum rates than wages or salaries earned from work.  Money spent by businesses on travel expenses, office supplies, loan interest, employee compensation (including medical and retirement plans) is excluded from taxation because the code taxes net income (before tax), not revenues, and offers the option of accounting for income on an accrual basis as well as a cash basis.   In the case of individual taxpayers, the code taxes their revenues, excludes some expenses selectively and doesn’t offer the accrual method of reporting income as an alternative.

Second, it’s not effective.  The annual federal budget deficit fiscal 2012 is $1.089 Trillion.  Need I say more about effectiveness?

Third, although it’s efficient (contrary to conservative Mitchology), it could be materially more efficient.  The federal tax code’s complexity and the vagueness of its statutes drive the cost of managing the IRS up.  These relationships are positive; as complexity increases, the cost of management increases, and as rule vagueness increases, the costs of, at least, calculation and collection increase.  From 1966 to 2011, the cost of running the IRS has grown from $625 million to $12.4 Billion, never a huge number in the federal budget.  During this period, the cost of collecting $100 in taxes due has increased only from $0.48 to $0.51 (that’s right—cents!), about ½% of collections.  Which private enterprise generates revenues on a ½% cost base?  (Btw, this metric peaked in 1993 at $0.60/$100, six years after the Tax Simplification Act of 1986 and bottomed out in 2000 at $0.39/$100).  There are footnotes to this analysis, but the message is still clear.

Fourth, it’s not enforceable.  In my business career, I had a few opportunities to aid the IRS in its investigations of tax avoidance activities.  And, I’m familiar with ways in which their enforcement mechanisms allow a great deal of “tax management”, especially in the case of privately owned business expenditures by and for business owners.

There is one more, huge, issue:  whether the tax code is an effective or efficient tool of economic behavior management.  Congress attempts to use it surgically to encourage or discourage behavior they deem desirable or undesirable at different times.  Targeted exclusions are too numerous to discuss in this post (already too long) and the links between their usage and their intended outcomes are tenuous, if there are any at all.  Their economic value is dubious.  As interesting as they are (to me), these topics will be discussed in other posts.  My conclusion as their usefulness as tools to manage national, state or local economies is that “surgical” applications of tax policy (exclusions, increases, reductions, eliminations, additions) of taxes rarely generate the outcomes intended and frequently result in unintended outcomes that are detrimental to their purposes.  Thus, increased taxes on gasoline purchases, because they are flat taxes, encourage automakers, with some success, to build cars with better mileage, they increase the cost of transportation more for lower income drivers than for higher income drivers.  As increased taxes drive the price of cigarettes up, the incidence of smoking among teenagers and the size of the black market for stolen cigarettes grow relative to the size of the total market for tobacco products.

Having made this point, I will admit the possibility that tax policy can be useful as a tool for managing aggregate economic behavior.  For example, we may use it to manipulate citizens’ decisions about their personal ratios of saving and spending, thereby, managing aggregate saving and spending without discriminating among different groups on an unrelated basis.  Taxing consumption instead of income could achieve this outcome.  Success just depends largely on the level of aggregation; tax policy may be an effective sledgehammer, but it’s a lousy scalpel (just look at the patient).

What, then, should federal, state and local tax codes be?  They should be progressive exclusively, simple enough to automate completely, easy to implement and to automate their enforcement, and they should tax economic “rent” income at equal or higher rates than income that results from productive work (redundancy for emphasis).  The tax code I propose achieves all of these goals and meets the standard of the four E’s.  It also offers powerful incentives for creating strange political bedfellows who may, as a result, work together to achieve common outcomes.  For those who want to see a consumption tax, I have something, too.  The devil is in the details of the tax rates and the total revenues to achieve, which are different discussions in which we need to engage.

First, I would reduce the tax code to almost no code at all:

1. Eliminate all deductions from income and exemptions to taxation,
2. Eliminate all taxes on business or commercial activities;
3. Eliminate all flat taxes or restructure them on a progressive basis, for example
   1. Sales taxes,
   2. Alcoholic beverage taxes,
   3. Gasoline taxes,
   4. Licenses, permits and fees for auto registration, professions and trades, construction and other typical activities at the state or local levels,
   5. Real estate taxes,
   6. Public utility rates, and
   7. Road tolls;
4. Eliminate or restructure Social Security and Medicare taxes,
5. Eliminate preferential treatment of income from capital gains, dividends or interest.
6. Eliminate such targeted tax schemes as lotteries for education funds, or taxes on gambling to be used for waterfront preservation or taxes on offshore oil set aside for ocean front development (Long Beach California’s harbor, beaches and roads were some of the outcomes of the largesse that resulted from the California oil boom).

Second, I would implement a new tax code:

1. Tax individuals and users of shared resources and nothing else.
2. Tax Income, capital gains, dividends, interest and all asset sales at a graduated structure, with:
   1. Eight income brackets,
   2. $45,000 upper bound on the bottom bracket
   3. $1,000,000 lower bound on the upper bracket,
   4. Top tax rate of 72% of marginal income above $3,000,000
   5. Seven other brackets at 64%, 56%, 48%, 40%, 32%, 24%, 16%, and 8%.
3. Tax income from work according to the same rate structure, but, with a higher lower bound on the top bracket (and, therefore, the other brackets):
   1. Eight income brackets,
   2. $45,000 upper bound on the bottom bracket,
   3. $1,000,000 lower bound on the top bracket,
   4. Top tax rate of 72% of marginal income above $1,000,000,
   5. Seven other brackets at 64%, %56%, 48%, 40%, 32%, 24%, 16%, and 8%.
4. Tax water, air and food crop pollutants and abuses as well as all activities that accelerate global warming at aggressively progressive rates—pollute more, pay more per unit of pollution, use “too much” of a shared resource, pay more per unit of that resource.
5. If we decide that we can’t trust our legislators to manage the federal budget so as to allocate sufficient funds to maintain Social Security and Medicare, then simply write into the code that a percentage of all taxes collected would be set aside for them.
6. Require digital, online filing of tax forms and returns of all taxpayers.  The federal government would provide this service for those who could not afford it.  Require that all transactions be reported electronically.

I’ve advocated for the four E’s and a simplified tax code at each level of government in previous posts.  I’ve also attempted to make a case against using tax policy as an instrument of behavior management.  I’ve made this case simply on the observation that tax policy cannot be used to manage behavior surgically.  By that claim, I mean, for example, that although tax policy can be used to encourage exports of heart monitors, there would be, inevitability, unintended, unanticipated consequences to such policy the costs of which outweigh the benefits of that policy, and there may have been no need to encourage such exports, anyway.  Yet, here I am advocating taxes on activities that pollute air, water, and food, that is, all shared resources in order to discourage polluting activities and activities that accelerate global warming.  Is this aspect of my proposed tax code inconsistent with the Equity principle and with my assertion that tax policy is not an effective behavior management tool?  How, then, does this proposed code satisfy the four E’s?

The proposal to eliminate taxes on commercial activities is counterintuitive to populists, liberals, progressives, and just about anybody except someone who owns a business privately or who believes that the government at all levels must be reduced in scope to a small fraction of its current levels in order to optimize the material and personal well being of the citizenry.  Let’s think this issue through carefully.  In my next post, I’ll do just that.

The Four E’s of Taxation

It’s obvious:  “Federal, State and Local tax law must be reformed.”[1]

If, by “reformed” we mean, “improved”, then I agree with this statement.  As it’s a command, it’s not literally true or false, so, we should consider it’s efficacy rather than it’s veracity.  In my previous posts to this blog, I’ve made the case for tax reforms.  To recap, the federal, state and local tax laws are too complex, insufficiently progressive where they are progressive, regressive in other areas, challenging and expensive to maintain and enforce, and generally ineffective at fulfilling their role in governing.

In general, a tax code must satisfy four properties (the “four E’s”), it must be:

1. Equitable,
2. Effective,
3. Efficient, and
4. Enforceable.

By “Equitable”, I mean, “must affect each taxpayer equally”, to the extent possible.  This notion is the most difficult of the “four E’s” to define or even characterize.  To many, it simply means, “fair”, viz., applies equally to everyone in a single way.  A single tax rate for all is the usual example of this type of fairness.  I’ve argued, I believe persuasively, that the nature of economic needs and wants renders a single tax rate regressive, therefore, inequitable.  In addition, no matter what tax code we adopt, if we apply it to everyone, it meets this standard.  I’ve argued that some income is more valuable than other income and that as annual income, say, increases, it’s marginal value to the earner decreases.  An Equitable tax rate schedule would tax higher marginal income at a greater rate than lower marginal income; the first dollar you earn is more valuable than the millionth dollar you earn.  The current federal tax code satisfies this principle.

By “Effective,” I mean, “results in enough money to fund the associated government”.  Of course this notion depends on prior notions we hold about the functions of government, viz., their nature, their quality and their cost.  Governance in a republic includes an iterative process of clarifying and changing these prior notions and designing tax structures that reflect these notions.

By “Efficient”, I mean, “optimizes the ratio of benefits to costs”.  In the area of tax codes, this means, to me, the ratio of the total cost to determine and collect taxes to the total amount collected in any given year.

By “Enforceable,” I mean, “taxes due from any taxable entity can be determined with precision and collected without use of force or litigation”.  This standard is quite strict (perhaps, a pipedream); it requires the elimination of estimates.  Such estimates as “economic life” of an asset, “depletion basis” of a natural resource (oil field, landfill, mineral deposits), “full cost” of production, “reasonable economic transfer price” and “goodwill” are estimates, the outcomes of which impact the amount of taxes due and when they must be paid.

Only the federal income tax and some state income taxes address any of the four E’s; none of the current tax regimes satisfies any of them.  This criterion is Equity, which they address inadequately.  When Warren Buffet pays taxes that represent 17% of his income and Mitt Romney pays taxes that represent 13% of his income, yet, most taxpayers pay taxes that represent at least 25% of their incomes, it’s clear that higher marginal income is not taxed at higher rates.

In my next post, I’ll outline a tax code that is Equitable, Effective, Efficient and Enforceable.  I will argue that it improves the international competitive position of US companies, reduces the size of the IRS, minimizes tax management, funds all governments, releases resources for more productive deployment elsewhere, offers one mechanism for minimizing “the tragedy of the common” use of shared resources, and never needs to be changed.

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[1] I don’t use “reform” because reform is ambiguous; “reform” means, “change” and doesn’t imply “improve.”  Unfortunately, when we call for “tax reform” or “gun law reform” or any other “reform”, this term connotes improvement

It’s obvious: “Death taxes are unfair and unwelcome.”

It’s obvious:  “Estate taxes are really a tax on death; they’re wrong and unfair.”

There are three claims in this statement:  1) estate taxes are a tax on death; 2) estate taxes are a form of double taxation; and 3) estate taxes are unfair.  Let’s review these claims in order.

Estate taxes are not a tax on death.  This mistake is simply a category mistake: the claimants have categorized “death” improperly.  There are two kinds of taxes: taxes on assets and taxes on transactions.  Asset taxes consist of real property or real estate taxes.  Asset owners pay a tax that is based on the assessed market value of the asset to the taxing authority.  Transaction taxes consist of taxes paid on an economic transaction, including monetary and barter transactions.

The death of a person is neither an asset nor a transaction.  To speak of “death taxes” in the United States is to talk about nothing.  So, what are estate taxes?  Estate taxes are not an asset tax; the estate is not taxed on its value.  If this claim surprises you, keep reading.  Estate taxes are taxes on a transaction—the transfer of ownership assets from one person to another on the death of one of the parties to the transaction.  Your heirs won’t be taxed because you died; they’ll be taxed on the incremental value of the assets you gave them (called a “bequest” instead of a “gift” in this special case of giving).  To the heir, this bequest constitutes income.  This distinction is crucial.  To the deceased, the estate is an asset, but, to the heir, the estate is income, whether it’s a gift, a bequest, lottery winnings, other gambling winnings, ill-gotten gains (robbed a bank, for example) or payment for work.

Why is this difference crucial to understanding the nature of inheritance or estate taxes?  By the way, the phrase, “inheritance tax” is the only accurate phrase of the three I’ve used so far.  A tax on a bequest to an heir is, in fact, a tax on the heir’s inheritance rather than a tax on the deceased’s estate. This fact about the nature of the asset and the nature of the transaction is crucial to understanding the exact nature of its taxation.   Heirs inherit the estates of their benefactors.  This inheritance has a determinable value to the heir as income to the heir.   This inheritance is not income to the deceased.  Therefore, the federal government taxes it as income to the heir.  Is it capital gains to the heir?  No, the heir didn’t buy the asset, then, sell it to another party.  Before the transaction, did the heir own it; was it one of his assets?  No.  Has this income been taxed before?  No.

Here is where the case for double taxation is made.  The owner of the estate bought the assets of which the estate consists with, presumably, after-tax income.  Value accrued to these assets before the owner died.  Since the owner paid taxes on a cash basis, he paid taxes on this accrued value increment as he sold assets at a profit during his lifetime; he probably paid them at the reduced capital gains rate rather than as income from productive labor.  In addition, the inheritance tax is calculated on the basis of the gain in asset value to the dead guy, not to the total income to the heir.  Therefore, the taxes paid on the transfer to the heir are the first taxes paid on this gain, not the second.  During the presidency of G. W. Bush, the first $5,000,000 of inheritance income was exempted from any taxation whatsoever.  Thus, up to $5,000,000 of asset value accumulation was never taxed originally and will never be taxed during the heir’s life.

This situation is patently unfair to wage and salary earners, if by fair, we mean that a productive worker should be paid most of the value of his labor, then, this notion of fairness doesn’t apply to estate taxes.  The earner is dead; the heir has done nothing to earn this money.  If by fair, we mean something else, then, what do we mean?  Do we mean, “Earned by my ancestor?”  Do we mean, “Acquired by my grandfather, value added by some combination of work and good luck and given to me?”  Do we mean, “started by my dad, who taught me how to run the business and left it to me?”  I doubt that any of these alternative senses of fairness are held by any but those who are or are likely to be heirs of substantial inheritances.

The absence of inheritance taxes is an egregious flaw in our tax code.   Whereas, the ability to accumulate wealth and leave it to one’s descendants is an incentive for productive behavior, bequeathing an inheritance doesn’t stimulate productivity in our descendants.  I could argue easily that leaving a substantial inheritance to one’s children is, especially for them, counterproductive to their becoming productive in the way that we were.  Warren Buffett and Bill Gates understand this point.  Why don’t those who want to eliminate the inheritance tax from the tax code?  Warren Buffett and Bill Gates understand, too, that there is nothing “fair” about the current inheritance tax code.

“Federal state and tax law must be reformed.”

It’s obvious:  “Federal, State and Local tax law must be reformed.”[1]

If, by “reformed” we mean, “improved”, then I agree with this statement.  As it’s a command, it’s not literally true or false, so, we should consider it’s efficacy rather than it’s veracity.  In my previous posts to this blog, I’ve made the case for tax reforms.  To recap, the federal, state and local tax laws are too complex, insufficiently progressive where they are progressive, regressive in other areas, challenging and expensive to maintain and enforce, and generally ineffective at fulfilling their role in governing.

In general, a tax code must satisfy four properties (the “four E’s”), it must be:

1. Equitable,
2. Effective,
3. Efficient, and
4. Enforceable.

By “Equitable”, I mean, “must affect each taxpayer equally”, to the extent possible.  This notion is the most difficult of the “four E’s” to define or even characterize.  To many, it simply means, “fair”, viz., applies equally to everyone in a single way.  A single tax rate for all is the usual example of this type of fairness.  I’ve argued, I believe persuasively, that the nature of economic needs and wants renders a single tax rate regressive, therefore, inequitable.  In addition, no matter what tax code we adopt, if we apply it to everyone, it meets this standard.  I’ve argued that some income is more valuable than other income and that as annual income, say, increases, it’s marginal value to the earner decreases.  An Equitable tax rate schedule would tax higher marginal income at a greater rate than lower marginal income; the first dollar you earn is more valuable than the millionth dollar you earn.  The current federal tax code satisfies this principle.

By “Effective,” I mean, “results in enough money to fund the associated government”.  Of course this notion depends on prior notions we hold about the functions of government, viz., their nature, their quality and their cost.  Governance in a republic includes an iterative process of clarifying and changing these prior notions and designing tax structures that reflect these notions.

By “Efficient”, I mean, “optimizes the ratio of benefits to costs”.  In the area of tax codes, this means, to me, the ratio of the total cost to determine and collect taxes to the total amount collected in any given year.

By “Enforceable,” I mean, “taxes due from any taxable entity can be determined with precision and collected without use of force or litigation”.  This standard is quite strict (perhaps, a pipedream); it requires the elimination of estimates.  Such estimates as “economic life” of an asset, “depletion basis” of a natural resource (oil field, landfill, mineral deposits), “full cost” of production, “reasonable economic transfer price” and “goodwill” are estimates, the outcomes of which impact the amount of taxes due and when they must be paid.

Only the federal income tax and some state income taxes address any of the four E’s.  This criterion is Equity, which they address inadequately.  When Warren Buffet pays taxes that represent 17% of his income and Mitt Romney pays taxes that represent 13% of his income, yet, most taxpayers pay taxes that represent at least 25% of their incomes, it’s clear that higher marginal income is not taxed at higher rates.

In my next post, I’ll outline a tax code that is Equitable, Effective, Efficient and Enforceable.  I will argue that it improves the international competitive position of US companies, reduces the size of the IRS, minimizes tax management, funds all governments, releases resources for more productive deployment elsewhere, offers one mechanism for minimizing “the tragedy of the common” use of shared resources, and never needs to be changed.

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[1] I don’t use “reform” because reform is ambiguous; “reform” means, “change” and doesn’t imply “improve.”  Unfortunately, when we call for “tax reform” or “gun law reform” or any other “reform”, this term connotes improvement.

Taxes and Small and Middle-market Businesses

It’s obvious:  “Cutting taxes to Small and Middle-market Businesses would create jobs.”

As usual, one man’s obvious principle (frequently accepted as “fact” or “natural law”) is another man’s dubious (frequently regarded as “fiction” or “myth”).  In the real world, this claim complicated.  First, though, we need to eliminate the naïve view, viz., if you reduce the tax payments required of a small company, its owner would hire employees with annual total compensation equal to the value of the reduction in tax payments.  This idea is ridiculous.  Expanding his payroll is the last item on the small business owner’s agenda; he will add employees only if demand for his product or service exceeds capacity by enough to force him to work harder than he wants to, or do jobs he doesn’t want to do, and if he is confident that demand will continue to grow or stabilize at this new, higher amount for the foreseeable future.

The initial, short-term, effect of reducing marginal tax rates to businesses is to enrich their owners.  In addition, there is no competitive advantage from tax rate reductions to a particular company in a domestic market.  Rate changes (up or down) affect all companies equally.  As a result, competition would drive prices toward a lower equilibrium price (where marginal price equals marginal cost) at the same output.  Short-term result:  enrich owners; long-term result: reduce prices and, thereby, enrich costumers.  Advocates of tax rate reductions to businesses regard this long-term outcome as the way to create jobs.  They believe that by reducing the price of a good, producers create demand for it.  This growth in demand persuades producers to increase output.  To increase output, they must hire more people to produce the additional goods.

This belief is simplistic.  There are three sources of complications that render this view inaccurate, if not simply false.  First, companies may have unused capacity.  Second, the price/output point of supply-demand equilibrium has moved down the demand curve, in which case the total value of output remains constant, rather than having shifted the demand curve to the right.  Third, the remaining owner-competitors reap a windfall from exogenous events. 

In the first case, owners would hire no new workers nor would they start or accelerate their planned investments in plant or equipment.  In a recession or slow-growth rebound, many companies have plenty of unused capacity. Until that capacity is utilized fully or producers are confident that it will be used in the foreseeable future, they won’t expand.

In the second case, competitors just have to work harder (produce more units) to maintain their share of total industry output or the market for their goods.  As prices decline, competition intensifies and less-profitable and unprofitable producers leave the market.  They leave the market by eliminating those product lines or selling them.  If they eliminate them, all of the jobs disappear.  If they sell them, many of the production, warehouse, logistics and finance and administrative jobs would be consolidated into the buyer’s operations.  In both scenarios, jobs are lost, and plants, warehouses or offices would close and remain empty for some time.  Local economies and landscapes would be damaged or devastated (think steel and the Monongahela River Valley, although the competitors were international).  People would suffer (and have suffered) serious economic hardship from such dislocation.

In the third case, owners don’t invest or spend this money immediately; they pay themselves more than they would at initial marginal tax bracket, and they save this additional pay.  Buying outstanding issues of stocks, bonds or options on the securities exchanges is not a form of investment; it is a form of saving.  No new assets or value are created by these purchases.  If they lack confidence in the economy, they move some of it out of the economy completely by converting it to precious minerals, to other currencies or to real property (commodities, art, real estate, etc.) unrelated to their company’s business activities.  Of the remainder, they keep some in cash (to increase liquidity as safety precaution or to compete for investment opportunities) or buy bonds (lend money to private companies or governments).  If they are confident that the economy will rebound in the short term, they keep some in cash, invest some in the equity markets, and invest some in their companies.

Proponents of tax rate reductions for businesses always argue that there is no economic difference between different methods of stimulating business activity.  In the very long term, this claim seems reasonable.  But, the mechanism by which such stimulus works is complicated and depends too much on the long-term expectations of people and institutions.  These expectations are subject to significant fluctuations in an array of political and economic forces that are neither controllable nor predictable.  In the short term, this claim is ridiculous.