Tag Archives: taxes

The Gift That Keeps on Giving

By James Kwak

By now most of you probably know about the video of Mitt Romney at a fund-raiser for rich people dissing 47 percent of Americans, including seniors, one of his core constituencies. (Many seniors don’t pay income tax because they don’t have enough income, since Social Security is not taxed except for high-income households. For more on the “47 percent,” see here.)

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No There There

By James Kwak

On the one hand, over in Romney headquarters, they can take heart from the fact that the economy continues to sputter, as evidenced by the latest jobs report. On the other hand, as the election draws near, people will only ask more questions about what President Romney would actually do. For months now, the campaign has whispered one thing to the base (e.g., “severely conservative”) while being purposefully vague to everyone else, hoping that independents will assume he is still the moderate who introduced universal health care to Massachusetts. Now that strategy is breaking down.

Exhibit A is yesterday’s comical back-and-forth-and-forth-and-back on the Affordable Care Act. But the more important Exhibit B is the Romney “tax plan”—you know, the one that cuts rates for everyone by 20 percent, yet does not reduce revenues, does not increase taxes on the middle class, and achieves this miracle by eliminating tax expenditures, but without touching the preferences for investment income or the mortgage interest tax deduction.

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The “Me, Too” Party

By James Kwak

In the current issue of Democracy, Elbert Ventura discusses the history of a problem that I’ve brought up as well: the transformation of the Democratic Party into the party of tax cuts. Except, that with the Republican Party as the real party of Texas-sized tax cuts, the Democrats can never be more than the kid brother, half-hearted, talking-out-of-both-sides-of-its-mouth party of tax cuts.

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Once More, With Feeling*

By James Kwak

Peter Orszag wrote an article for the latest Democracy** about political dysfunction and the “looming fiscal showdown” at the end of this year. A lot of it is a warmed-over description of political polarization, although Orszag ignores one of its most important causes: the growing influence of money in politics and the resulting need for politicians to go chasing after contributions from extremist billionaires. (Orszag instead subscribes to the theory that political polarization results from public polarization, which has been pretty well debunked by Fiorina and Abrams.)

Orszag’s recommendation, however, is spot-on: First let the Bush tax cuts expire; then, assuming that economic stimulus is necessary, push for a big, across-the-board, temporary tax cut. (Orszag proposes a payroll tax cut and an increase in the standard deduction; I’ve previously proposed a payroll tax cut.)

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Why Raise Taxes on Poor People?

By James Kwak

My Atlantic column today is on the bizarre fixation that some conservatives have with taxing poor people, pointed out by Bruce Bartlett in his latest column. Here’s one explanation:

The other, even-more-disturbing explanation, is that Republicans see the rich as worthy members of society (the “producers”) and the poor as a drain on society (the “takers”). In this warped moral universe, it isn’t enough that someone with a gross income of $10 million takes home $8.1 million while someone with a gross income of $20,000 takes home $19,000. That’s called “punishing success,” so we should really increase taxes on the poor person so we can “reward success” by letting the rich person take home even more. This is why today’s conservatives have gone beyond the typical libertarian and supply-side arguments for lower taxes on the rich, and the campaign to transfer wealth from the poor to the rich has taken on such self-righteous tones.

Also, in some housekeeping news, I’ve switched to a personal Twitter account, @JamesYKwak. My blog posts should generate tweets in that account; Simon’s should generate tweets in the old account, @baselinescene. I’ll try to aggregate all the stuff I write in various places in my new Twitter stream.

The Baseline Scenario Facebook page should be aggregating both of our Twitter streams, but I had a little difficulty with it on Monday, so who knows. It seems like Facebook changes the way everything works every other Tuesday, so you never know when something will break.

Bad Dividend Math

By James Kwak

While working on a new Atlantic column, I came across this article by Donald Luskin (hat tip Felix Salmon/Ben Walsh) arguing that “Taxmageddon” (the expiration of the Bush tax cuts at the end of the year) will cause the stock market to fall by 30 percent.* His argument is basically this: if the marginal tax rate on dividends increases from 15 percent to 43.4 percent, the after-tax yield falls by 33.4 percent, so stock prices should fall by about the same amount.

Ordinarily I don’t bother with faulty claims like this—there are only so many hours in the day—but it bothered me so much it cost me some sleep last night.

The first problem is the only one that Luskin acknowledges: lots of investors don’t pay taxes on dividends. He mentions pension funds; there are also non-profits and anyone with a 401(k) or IRA. According to Luskin, only about one-quarter of dividends are received by people who will pay the top rate. Maybe they are the marginal investors who set prices, he speculates. Well, maybe. But an increase in the tax rate will make dividend-paying stocks more expensive for them but the same price as before for non-taxpaying investors—so as long as we’re going to stick to theory, the former should sell their stocks to the latter for some price between the two.

More important, the price of a stock (in theory, again) is the discounted present value of its future dividend stream aggregated over an infinite horizon. So we need to know what the tax rates will be in all future years. That’s clearly unknowable. If the tax rate goes up on January 1, 2013, that will give us no information about the tax rate in 2113. On the other hand, it will give us very good information about the tax rate in 2013. And it will give us a little bit of information about the tax rate in 2023. In other words, the informational value of a change in tax rates only affects a small part of the summation you have to do if you want to value a stock by its dividend stream. If a company is going to shut down in 2013, liquidate its assets, and return one massive dividend to shareholders, it affects most of the value. If a company is Facebook and is unlikely to pay dividends for a long time, it affects very little of the value. So the impact of such a change on stock prices will be a lot less than the theoretical 33.4 percent that Luskin calculates.

Then there’s the little matter of markets. Luskin’s article chides the “stock market” for ignoring the upcoming change in tax rates on dividends. How does he know? Did he ask the market? More likely, the market is pricing in the possibility of a change in tax policy. In theory, market prices today should reflect the expected future tax level, which is somewhere between 15 percent and 43.4 percent—closer to which one, we don’t know. This is another reason why the actual impact of a tax increase will be smaller than 33.4 percent; the latter assumes that every single investor today is blindly assuming that the tax rate will remain at 15 percent.  (Actually, since the Medicare surtax is already law, every single investor knows that the tax rate will be at least 18.8 percent, not 15 percent.)

But this is all theory. There is actually a way to test these things. To the extent that a change in the dividend tax rate affects stock prices, it should affect high-dividend stocks more than low-dividend stocks. Even on the theory that the value of a stock is the discounted value of its future dividend stream, for a high-dividend stock, much of that value comes from dividends in the next decade, which are likely to be affected by a change in the tax rate. By contrast, for a company that doesn’t pay dividends, the value of its dividend stream is located far out in the future, where a change in today’s tax rate has little expected impact. So if Luskin is right, the 2003 tax cut (which established the 15 percent rate for dividends) should have caused not only a sharp increase in stock prices but also a sharp increase in the price of value stocks relative to growth stocks.

So, courtesy of Yahoo! Finance, here are the closing prices of the Vanguard Value Index (red), which includes high-dividend stocks, and the Vanguard Growth Index (blue), which includes low-dividend stocks, for November 2002 through May 23 2003, the day the final bill was passed by both houses. The question, though, is when the 2003 tax cut would have affected stock prices. There’s no separation between value and growth stocks around November 5, the day the Republicans won the midterm elections.  (Remember, the Democrats had a Senate majority in 2002.) There’s none around January 28, when President Bush called for tax preferences for dividends in his State of the Union address. There’s no reaction around February 27, when the bill that would cut taxes on dividends was introduced.

Now, there is a separation around May 15, when the Senate version initially  passed. (Passage in the House was assured because of the Republican majority there.) This implies that there was significant uncertainty about whether the bill would pass; when the uncertainty cleared, high-dividend stocks gained relative to low-dividend stocks. Score one for Luskin!

But if there was uncertainty that cleared on May 15, and Luskin is right, then two things should have happened: high-dividend stocks should have gained relative to low-dividend stocks, and all stock prices should have shot up. But that’s not what happened. High-dividend stocks went up; low-dividend stocks went down. Investors’ overall appetite for U.S. stocks didn’t change; at the margin, some realized that after-tax dividend yields had just gone up, so they switched from low-dividend to high-dividend stocks.

By May 23, the last date on that chart, passage was a certainty, so the impact of the tax change should have been 100 percent priced in. Do you see a 30 percent increase? I don’t.

Want more evidence? Here are the same two index funds for December 1 through December 17, 2010, when the dividend tax cut was extended for two years. The extension was in serious doubt until December 6, when Democrats and Republicans reached a compromise agreement. Again, you can see an increase in the price of high-dividend stocks relative to the price of low-dividend stocks, starting around December 6. This indicates that the market was reacting to a significant change in the probability of an extension. But there’s no sharp, 30 percent increase in the overall level of stock prices.

So the tax rate on dividends does seem to have a small but visible impact on the relative price of high- and low-dividend stocks. And it may have a small impact on the overall price level, which would make sense. But 30 percent, or anything close to it, is pure fantasy.

So why all this hysteria about a collapse in the stock market on January 1? Well, here’s one hint, from Luskin’s article:

“If there’s a bargaining failure and the scheduled tax hikes on dividends aren’t stopped, we’ll be sorry we’re spending so much political energy now debating about the ’1%’ and their supposed privileges. It’s the 30% down in the stock market we ought be worrying about.”

This is just another attempt to mask the blatant unfairness of the Bush tax cuts by arguing by arguing that that they are good for all of us (well, at least all of us who own stocks, but that’s a matter for another post). They’re not.

* Luskin also talks about “trillions more in new tax hikes under ObamaCare.” Huh? The revenue provisions of the Affordable Care Act are projected to bring in $520 billion over the next decade; even if you include the revenue-increasing coverage provisions (like the excise tax on high-cost health plans), you only get up to $813 billion. That’s not “trillions,” unless you’re talking about an undiscounted infinite horizon.

Stephen King Weighs In

Great article by Stephen King (hat tip Felix Salmon/Ben Walsh). Excerpt:

“The Mitch McConnells and John Boehners and Eric Cantors just can’t seem to help themselves. These guys and their right-wing supporters regard deep pockets like Christy Walton and Sheldon Adelson the way little girls regard Justin Bieber … which is to say, with wide eyes, slack jaws, and the drool of adoration dripping from their chins.”

Like me, King wants his tax bill to go up.

About That State and Local Tax Deduction

By James Kwak

A couple of days ago I criticized Mitt Romney for thinking that eliminating the deductions for mortgages on second homes and for state and local taxes would pay for his 20 percent rate cuts. But there’s a more important general point to be made.

The deduction for state and local taxes is a subsidy from the federal government to state and local governments. This is how it works: If you’re in the 35 percent tax bracket, for every $100 of taxes you pay to state and local governments, the federal government gives you $35. In other words, for every $100 of taxes levied, you pay $65 and Barack Obama pays $35. That’s called a subsidy. Without it, the state and local governments would only get $65—or they would have to raise taxes by over 50 percent, which would make you mad.

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Mitt Romney Still Can’t Do Arithmetic

By James Kwak

From his closed-door fundraiser yesterday, courtesy of NBC:

“I’m going to probably eliminate for high income people the second home mortgage deduction,” Romney said, adding that he would also likely eliminate deductions for state income and property taxes as well.

“By virtue of doing that, we’ll get the same tax revenue, but we’ll have lower rates,” Romney explained.

Let’s check Romney’s arithmetic.

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The Conventional Wisdom of Tax Reform

By James Kwak

In the Times this weekend, David Leonhardt has a generally good overview of the tax policy showdown that is scheduled for later this year, as the Bush tax cuts approach expiration on January 1. He outlines several of the central issues we face: “hypothetical solutions are a lot more popular than actual ones”; everyone says she wants tax reform, but the tax expenditures that would have to be eliminated are very popular; and any significant deficit solution will directly affect vast numbers of Americans.

I have a few differences with Leonhardt, however. First, after his colleagues David Brooks and James Stewart, he seems to have fallen briefly under the spell of Paul Ryan: “Mr. Ryan’s plan would cut the top rate to 25 percent, from 35 percent, and still leave overall tax collection roughly where it has been, by eliminating tax breaks.”

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The Incredible, Magically Metamorphosing Taxpayer-Subsidized Executive Perk

By James Kwak

Once upon a time, the story goes, corporate America was fat and happy. Top executives worked in palatial office suites bedecked with flowers, flew everywhere in private jets, and ate every meal at the Four Seasons or Le Bernardin.

Then there was the shareholder value revolution. Michael Jensen and the rest of the Chicago School efficient-market legions showed that shareholder value was the only thing that mattered and stock prices were the only measure of shareholder value. Activist investors demanded an end to executive perks and ushered in the era of pay for performance, in which executives are paid in stock options, so they only make (a lot of) money if shareholders make money. Congress event went along by capping the tax-deductible amount of executives’ base pay, which helped along the shift to stock-based compensation.

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New “Debt for Beginners” Section

By James Kwak

I created a new “Debt for Beginners” page on the White House Burning website. It’s a collection of previous articles, mainly written for a general audience, on deficits, the national debt, government spending, taxes, and the politics thereof. It’s intended as a starting point for people who want to get up to speed on these issues.

Loyal readers are probably familiar with all the material already.

Why Do New York Times Columnists Keep Swooning for Paul Ryan?

By James Kwak

After David Brooks last year, now it’s James Stewart who has fallen for Paul Ryan’s rugged good looks. He attempts to defend Ryan’s tax proposals against charges that they favor the rich:

“To me it sounds like a proposal to raise [the wealthy's] taxes by depriving them of cherished ‘loopholes,’ to use the proposal’s word. . . .

“There’s no getting around the fact that a 25 percent rate on the top earners would nearly double Mr. Romney’s effective rate and more than double it for the 101 of the top 400 taxpayers who pay less than 10 percent, assuming the loopholes are indeed closed.”

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The Fetishization of Balance

By James Kwak

I generally don’t bother reading Thomas Friedman. A good friend gave me a copy of The World Is Flat, and I started reading it. Somewhere in the first one hundred pages Friedman has an extended discussion of workflow software (as a key enabler of globalization) and I realized that he knew absolutely nothing about workflow software, so I stopped reading it and gave it away.

Another friend pointed out Friedman’s op-ed in the Times earlier this week in which he argues for “grand bargains” and “balanced” solutions to, well, all of our problems. For example, he says, “We need a proper balance between government spending on nursing homes and nursery schools — on the last six months of life and the first six months of life.” Despite the nice ring, that’s about as empty a statement as you can make about public policy.

But this is the one that really confused me (and my friend):

“The first is a grand bargain to fix our long-term structural deficit by phasing in $1 in tax increases, via tax reform, for every $3 to $4 in cuts to entitlements and defense over the next decade.”

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Greg Mankiw’s Contorted Defense of Mitt Romney

By James Kwak

It’s really hard to defend the carried interest exemption (the one that allows private equity and venture capital partners to pay tax on their share of fund profits at capital gains rather than ordinary income rates). You have to give Greg Mankiw a hand: he sure gave it a good shot in the Times this weekend.

Mankiw’s general point makes a lot of sense. He argues that it’s sometimes hard to distinguish returns from labor and returns from investment, using five examples of people who buy a house for $800,000 and later sell it for $1,000,000. For example:

“Carl is a real estate investor and a carpenter. He buys a dilapidated house for $800,000. After spending his weekends fixing it up, he sells it a couple of years later for $1 million. Once again, the profit is $200,000.”

In this case, although some of Carl’s profit is due to his labor, all of it gets treated as capital gains by the tax code. In a perfect theoretical tax world, you would divide Carl into two people, the investor and the carpenter, and the investor would pay the carpenter some amount for his labor; the carpenter would pay ordinary income tax on that amount (and the investor would deduct it from his taxable profits). But that’s not how we do things.

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