Month: November 2004
In 1940 the instructions to the Form 1040 were about four pages. Today they are more than 100 pages, and the form itself contains more than 10 schedules and more than 20 worksheets. The complete tax code totals about 2.8 million words – about four times longer than "War and Peace" (and considerably harder to parse).
1. In a sufficiently wealthy or sufficiently egalitarian society, a flat tax is a no-brainer. Distributional dilemmas are the main obstacle, whether in reality or the public perception.
2. Much of the complexity of the U.S. tax system stems from the definition of income; the simplification benefits from moving to a single flat rate, while real, are often overrated. A VAT can be complex as well.
3. If I were spending political capital on reforming a tax system, I would sooner push for a more favorable treatment of capital income. Similarly, if we were sacrificing revenue or fairness, my priority would again point toward capital income.
The bottom line: My ideal tax system has two or three rates, with slight progressivity. I would keep the tax privileges of non-profits, but otherwise be reluctant to use the tax system for social engineering. So I favor a "not quite flat tax." Tax simplification is worth doing, whether or not it is linked to pure flatness of rates. That being said, flat tax advocacy remains a good way to hold politicians’ feet to the fire. All tax systems are too complicated, and moves toward simplification are rarely a mistake.
Addendum: Bruce Bartlett summarizes some tax reform ideas.
Larry Kotlikoff tries to make everyone happy:
†¢ Part 1 [of the plan] replaces Social Security’s payroll tax with a federal retail sales tax.
†¢ Part 2 eliminates any further Social Security benefit accrual, paying (with the sales tax receipts) only the benefits now owed current retirees and current workers.
†¢ Part 3 sets up an individual account system, but one that Democrats as well as Republicans can support.
The change in taxation is progressive, while the account receipts are put in a global index fund with government guaranteeing the downside. Here is the full argument.
I file this under the "would likely lead to massive socialism" category, but many leading (and market-oriented) economists have endorsed the idea. In the best case scenario it could work, but this would require reasonable fiscal transition costs, that the accounts remain truly private, and that returns capture some of the "equity premium" on stocks. I’ll turn to the latter topic within the next few days.
Thanks to Craig Newmark for the pointer.
Should we give people prizes for helping the poor? Robin Hanson thinks so:
Organized charities (especially government ones) spend a large fraction of their income on administration and still suffer relatively poor information regarding who is worthy of what charity. The most effective charity is often one on one, one charitable person helping one person in need they have met through some ordinary social context. Such personal charity is more likely to offer the kind and amount of aid needed, and to satisfy the emotional needs of both parties. The problem is, charity money often comes concentrated from taxes or a few rich donors.
My solution idea comes from the Bible, which tries to convince its readers that they should be kind to strangers in need, because they might be angels in disguise come to test their charity. (Paul said "be ye not fearful to entertain strangers, for some have entertained angels unawares".) What if concentrated charities funded "angels" to go around acting like they are in need of help, noting who helped them the most, and then giving those people large publicized rewards later, say in a couple of years? The help offered could range from giving directions to offering a job.
Those rewards, and the publicity that goes with them, might induce people to try to help folks they meet more often, so that they might win this "charity lottery". The percentage of administrative costs might be lowered by offering large rewards relative to the wages of the angel.
Prizes tend to induce the appropriate effort when the desired result is well-specified in advance; this condition appears to be satisfied in this case. But if I was poor, would I rather just receive the funds directly, in lieu of seeing a prize for helping me? (If you think that Robin deserves the prize of tenure, as I do, we should be giving prizes to people for thinking of prizes for those aiding the poor..and perhaps I should get a prize for voting for him…)
The prize competition is better for the poor if you can get people to compete very intensely for the prizes, perhaps in negative-sum fashion. Good samaritans might treat the game as a fun lottery, thereby spending more resources than the government has pledged in the first place. Alternatively, the prize system may mobilize decentralized information better than a simple government cash drop.
The bottom line:
We don’t spend nearly enough time trying to figure out how to help the poor. Here is Robin’s full argument.
Many thanks to our superb guest blogger Daniel Akst! Be sure to read his columns and his novels. When is the next one, Dan? Next week Tyler will be back to blogging from Fairfax rather than Calcutta.
Arnold Kling, Brad DeLong, Jane Galt, Matthew Yglesias, Ed Prescott all flirt with various versions of the forced saving idea, typically in the context of social security reform. Should government, even as a second best solution, require individuals to put aside a certain percentage of their funds for retirement? This is not "pay as you go," we are talking about individual lockboxes.
The idea tempts me but I must decline.
First, how much can our government force people to save in the first place? You can make them lock up funds in an account, but they can respond by borrowing more on their credit cards, taking out a bigger mortgage, and in general investing less in their future. The net increase in savings will be much less than the mandated increase. And this will make it much harder to avoid the welfare aspect of social security.
When do the savers receive true property rights over the funds? Surely not at 65. They could then spend it all and apply for the dole. We are back to letting people starve or constructing a secondary safety net; the latter is almost certain to happen, although that was precisely what the forced saving scheme was trying to avoid. Alternatively, the government could regulate how much a person can spend from the lockbox each year (must it limit your borrowing too?). Imagine being on the verge of death and petitioning the government to spend down your account to meet your medical bills or make a large donation. The complications are not encouraging.
Let’s put aside the parallels with IRAs and the like. Those plans work as they do because we already have a safety net in place for the elderly. And note that Chile (and many other countries), which has "privatized" its social security plan, maintains a secondary safety net as well.
Private accounts meet further problems if people live for a long time. What about the woman who survives to 105? It is impractical to force everyone to save enough to last until that age. So either the 105 year olds starve or we are back to the secondary safety net. Perhaps you are a libertarian who thinks none of these people will starve; still I predict that the political pressures for public assistance will be overwhelming. We will end up with both forced savings and a welfare system.
Ed Prescott suggests that private accounts would lower marginal tax rates on labor by lowering the current payroll tax. But while the payroll tax is lower, the newly created "forced savings tax" is higher. Fewer toys, less hard work. The net tax distortion likely falls to the extent that the private accounts do not occasion any redistribution of wealth (impatient or not, you keep what you put in, instead of losing it altogether). But then Prescott’s real point becomes transparent. A social security system with no transfer aspect involves a lower resource burden. This is true, but hardly news and hardly a strong argument against welfare per se. Put the transfers back in, and there is no guarantee that the real resource burden falls.
Yes there are some good arguments for forced savings, as Brad DeLong has pointed out. But they are the least libertarian arguments available, namely that we should have forced savings, as a means of instituting government allocation of capital, and a large safety net. The most robust libertarian argument is simply the view that we should not coercively transfer wealth to the elderly poor. And this I cannot imagine sticking as policy. I stand where I started, namely that social security should evolve into a welfare system for the elderly, but without the forced savings component.
In February we reported on a new study showing that the stock picks of Senators, as revealed in their financial disclosure forms, outperformed the market by a whopping 12 percent. Insider trading anyone? Although it’s not clear whether any laws have been broken, Alan Ziobrowski, one of the study’s authors says "there is cheating going on, at a 99 percent level of confidence."
The SEC looked at the study but, surprise, surprise, it seems that they are too busy going after Martha Stewart to have the time to look into evidence that our leaders are using their political power and influence for personal gain. An article in the Philadelphia Inquirer notes slyly, "the SEC may have little incentive to tangle with the Senate, given their relationship. Senators approve members of the SEC’s governing body, as well as the agency’s budget."
Unfortunately the article is not yet published, it is forthcoming in the Journal of Financial and Quantiative Analysis.
Thanks to Professor Bainbridge for the pointers.
I am back from India, somewhat heavier and numerous CDs and cookbooks richer. Do not expect any more India posts for the foreseeable future. If you wish to follow the country, try the excellent blog Sepia Mutiny.
For a thorough change in mindset, here is Michael Blowhard’s post on Joseph Spence, Bahamian finger-picking guitarist and one of the most original Caribbean musicians of the postwar era.
To graduate from a four-year college, and often from high school as well, most students needs to study a foreign language. Unfortunately, students at every level are permitted to graduate without knowing much about money. The JumpStart Coalition, which promotes financial literacy among the young, surveys high school seniors on this subject, and while the results improved a bit this year, they were still pretty dismal: "This year, 65.5 percent of students failed the exam and 6.1 percent scored a C or better." (The full survey is here.)
This has always been a pet topic of mine. A relatively small investment in teaching kids about personal finance might not only improve their lives as adults but also promote economic growth by leading to better spending decisions and more savings and investment. This could become even more important if the Bush administration moves ahead with any plans for privatizing Social Security.
One way to sell colleges on the idea: more financially savvy graduates will be able to donate more money down the road. The payoff should be highest for arty colleges that don’t produce the kinds of MBAs who will later endow chairs, buildings and the like with just a fraction of their wealth. In fact, given the focus of college presidents on fund-raising, it’s odd that this kind of education hasn’t been given more emphasis by now. Maybe administrators are using the wrong discount rate.
Addendum: Gary Leff of View from the Wing sent a thoughtful email arguing persuasively that college administrators are unfortunately using the right discount rate from their own point of view, because any possible donations are many years off into the future, far beyond the relatively limited term of the average college president. By contrast, the costs (in academic capital as well as dollars) of requiring kids to learn something about money are all too immediate. So it doesn’t happen.
Recent Nobelist Ed Prescott comes out swinging for social security reform in a fine article in the WSJ.
Some politicians have vilified the idea of giving investment freedom to
citizens, arguing that those citizens will be exposed to risks inherent in the
market. But this is political scaremongering. U.S. citizens already utilize
IRAs, 401Ks, PCOs, Keoghs, SEPs and other investment options just fine, thank
know how to invest their money — why does the government feel the need to
patronize them when it comes to Social Security?
It would be one thing if the government’s Social Security system
paid a decent return, but as the President’s Commission reported, for a single
male worker born in 2000 with average earnings, the real annual return on his
currently-scheduled contributions to Social Security will be just 0.86%. … A bank would have to offer a pretty fancy toaster to
get depositors at those rates of return.
Further, about two dozen countries have reformed their state-run
retirement programs, including Chile, Sweden, Australia, Peru, the U.K.,
Kazakhstan, China, Croatia and Poland. If citizens in these countries can handle
individual savings accounts, especially citizens in countries without a history
of financial freedom, then U.S. citizens should be equally adept. At a time when
the rest of the world is dropping the vestiges of state control, the United
States should be leading the way and not lagging behind.
Prescott sees two economic benefits of private accounts, higher savings and greater labor supply (see my earlier post). Brad DeLong has argued that investing in the market makes sense only if the equity premium is a market failure and not a response to risk. At best, however, the market failure argument is a sufficient but not necessary reason for market investment. We don’t really understand the equity-premium, however, so Prescott is right to focus on higher savings and greater labor supply – neither of these benefits of private accounts requires a non risk-adjusted premium. Prescott’s focus is especially revealing because it was he and Rajnish Mehra who first brought the profession’s attention to the equity-premium puzzle.
The Hindustan Times reports:
They have taken over our toys, cutlery, nail-cutters and other sundry items. And this Diwali [Festival of Lights] they have taken over our Gods as well. Meet Lord Ganesha and Goddess Laxmi – made in China, sold in India. Showrooms and giftshops are flooded with Chinese idols and electric diyas. And consumers are lapping them up. “These idols are very popular because of their better quality and cheap price,” says [one merchant].
There is a variety in the Chinese idols. They are also unbreakable and washable. “We have idols in porcelain, fibre and polycrystal. The Indian idol is heavier and does not look polished,” says Vimal Shah…There are now nearly 15 units in Fujin, China specialising in manufacture of Indian religious idols…
So are the Indians willing to buy everything from China? No. The Delhi High Court recently banned the import and marketing of Chinese-made globes. They don’t portray Jammu and Kashmir as belonging to Indian territory.
In Calcutta I confront this question every time my cab stops. Put aside the usual debate about selfishness and altruism, assume you will give something away. To whom should it go? Why not give it to the gentleman sleeping under a piece of cardboard who is poor but not begging?
You might think that begging is an overcrowded occupation subject to congestion. Perhaps the presence of many beggars causes many potential donors to ignore beggars altogether. In that case giving to beggars will encourage too much entry into the activity. Better to give elsewhere. This conclusion is overturned, of course, if a larger network of beggars is somehow good for all the beggars concerned.
Alternatively, what if begging is a constant cost activity? In that case donations induce more entry into begging, bringing the return back down to the (constant) cost of begging. You might create a transitory gain for some beggars, but the "bidding back down" effect is weaker for the gentleman sleeping on the street. The elasticity of street-sleeping with regard to donations is currently very low, probably zero. No one sleeps on the street in the hope of receiving a tourist donation.
Along related lines, the more you give to beggars, the harder beggars will try. This leads to what economists call "rent exhaustion," which again limits the net gain to beggars.
In short, you wish to give to the relatively inelastic factors. This usually rules out beggars, who respond to incentives rather quickly. If you are going to give, pick the poor person who is expecting it least.
If the sea level rises considerably, the watery real estate of West Bengal will fall in value. Let’s say we knew that Calcutta would flood in fifty years’ time, how would the adjustment process work? Will people leave a dying city too rapidly or too slowly, as defined in economic terms?
Under one scenario, not everyone need leave the city. The city ought to shrink, but can survive at a less populated level. Furthermore then suppose that the stayers are better off, because they do not incur migration costs. Each person then will wish that others leave and he gets to stay. Migration will become a game of "chicken," and people will postpone leaving for as long as possible, hoping to be the lucky stayers. This is related to the reason why not all auto workers leave Detroit when the plant shuts down. They are hoping they will be rehired if/when a scaled plant reopens; everyone waits for the other guy to leave.
Alternatively, perhaps the flooding will be severe and everyone must leave Calcutta. Ideally the residents should coordinate on some new locale with urban increasing returns. Do you prefer to be the first one to leave or the last?
If the new locale is known, land rents might be bid up rapidly in anticipation of the forthcoming change. If you arrive first, you pay the higher rent without yet reaping the benefits from the new, still-forming city. You might rather wait for the others to come first. Markets will know this, and perhaps land prices won’t be bid up so much at first. The equilibrium likely involves mixed strategies and a partially successful solution. Of course many residents here in Calcutta don’t pay rent but rather sleep on the streets. They may be the ones who drive a satisfactory solution, since they can reap unpriced benefits from moving. Expect them to walk of course.
If the new urban locale is not known, it is hard for Calcutta residents to know where to go.
Note that if increasing returns are truly strong, having a long time to adjust may not help much. Once some of the city starts moving, the rest must follow. The period for adjustment becomes compressed, whether this happens right away or as the likelihood of flooding arrives.
I predict most residents will not form a new city to mimic the increasing returns of the old. Most likely, they will migrate to other very large Indian cites; when large numbers had to leave Pakistan during Partition, many of them settled in Delhi.
How costly will this additional concentration of population be? To Western observers, Indian cities appear impossibly overcrowded. But in income-adjusted terms, are Indian cities overcrowded at all? Might they be undercrowded and still capable of reaping additional economies of scale? In this case the real problem is that too many Indians keep a sentimental attachment to their rural areas, to the detriment of their potential urban neighbors. Migration out of Calcutta would again be too slow, relative to an optimum, but in absolute terms things would work out OK.
Adjusting for income, are American cities and suburbs more or less likely to be overcrowded than Indian cities?