Econoblog on tax reform

Max, are you willing to raise your hand and say: "I want to in essence
double the real rate of taxation on capital income. I don’t think the
growth rate will fall"?

That is from my debate with Max Sawicky, here is the link.  Go see if Max raises his hand.

Addendum: I’ve opened up comments, since Max seems to be requesting that.


There appears to be the most consensus amongst economists outside the real estate or construction industries, both left and right, that the mortgage interest deduction is bad economic policy.

It's a shame that this is where the opposition to the reform is being played in the political arena.

Tyler definitly won points on style in that econoblog. Very dramatic performance. The "are you willing to raise your hand..." bit is very nice indeed.

However, he's begging the question. As Max established near the top of the debate, we're not discussing ideals in a vacuum. A certain amount of revenue has got to be raised. The choice is not just between 30% capital gains tax and 0% capital gains tax, but between a higher capital gains tax and lower income tax or a lower capital gain tax and higher income tax. I'm sure there are many of you out there who would like 0% capital gains tax, lower income taxes (and a pony), but that choice is not within the parameters of this discussion.

I am surprised and disappointed that so many economists are making the mistake of saying that interest on home mortgages should not be deductible. It should be. What should be taxable is the imputed rental value of owner-occupied homes. This is a phantom source of income for people who own homes that is not taxable and it should be.

The difference between eliminating mortgage deduction and taxing imputed rental value is huge for homes that have not been on the market for five or more years.

Imputed rental value would be difficult for a homeowner/taxpayer to know, but it would be trivial for a government to estimate. Basically, all homes are assessed anyway for local taxes, and imputed rental value is closely related to the house price. The federal government could just tell you want your home should rent for.

While we’re at it, we might as well tax the imputed rental value of rent-controlled apartments. Why should we subsidize those people in New York lucky enough to get one of those precious rent-controlled apartments?

But realistically, we could not hope to raise the tax on imputed rental value from 0% to 100% overnight. It should be done gradually to prevent panic in the real estate market.

Max is completely correct that there is no justification in making capital income non-taxable. There is good economic reasons for deferring taxation until those capital gains are spent as consumption (like the IRA) but all income should eventually be taxable.

We should move from an income tax to a consumption tax. I provide details in my post:

I'm a bit confused by Tyler's position on taxing capital income versus labor income. Tyler's position seems to be that capital does more to increase economic growth than labor therefore capital should be given special help in the tax code.

1. Why should this be? In a free market capital can be increased as well as labor (by switching away from labor saving machines, pulling people like stay at home moms and others into the labor market etc.). If capital generates more economic growth than labor then shouldn't the market increase capital until it gets to the point where the marginal benefit of additional capital equals the marginal benefit of increase labor? Especially considering that the returns on capital are already given preferential tax treatment as Max observes?

To clarify the above, imagine someone asserted plumbers are more essential to economic growth than carpenters therefore there should be special lower income tax brackets for income earned from plumbing. A good economist like Tyler would jump up and say if the above was true the market would increase the supply of plumbing as needed to take full advantage of the additional benefit plumbing has over carpentry. Now why is $100 earned from capital gains on a stock sale somehow better for the economy than $100 earned by putting in 3-4 hours of overtime during a busy work season?

2. Why should the gov't 'manage' capital by given it preferrential tax treatment? Tyler tries to present a 0% rate as neutral but why not a -5% rate (essentially a subsidy)?

3. The 'raise your hand' argument fails to consider the extensive changes that would happen by treating all income essentially the same. As Max points out such a policy would low rates accross the board since the base is now broader and not littered with swiss cheese 'income holes' where people enjoy no or little tax on income generated from 'gov't blessed' methods.


First of all I happen to support radical tax simplification: eliminate
all deductions and put in either some kind of flat tax on income (including
capital income) or maybe a VAT that replaces the whole income tax. I
note that divisions on the right over roughly these alternatives have
prevented either from getting sufficient traction to be seriously
considered by the current commission or the political sphere more generally.

While all that hand raising stuff was dramatic, it is important to keep
in mind that the kind of investment that leads to economic growth is
the real capital investment in machinery, equipment, factories, R&D,
and so forth. There is not an obvious link between that and people
"investing" in stocks and bonds or whatever, for which you would like to
have a lower tax rate. Indeed, Max hit the nail on the head when he
noted that we have been giving all kinds of tax breaks for savings,
and they have been going steadily down, even though real capital
investment has remained high (albeit at the threat of endangering the
long term international solvency of the entire US).

Finally, something he hinted I think is very important and is also
something that public choice theory I think makes a serious point about.
Although the current system is clearly inefficient and inequitable in
all kinds of ways, is there not an argument for just leaving the system
alone in place with no changes for an extended period of time? Then
people would learn what it is and go about their business rather than
funneling all kinds of money to rent seeking tax accountants, lobbyists,
and politicians who are busy churning the system every year so that
nobody knows what the heck it is?

Why not trust in the market to take care of it? If people do become more risk-averse with their money due to the higher tax on capital gains but the same investment opportunities are out there, surely banks would step in to make money by lending those funds out to start-up businesses. The only investment opportunites we lose would be the ones deemed marginal by the banks, the of this world, and for that we might well be grateful.

Barkley Rosser raises a good point. Most of the investment in this country actually does nothing to promote real capital investment. Investing in existing companies is like trading gold ingots back and forth -- it would not increase the supply of gold. Why not have a tax break geared primarily to investments in small start-up businesses if that is what we want to encourage? Of course, such a tax break would be meaningless without substantial taxes on other forms of capital gain.


So, what about the people who do not make enough money
to pay your lump sum tax? Unless there are humongous
changes in government spending or humongous amounts of
income redistribution, there will be millions of those

Barkley, unless tax rates get incredibly high, every person has enough income to make a lump-sum payment of their income taxes.

The question is whether they will actually set aside the appropriate amount of money through the year, so that they have it on hand when the taxes are due.

For that reason I am not in favor of once-a-year lump-sum taxation, but I am opposed to having taxes added on to a purchase price (visibly at the cash register, or invisibly incorporated in the posted price - although of those two I prefer the former) or withheld from income. We do not buy government services from the grocery store or from our employer as such, so we should not be paying those entities for our government services. We should be writing checks to the government.

And for that matter, I would strongly favor a small number of days (possibly even as low as two) per year for lump-sum taxes to be due, if combined with one additional reform: that elections must be held only on the days that taxes are due.

If we do eliminate piecemeal tax payment through intermediaries, though, I suspect we'd probably go to a once-a-month payment system for taxes currently pieced out (or their replacements).

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