Re the fiscal cliff, I’ve tried hard to keep my head in the sand, figuring I can always go back to watching the news in 2016. So I’m not completely up to date on all this stuff, and I might be missing something important. But here are a few last-minute observations:
- “Going over the cliff” refers to a bunch of tax increases together with a bunch of spending cuts. Tax increases and spending cuts are not the same thing, so there are really two separate cliffs here. We should analyze them separately.
- Taking the path of spending as given, lower taxes now mean higher taxes later and vice versa. Given that, it’s not at all clear that higher taxes now are a bad thing.
- Going over the cliff means that a lot more people will be paying the AMT. That’s definitely a good thing. The AMT is a far simpler and more efficient tax than the ordinary income tax. Letting the AMT kick in might be the most politically feasible way to effectively eliminate a ton of otherwise untouchable deductions.
- A lot of the spending cuts are desirable, and might never happen unless we take the cliff plunge.
- There seems to be a lot of concern about the timing of this thing, with references to a “fragile economy”, etc. But I think it is nuts to tie long-term tax and spending policies to the vagaries of the business cycle. If we can make our tax code more efficient, we should do that. If we can eliminate inefficient spending, we should do that. Arguably, plunging over the twin cliffs is a way to accomplish both.
- Obviously, the whole package is highly imperfect. It entails, for example, a huge increase in estate tax rates, which ought to be zero. But perfection is not a realistic goal. The choice is not between plunging over the cliff and walking safely away from the precipice; it’s between plunging over the cliff and clinging to some branch while waiting to be rescued by the same people who got us here in the first place.
All of which leads me to root for the plunge.
Except that after the plunge, our idiot politicians will fall all over themselves and each other to pass more insane idiocy to ‘fix’ the effects of the plunge off the cliff.
For 1, since both have similar effects on aggregate demand in the Keynesian model, that is why they are considered together. Doesn’t the “cliff” refer to an expected drop in aggregate demand? (In the Keynesian model)
#2 is wrong. Default is another logical possibility, one that becomes more realistic (inevitable) as the debt grows. Hummel argues this is likely economically unavoidable and politically the best option from a libertarian perspective, so avoiding taxes now is preferable.
Steve: I respectfully disagree that a 43.4% tax on dividends – which is where a cliff-dive would take us – is just “imperfect.” It is abominable. For all the reasons you’ve beautifully explained in the past, I’d think you would agree.
Zachary Shrier: I’m not sure a high dividend tax is so bad, because it’s easily avoided by the expedient of not paying dividends — at which point, of course, the capital gains rate becomes crucial.
@Ted Levy: You’re right that default is an option, but I don’t think that makes Steve’s point #2 wrong. Default is just a tax on those who hold the nation’s debt. Even defaulting means a higher future tax on someone.
Why is everybody (not here) acting as if the world ends at midnight, like it was the Mayan calendar or something? In the New Year, Congress can undo any or all of the “cliff” that it does not like. In fact it might be easier to do that since it will be legislating tax cuts and expenditure increases rather than the reverse.
But I think it is nuts to tie long-term tax and spending policies
No offense Prof. Landsburg, but I think it’s nuts to talk about any U.S. Tax Policy as being long term.
In my 30 years as an adult the Bush “Temporary” Tax Rates have been the longest lasting.
Will A:
No offense Prof. Landsburg, but I think it’s nuts to talk about any U.S. Tax Policy as being long term.
In my 30 years as an adult the Bush “Temporary” Tax Rates have been the longest lasting.
Point well taken.
“Cliff” may be a particularly useful description if one thinks of politicians as lemmings.
Re Evan (#6): I respectfully disagree. Not all financial losses are taxes. If I make a bet with my bookie and lose, I have not been taxed. If I make a bet by buying a government bond that the government will continue to tax others in the future to cover principal and interest, and they default instead, I have not been taxed. I have made a voluntary financial bet that didn’t pay off. That’s VERY different from a tax. In fact, that’s one argument Hummel makes, from a moral POV, in preferring default.
I agree #2 is questionable…
1. Lower revenues now imply higher revenues later, but tax rates != revenues. Lower tax rates could easily lead to higher revenue if they encourage more growth than would occur under the higher rates.
2. Even if revenue does go up in conjunction with higher rates, history suggests it is extremely unlikely it will be used for debt reduction. Your preliminary, “Taking the path of spending as given”, is so unlikely in the case of higher revenue that any conclusion based it is a moonshot.
For what’s its worth, I think the status quo beats the cliff. I’d prefer the spending cuts without the tax hikes, but the broad-based tax increases seem so likely to prolong the malaise that neither is better than both. Of course in the end we’re going to get some deal that will probably manage to be worse than either of those options.
Mike S,
Lower revenues now imply higher revenues later, but tax rates != revenues.
No where did Steve make the claim that tax rates are the same as tax revenue. Steve said quite clearly and in plain English “Taking the path of spending as given, lower taxes now mean higher taxes later and vice versa.” Rates aren’t mentioned at all.
His statement is quite true as it’s simply a matter of arithmetic. For a more detailed discussion, read chapter 11, but I recommend reading the entire book.
Even if revenue does go up in conjunction with higher rates, history suggests it is extremely unlikely it will be used for debt reduction.
Steve is not in favor of reducing the debt, and for good reason, nor was he implying that the higher taxes would be used for debt reduction.
“I’m not sure a high dividend tax is so bad, because it’s easily avoided by the expedient of not paying dividends — at which point, of course, the capital gains rate becomes crucial.”
Only if you assume that corporate management is honest enough to be trusted to fairly manage the retained earnings that they’re essentially holding for investors in escrow. If instead they use their large cash piles to embark on low or negative return prestige projects, non-sensical acquisitions or to generally slacken the profits, then lower dividends do indeed drag economic growth.
Equities typically rise when corporates with large piles of cash announce dividends. That’s because investors are a lot more demanding and careful with their own money than corporate executives. There may be some exceptions, if Steve Jobs is the CEO I’d rather have him retain the earnings and use them whatever way he likes, but these tend to be rare.
Ken,
If “lower taxes now mean higher taxes later” is referring to tax revenues, then it is irrelevant to the fiscal cliff. The outcome of the cliff negotiations (which now are thankfully looking like a deal to maintain tax rates, albeit for those making under 400k) will determine future tax rates, which are ambiguous as to future tax revenues. I suspect Steve meant higher taxes now would generate more revenue now. If the point was going over the cliff -> higher rates -> lower revenues -> “not … a bad thing”, then that is startling statement. Surely we either want higher growth (lower rates) or higher tax revenue (could be higher or lower rates), not low growth and low revenue.
Thanks
I have done quite a bit of economic anaylisis of the “spending cuts” and have found that very little will be cut if at all. The “spending cuts” are a fantasy. Why is lessening the growth of a spending increase that still increases when all is said and done considered a cut?
I just don’t get it. I think that is what the politicians want.
Mike S,
I suspect Steve meant higher taxes now would generate more revenue now.
I’m pretty sure this is NOT what he means. And you are playing fast and loose with words. Taxes means tax revenues. You seem to want to hop back and forth between using the word taxes to mean rates or revenues, which of course is silly.
If the point was going over the cliff -> higher rates -> lower revenues -> “not … a bad thing”
I’m quite sure you’ve just made up this logical chain and randomly assigned it to Steve. No where in his post does he make the claim you have assigned to him. He has quite clear says “Taking the path of spending as given, lower taxes now mean higher taxes later and vice versa. Given that, it’s not at all clear that higher taxes now are a bad thing.” This is really rather plain English and am surprised you are having a hard time understanding it. The sentence obviously indicates that with current path of spending the two choices of
1. high taxes now and low taxes later
2. low taxes now and high taxes later
It is unclear whether choice 1. or 2. is preferable.
@Ken #16
If subsequent generations will be richer than us, I vote for lower taxes now and soak the rich later.
Could someone reiterate the argument against the estate tax here for me? Is it simply that it is double taxation, and thus nonsensical? Or is it because it encourages overconsumption? Am I missing something or is that the entire argument against it?
@19: It also discourages long term capital investment and capital formation.
As a tax professional, I’m going to have to disagree that the AMT is simpler than the ordinary income tax. Functionally and mechanically, the AMT works as an extra series of steps (mainly add-backs of certain deductions) layered on top of the ordinary income tax systems. So it cannot be simpler. It’s the ordinary system plus even more complications.
I’m not sure a high dividend tax is so bad, because it’s easily avoided by the expedient of not paying dividends — at which point, of course, the capital gains rate becomes crucial.
If the dividend tax rate is higher than the capital gains rate, can the corporation do an end-run around the dividend tax with a stock buyback?
Tristan: The argument against the estate tax is the same as the argument against any tax on capital. You can search this blog for posts that contain the phrase “Chamley-Judd”.
I believe that we should be looking at the objectives of Obama to make this country a socialist one by creating a crisis that will cause his side to come to a supposed remedy. So far he is maintaining his army of have nots and he will attack any effort to dimiinish their commanding position. Spending cuts will cause a dmimishment for have nots and thwart their winnings. Obama has his mind set for his victories and will refuse to accept any compromise. What is considered good or fair is a question of definitions and objectives.
No where did Steve make the claim that tax rates are the same as tax revenue.
No, but the clear presumption was that the higher rates embodied in the cliff would result in “higher taxes” (“Given that, it’s not at all clear that higher taxes now are a bad thing”).
My problem is with this: “Taking the path of spending as given,…”. That’s fine as a logical matter, but more revenue will lead to more spending. That’s pretty much been the whole point of the standoff: What is the mix of higher taxes and lower spending that will eventually happen to keep the debt on a sustainable path? The Democrats want more on the tax side, ergo less on the spending side. The cliff is about 80 percent higher taxes, 20 percent lower spending, and that’s being optimistic.
I think Ken and Mike’s discussion is central to this argument. Ken says “taxes means tax revenues”. The “cliff” entails higher tax rates. Steves states “lower taxes now mean higher taxes later and vice versa… Higher taxes now are not a bad thing” In the context of the fiscal cliff, I think Steve implies higher tax rates now would lead to higher tax revenues now.
The point of no-return for tax revenues is somewhere about 70%, I think, but that only considers direct effects, I think. If increasing taxes supresses the economy in a Keynesian way, it is possible that higher taxes could lead to lower revenues even for a modest increase. If this were to happen, higher tax rates with lower tax revenues would surely be to nobodies benefit. My rather ill0informed assumption was that this was the prediction of going over the cliff – recession would follow which would lead to lower tax revenues (among other things).