Tax advantaged "sale-leasebacks" with strapped-for-cash municipalities (SILOs, in the ever-present tax acronym set) came back to light when the Washington Metro train crashed a week ago. The cars were ones that were involved in the metro authority's SILO deals with various banks, and the authority didn't have any spare cash left to fund replacements. See this A Taxing Matter posting on the Metro SILOs, Jun 25, 2009.

I won't rehash the entire discussion of SILOs covered there. Just note that the transit SILO deals were contrived to permit banks to "buy" the federal income tax depreciation deductions on municipal equipment. The municipalites couldn't use the deductions, since municipalities are tax-exempt entities. The buying corporations were subject to US tax (usually, a bank) and they were looking for every way possible to avoid paying tax--they would essentially pay a fee to the municipalities, sharing part of their tax savings, for serving as an accommodation party in these deals. They "purchased" the municipalities' property with nonrecourse debt, and then had "lease income" that was offset by both interest deductions and depreciation deductions, generating artificial losses from the accelerated depreciation. Most of the purchase price was set aside to defease the seller's obligation under the lease, with the excess the fee for accommodating the tax shelter.

Jim Lehrer covered transit agency SILOs in the March NewsHour, depicting many of the transit agencies as motivated by their desperate need for capital--and encouraged by the federal Dept. of Transportation to use these means to get some. So there is a vicious double circle of irony here, that as states and localities cut taxes during the GOP years, under the flawed assumption that lower taxes means higher revenues, the states and municipalities also cut back on the funding needed by these important public service agencies, and an arm of the federal government encouraged these transit agencies to enter these deals, and at least 30 of them did, serving as accommodation parties in tax shelter deals with banks, so that banks would pay even less taxes than they already did.

Future SILOs were generally undone by new section 470, one of the few revenue raising provisions in the 2004 tax act. (The 2004 Act otherwise amounted to a pile of tax breaks for US corporations, such as the rate cut on repatriating offshore profits. It was misleadingly labeled the "American Jobs Creation Act" to signal the purported justification for all the corporate tax breaks. It didn't lead to the creation of many jobs.) The new section disallowed to U.S. taxpayers a "tax-exempt loss", defined as the excess of deductions other than interest and interest deductions allocable to tax exempt use property over the aggregate income from the property. Exceptions allowed certain "true" leases--essentially, ones in which the obligation of the seller-renter had not been defeased by the payment from the buyer and where the buyer had actually put some equity into the deal (the provision requires only 20% of genuine, at-risk equity). There are fewer tax benefits to true leases, so even with the exception, the provision deters leasing deals.

One hitch--the act only applied prospectively, and the transit deals (just one of the varieties of SILOs that were being done at the time of the 2004 change) got special treatment, in that any deals in the pipeline were allowed to be grandfathered in as long as they were done by 2006!

The IRS pursued the old deals with pre-2004 Act tools and won SILO (and LILO--the earlier "lease in, lease out" deals) cases against Fifth Third Bank, BB&T, PNC and other banks. See, e.g., IRS Wins AWG SILO Tax Shelter Case, TaxProf Blog (May 28, 2008) (dealing with the Ohio court's decision in 2008-1 USTC 50,370, in favor of the IRS in a SILO case involving two US national banks' "purchase", with nonrecourse loans from German banks whose proceeds were used by the "seller" to defease the lease obligation, of a German waste facility used to acquire beneficial tax deductions); Ohio Judge Rejects Tax Claims on $423 Million Alleged Purchase of German Facility Made by Cleveland & Pittsburgh-Based Banks, DOJ (May 30, 2008); DOJ, Ohio Jury Finds Cincinnati-based Bank not Entitled to $5.6 Million Tax Refund (LILO transctions); BB&T Corp, 2008-1 USTC 50,306 (4th Cir.) (striking down tax treatment of financial service company's lease of Swedish wood-pulp manufacturing equipment as a LILO shelter); DOJ, Statement of Assistant Attorney General Nathan J. Hochman on Today's Decision in BB&T Corporation v. United States (Apr. 29, 2008).

After the court victories, the IRS offered a SILO settlement for these deals that permitted them to keep 20% of their claimed tax losses and waived the penalties, if they terminated the transactions. IRS Commissioner's Remarks Regarding LILO/SILO Settlement Initiative (Aug. 6, 2008); Donmoyer, IRS Offers to Settle 45 leasing Tax-Shelter Disputes, Bloomberg.com (Aug. 6, 2008); Service Launces LILO, SILO Settlement Initiative, J. Acct. (Oct. 13, 2008). It later announced that "hundreds of taxpayers settled similar cases involving tens of billions of dollars." DOJ, Justice Department Highlights FY 2008 Tax Enforcement Results (Apr. 13, 2009). On leaving office, Korb statedthat "taxpayers representing over 80 percent of the dollars involved have elected to take advantage of the settlement initiative." See Korb Interview. (Dec. 19, 2008).

The settlement offer required taxpayers to terminate the transactions by Dec. 31, 2008, else they would be deemed terminated by that date, with taxpayers still able to claim the partial loss benefit through the actual termination date if they terminated the transaction by Dec. 31, 2010. That's a fairly strong incentive for termination, but the municipalities may be on the hook for hefty termination payments under their contracts. Even worse, the AIG situation provided a perfect trigger for causing a technical default to apply. AIG guaranteed these deals, so when its credit rating went down, the transit agencies are in technical default and liable for hefty penalty payments. (see NewsHour video, above).

There are real problems here, including the idea of one agency of the government supporting its "clients" (transit agents of municipalities) entering into deals like this that result in corporate tax cheats robbing the government of important revenues. Another problem is the idea of the banks that were instrumental in causing the fiscal crisis--by risky, speculative behavior that disregarded the systemic risks--using AIG's collapse because of that fiscal mess as an excuse to get municipalities that are especially cash-strapped because of the fiscal crisis (and finding their ability to borrow or get tax revenues severely restricted) to pay over large penalty amounts under their shelter contracts. It seems like an unfair windfall for tax cheating Big Banks at the cost of the people.

And of course, just extending the 2004 provision to make grandfathered SILO/LILO transactions illegitimate and their tax deductions disallowed doesn't solve this problem, since these are windfalls that the tax cheaters would get under their "lease" contracts.

Rep. Menendez of NJ has proposed a potential solution--the "Close the SILO/LILO Loophole Act" S. 1341, introduced in late June. His bill, he says, would "help protect WMATA and other transit agencies who are being threatened by banks seeking to gain a windfall from the current economic climate while potentially putting transit agencies at risk." See press release, As Lease-Back Deals Are Raaised as an Issue in Metro Crash, Menendez Says legislation Can help Unwind Deals, PolitickerNJ.com (Jun 26, 2009); Davis, Bill Would Tax Banks that Sue Agencies , Star Ledger (Jun 24, 2009); Letter from Menendez to Hoyer (Jun 26, 2009) (noting a need to "protect transit agencies from banks who are seeking to exploit a technicality that would result in agencies having to pay banks millions of dollars that could otherwise be used to shore up equipment and ensure safe operations, even though they have not missed a single payment to the bank"). The bill imposes an excise tax equal to 100% of any "ineligible amount" collected by "any person other than a SILO/LILO lessee" as a party to a SILO/LILO transaction. Ineligible amounts are proceeds from terminations, rescissions, or remedial actions in excess of those under defeasance arrangements. The bill also would deny deductions for attorney fees and other costs attributable to seeking to recover ineligible amounts.

It's messy, but it does end up with the right results, it seems. I note, though, that there are no additional co-sponsors at this time. Doesn't look like Congress is hopping on the bandwagon.

I spent most of the evening reading Underbelly posts, so this link is probably due to Buce:

On Oct. 22, 1986, President Reagan signed into law the Tax Reform Act of 1986, one of the most far-reaching reforms of the United States tax system since the adoption of the income tax. The top tax rate on individual income was lowered from 50% to 28%, the lowest it had been since 1916.

About thirteen years from 1916 to 1929. About thirteen years (plus the Clinton Administration) from 1986 to 2008.

Last week, the Senate failed to invoke cloture on S.3335, a measure which among other things would extend the production tax credits for solar and wind energy, plug the Highway Trust Fund deficit, and keep the Alternative Minimum Tax at bay for elements of the lower-upper-middle-classes for another year. The vote was 51-43, with a few mostly endangered Republicans joining the Democrats, and Harry Reid voting Nay for procedural reasons — so the bill does have at least majority support.

In fact, since the elements of the package are broadly popular if not useful, this bizarrely enough seems to be an effort of the Republicans to be against a package of tax cuts before they're for it. (More Republicans than Norm Coleman and Gordon Smith would be hard pressed to vote Nay in a final vote, methinks.) Whether this represents Pyrrhic support for the Bush administration's idiotic plan to raid transit funds for the highways, or an effort to get the Democrats to accept oil drilling to get essential legislation passed, is unclear from the reporting I've seen.

I'd seen Tom Ridge on TV yesterday claiming that it's the Republicans with a comprehensive energy plan, whereas Obama is supposedly opposed to the zero nuclear plants currently under construction. In fact, not only are the Republicans working to effectively throw a spanner in the works of the rapidly expanding renewables industry — providing generating capacity with no sensitivity to fossil fuel prices in multi-gigawatt quantities now. In fact, it may be down the page but McCain supports the tax credits his caucus is opposing.

It makes me wish I were rich enough to get on the air with an ad on this flip-flopping and obstructionism by the Grumpy Old Party.

Last week, the Senate failed to invoke cloture on S.3335, a measure which among other things would extend the production tax credits for solar and wind energy, plug the Highway Trust Fund deficit, and keep the Alternative Minimum Tax at bay for elements of the lower-upper-middle-classes for another year. The vote was 51-43, with a few mostly endangered Republicans joining the Democrats, and Harry Reid voting Nay for procedural reasons — so the bill does have at least majority support.

In fact, since the elements of the package are broadly popular if not useful, this bizarrely enough seems to be an effort of the Republicans to be against a package of tax cuts before they're for it. (More Republicans than Norm Coleman and Gordon Smith would be hard pressed to vote Nay in a final vote, methinks.) Whether this represents Pyrrhic support for the Bush administration's idiotic plan to raid transit funds for the highways, or an effort to get the Democrats to accept oil drilling to get essential legislation passed, is unclear from the reporting I've seen.

I'd seen Tom Ridge on TV yesterday claiming that it's the Republicans with a comprehensive energy plan, whereas Obama is supposedly opposed to the zero nuclear plants currently under construction. In fact, not only are the Republicans working to effectively throw a spanner in the works of the rapidly expanding renewables industry — providing generating capacity with no sensitivity to fossil fuel prices in multi-gigawatt quantities now. In fact, it may be down the page but McCain supports the tax credits his caucus is opposing.

It makes me wish I were rich enough to get on the air with an ad on this flip-flopping and obstructionism by the Grumpy Old Party.

Mark Thoma points to Thomas Palley playing lightning rod with "Tax Policy and the House Price Bubble." With a title like that, you might expect a prima facie case for a causal link between tax preferences for homeownership and the bubble, but Palley's lede is deeply buried and there turns out not to be a lot of there there. The central issue is that there's no obvious variation in tax policy that is associated with the bubble. More after the jump.

Plenty of Sensible Economists have sniped at the mortgage interest deduction among other favorable tax treatments for homeownership. Reforming, though not eliminating, the mortgage interest deduction also was a recommendation of the Tax Reform Panel whose report was broadly ignored after its 2005 publication gave some of us in the econoblogiverse plenty of material (for anyone interested, my contemporary blogging on the subject is linked here). Palley recites the traditional indictment: the tax policies are expensive (*), pay the middle- to upper-middle classes to do something they'd do anyway (**), are unfair to low-income taxpayers who don't itemize or otherwise get a smaller deduction (***), and by increasing house prices work somewhat at cross purposes to the notional intent of making housing more affordable. Fair enough.

Thing is, as far as the housing bubble is concerned, none of this is new. The deduction was distorting the housing market well into pre-bubble history. Indeed, the reductions in marginal tax rates affecting most middle- and upper-income taxpayers ought, in principle, to have reduced the distortion on the margin. Here, for instance, is the CPI-adjusted OFHEO house price index against the marginal tax rate applicable to a family with a constant-dollar income somewhat north of mine (****):



Correlation is not causality, of course, but the simple correlation here is negative (-0.55). Moreover, there isn't any clear connection between the major changes in tax policy over the period and bubbly prices, unless someone can account for the rather variable lag structures. The 1986 tax reform eliminated the deductibility of non-mortgage interest, which in particular made home-equity credit relatively attractive; in 1997, the capital-gains treatment for owner-occupied housing changed. In both cases, at least using the CPI adjustment, prices had started recovering from their local troughs before enactment of the changes.

The '97 change — which replaced a tax deferral for homeownership capital gains rolled into another residence with a flat exemption of $250,000 for an individual (twice that for joint filers) — is tricky. It does favor owner-occupied housing as an asset class by making something of a Roth IRA out of one's house. However, the benefits relative to previous law only assert themselves upon exit of the owner-occupied housing market, and the complete tax deferral of rolled-over equity may have been worth more in the short run to movers up or down in areas with high nominal appreciation. Also, this was enacted against the backdrop of a right-of-center program to reduce taxation of capital income; I tend to the view that there's not a lot of distortion between a zero capital gains tax rate and the low rates that currently prevail for other long-term gains.

So Palley is left with a rather tenuous assertion connecting the bubble and tax policy:

The tax system has helped create a cult of home ownership, and that cult appears to have been an ingredient in the recent house price bubble.

I don't think the tax preferences exactly hurt the cult's marketing, but let's face facts: to explain the bubble, it's necessary to find factors associated more-or-less with the bubble era, and from that perspective it should be amply clear that the irrational exuberance came roaring out of the financial world. The cult part was all the spinning of tales for why houses were just like stocks in the late-90s except for the crashing back to earth part, combined with the deployment of financial technologies which, while not necessarily dangerous per se (*****), certainly bore risks of unintended consequences that were broadly ignored. So now we have a socialized financial system (at least on the downside), woohoo!

Meanwhile, I'm skeptical to say the very least regarding claims that we'd be living in a paradise of economic dynamism if only we were all unencumbered by our illiquid and inconvenient owned housing. Long-term wage stagnation is a huge problem, but one that can't fairly be placed at homeownership above other causes.

So Palley has some reasonably sensible reform plans that someone might phase in, but I'm not going to tell anyone that a bit of political capital ought to be spent on them that might otherwise be spent extracting us from George and Dick's Excellent Adventure or breaking our addictions to oil and/or GHG emissions — both of which are far more difficult and urgent.


(*) $80 billion is a lot of money, but at ~3% of the federal budget, not the biggest boondoggle in annual expenditures.

(**) Distastefully inefficient to the extent it's true.

(***) Also true in large part, though non-itemizers do have the standard deduction.

(****) This is based on a constant-dollar income putting a 2007 taxpayer in the 28-percent bracket, not adjusted for other tax-law changes. Historical tax rates via the Urban Institute/Brookings Tax Policy Center.

(*****) If you think there's something magical about 20%-down financing, go read the Irvine Housing Blog's archives, handy link in the sidebar!

Mark Thoma points to Thomas Palley playing lightning rod with "Tax Policy and the House Price Bubble." With a title like that, you might expect a prima facie case for a causal link between tax preferences for homeownership and the bubble, but Palley's lede is deeply buried and there turns out not to be a lot of there there. The central issue is that there's no obvious variation in tax policy that is associated with the bubble. More after the jump.

Plenty of Sensible Economists have sniped at the mortgage interest deduction among other favorable tax treatments for homeownership. Reforming, though not eliminating, the mortgage interest deduction also was a recommendation of the Tax Reform Panel whose report was broadly ignored after its 2005 publication gave some of us in the econoblogiverse plenty of material (for anyone interested, my contemporary blogging on the subject is linked here). Palley recites the traditional indictment: the tax policies are expensive (*), pay the middle- to upper-middle classes to do something they'd do anyway (**), are unfair to low-income taxpayers who don't itemize or otherwise get a smaller deduction (***), and by increasing house prices work somewhat at cross purposes to the notional intent of making housing more affordable. Fair enough.

Thing is, as far as the housing bubble is concerned, none of this is new. The deduction was distorting the housing market well into pre-bubble history. Indeed, the reductions in marginal tax rates affecting most middle- and upper-income taxpayers ought, in principle, to have reduced the distortion on the margin. Here, for instance, is the CPI-adjusted OFHEO house price index against the marginal tax rate applicable to a family with a constant-dollar income somewhat north of mine (****):



Correlation is not causality, of course, but the simple correlation here is negative (-0.55). Moreover, there isn't any clear connection between the major changes in tax policy over the period and bubbly prices, unless someone can account for the rather variable lag structures. The 1986 tax reform eliminated the deductibility of non-mortgage interest, which in particular made home-equity credit relatively attractive; in 1997, the capital-gains treatment for owner-occupied housing changed. In both cases, at least using the CPI adjustment, prices had started recovering from their local troughs before enactment of the changes.

The '97 change — which replaced a tax deferral for homeownership capital gains rolled into another residence with a flat exemption of $250,000 for an individual (twice that for joint filers) — is tricky. It does favor owner-occupied housing as an asset class by making something of a Roth IRA out of one's house. However, the benefits relative to previous law only assert themselves upon exit of the owner-occupied housing market, and the complete tax deferral of rolled-over equity may have been worth more in the short run to movers up or down in areas with high nominal appreciation. Also, this was enacted against the backdrop of a right-of-center program to reduce taxation of capital income; I tend to the view that there's not a lot of distortion between a zero capital gains tax rate and the low rates that currently prevail for other long-term gains.

So Palley is left with a rather tenuous assertion connecting the bubble and tax policy:

The tax system has helped create a cult of home ownership, and that cult appears to have been an ingredient in the recent house price bubble.

I don't think the tax preferences exactly hurt the cult's marketing, but let's face facts: to explain the bubble, it's necessary to find factors associated more-or-less with the bubble era, and from that perspective it should be amply clear that the irrational exuberance came roaring out of the financial world. The cult part was all the spinning of tales for why houses were just like stocks in the late-90s except for the crashing back to earth part, combined with the deployment of financial technologies which, while not necessarily dangerous per se (*****), certainly bore risks of unintended consequences that were broadly ignored. So now we have a socialized financial system (at least on the downside), woohoo!

Meanwhile, I'm skeptical to say the very least regarding claims that we'd be living in a paradise of economic dynamism if only we were all unencumbered by our illiquid and inconvenient owned housing. Long-term wage stagnation is a huge problem, but one that can't fairly be placed at homeownership above other causes.

So Palley has some reasonably sensible reform plans that someone might phase in, but I'm not going to tell anyone that a bit of political capital ought to be spent on them that might otherwise be spent extracting us from George and Dick's Excellent Adventure or breaking our addictions to oil and/or GHG emissions — both of which are far more difficult and urgent.


(*) $80 billion is a lot of money, but at ~3% of the federal budget, not the biggest boondoggle in annual expenditures.

(**) Distastefully inefficient to the extent it's true.

(***) Also true in large part, though non-itemizers do have the standard deduction.

(****) This is based on a constant-dollar income putting a 2007 taxpayer in the 28-percent bracket, not adjusted for other tax-law changes. Historical tax rates via the Urban Institute/Brookings Tax Policy Center.

(*****) If you think there's something magical about 20%-down financing, go read the Irvine Housing Blog's archives, handy link in the sidebar!

Robert Stein has been kind enough to clarify a lot of points about his tax plan, so I'd like, if I may, to offer conservatives my thoughts on a tax plan. Not a tax plan, but things I feel they should keep in mind about taxes if their goal is to come up with a plan that will a) have the support of folks in the center and the center-left and b) be "pro-growth" in deed as well as in word.


1. Do not make assumptions about the percentage of people's income that will go toward taxes based on figures from the IRS Statistics of Income. The IRS Statistics of Income gives us reported taxable income, which has a much greater tendency to overstate the percentage of income paid in taxes by high income earners than it does for low income income earners. A couple reasons come to mind quickly...

1a. It is not going to include tax free income, such as tax free municipal bonds. These are generally not a part of the income stream of the working class.

1b. Its usually awfully hard to, shall we say, push the envelope when all of your income comes from one employer and is reported on a W-2. On the other hand, if your income comes from multiple sources, and it depends in large part on how big your costs are, things are a little different. Robert Stein used to work at the Treasury. I had a stint at a then Big 6, now Big 4 Accounting firm. The reason high net worth individuals pay enormous fees to the Big X is not because their returns are complex - its to ensure their returns are complex. That way, when there's a dispute, and the folks at the Big X are one side of the table, and the outgunned folks from the Treasury (whose goal is to one day be on the other side of the table, making more money - talk about Capture Theory!) meet, there's no question what the outcome will be. Costs are inflated using every loophole, and revenues are deflated the same way. And the incentive of folks who make enough money to go through PWC or E&Y or Deloitte or KPMG is not going to go away just because tax rates fall, unless those rates fall close to zero. And its not going to go away if the tax code is simplified.

2. Here's a table I made for another post a few months back based on data from IRS SOI Bulletin Historical Table 8. It shows the income taxes paid (as per the IRS SOI) as a percentage of the personal income (from the BEA's NIPA tables), not as a percentage of the personal income declared to the IRS.



I don't think its excessively cynical that the conclusion to be reached from this is that tax collections are less a function of marginal tax rates than they are of something else. Here's why - tax rates dropped dramatically while LBJ was President, and yet tax collections as a share of income went up. Conversely, as Republicans will never forget, GHW Bush raised tax rates... and still reduced the percentage of people's income collected in taxes.

For lack of a better term, let's call that something other than marginal tax rates that affects tax collections "enforcement." Its a simple matter - if the folks appointed to run the Treasury and the IRS are very much against the concept of taxation, tax collections as a percentage of income will diminish. Its no surprise or accident that the red bars are all one side of horizontal axis and the blue bars are all on the other.

3. I realize its fashionable to claim that one is "pro-growth" if one is in favor of lower taxes. I'm not sure if Robert Stein has used that term, but its certainly a term in vogue. The problem is this - another graph I used before...

I pulled some data from the BEA's NIPA table 7.1. For each president, its calculated from the last year before the President took office to the last full year the President served. (Since JFK was killed and Nixon quit more than half-way through the year, I assumed JFK's "last full year" was 1963 and Nixon's was 1974.)



Its hard to construct a story that includes both this graph and the previous one and that still puts the "pro-growth" label on lower tax collections*. I am not saying that higher tax rates produce faster growth - I am saying that there is an optimal rate of taxation when it comes to growth. Think of it as a Laffer curve, but with real GDP per capita growth rather than tax collections on the y-axis. At the rates of actual tax collections we've observed since 1952, not theoretical marginal collections but actual ones, taxes are now well below the level we need to maintain growth. Taxes pay for infrastructure we need to maintain a smoothly running economy, things like roads and bridges.



* Any such story usually involves the Kennedy tax cuts. To cut that off at the pass, let me point out here and now, for the umpteenth time, the Kennedy tax cuts came in 1964. Kennedy was already dead. Its one thing to credit them with some of the growth during the LBJ years, another to credit them with growth during the Kennedy years.

---

Correction. Modified the sentence referring to GHW Bush and taxes. Originally it referred erroneously to GW, and was somewhat nonsensical. Apologies for the screw-up.

END

Robert Stein has been kind enough to clarify a lot of points about his tax plan, so I'd like, if I may, to offer conservatives my thoughts on a tax plan. Not a tax plan, but things I feel they should keep in mind about taxes if their goal is to come up with a plan that will a) have the support of folks in the center and the center-left and b) be "pro-growth" in deed as well as in word.


1. Do not make assumptions about the percentage of people's income that will go toward taxes based on figures from the IRS Statistics of Income. The IRS Statistics of Income gives us reported taxable income, which has a much greater tendency to overstate the percentage of income paid in taxes by high income earners than it does for low income income earners. A couple reasons come to mind quickly...

1a. It is not going to include tax free income, such as tax free municipal bonds. These are generally not a part of the income stream of the working class.

1b. Its usually awfully hard to, shall we say, push the envelope when all of your income comes from one employer and is reported on a W-2. On the other hand, if your income comes from multiple sources, and it depends in large part on how big your costs are, things are a little different. Robert Stein used to work at the Treasury. I had a stint at a then Big 6, now Big 4 Accounting firm. The reason high net worth individuals pay enormous fees to the Big X is not because their returns are complex - its to ensure their returns are complex. That way, when there's a dispute, and the folks at the Big X are one side of the table, and the outgunned folks from the Treasury (whose goal is to one day be on the other side of the table, making more money - talk about Capture Theory!) meet, there's no question what the outcome will be. Costs are inflated using every loophole, and revenues are deflated the same way. And the incentive of folks who make enough money to go through PWC or E&Y or Deloitte or KPMG is not going to go away just because tax rates fall, unless those rates fall close to zero. And its not going to go away if the tax code is simplified.

2. Here's a table I made for another post a few months back based on data from IRS SOI Bulletin Historical Table 8. It shows the income taxes paid (as per the IRS SOI) as a percentage of the personal income (from the BEA's NIPA tables), not as a percentage of the personal income declared to the IRS.



I don't think its excessively cynical that the conclusion to be reached from this is that tax collections are less a function of marginal tax rates than they are of something else. Here's why - tax rates dropped dramatically while LBJ was President, and yet tax collections as a share of income went up. Conversely, as Republicans will never forget, GHW Bush raised tax rates... and still reduced the percentage of people's income collected in taxes.

For lack of a better term, let's call that something other than marginal tax rates that affects tax collections "enforcement." Its a simple matter - if the folks appointed to run the Treasury and the IRS are very much against the concept of taxation, tax collections as a percentage of income will diminish. Its no surprise or accident that the red bars are all one side of horizontal axis and the blue bars are all on the other.

3. I realize its fashionable to claim that one is "pro-growth" if one is in favor of lower taxes. I'm not sure if Robert Stein has used that term, but its certainly a term in vogue. The problem is this - another graph I used before...

I pulled some data from the BEA's NIPA table 7.1. For each president, its calculated from the last year before the President took office to the last full year the President served. (Since JFK was killed and Nixon quit more than half-way through the year, I assumed JFK's "last full year" was 1963 and Nixon's was 1974.)



Its hard to construct a story that includes both this graph and the previous one and that still puts the "pro-growth" label on lower tax collections*. I am not saying that higher tax rates produce faster growth - I am saying that there is an optimal rate of taxation when it comes to growth. Think of it as a Laffer curve, but with real GDP per capita growth rather than tax collections on the y-axis. At the rates of actual tax collections we've observed since 1952, not theoretical marginal collections but actual ones, taxes are now well below the level we need to maintain growth. Taxes pay for infrastructure we need to maintain a smoothly running economy, things like roads and bridges.



* Any such story usually involves the Kennedy tax cuts. To cut that off at the pass, let me point out here and now, for the umpteenth time, the Kennedy tax cuts came in 1964. Kennedy was already dead. Its one thing to credit them with some of the growth during the LBJ years, another to credit them with growth during the Kennedy years.

---

Correction. Modified the sentence referring to GHW Bush and taxes. Originally it referred erroneously to GW, and was somewhat nonsensical. Apologies for the screw-up.

END

Update....

Sheesh. I wake up this morning and my first thought is... what the heck was I thinking last night? I have to put a bit more thought into these things that I write at the end of the day.

We all make stupid mistakes and this qualifies as one of mine. I think its been a while since I put up something this dumb.

Sorry about that.

--------------

I'm doing a bit of work on taxes and income right now, and I found something really uncool. First, this table shows us the income limits for families for each income quintile and the top 5% of income earners. Second, Table 1A of this CBO spreadsheet gives us the total effective federal tax burden of faced by folks in the various income quintiles, and the top 10%, 5%, and 1% of income earners. (Data for 2003 and 2004 come from this update.)

With this, we can measure the progressivity (or lack of it) of the tax system. See, if the system is progressive, then the difference between the tax burden imposed on people who earn a lot and the tax burden on people who earn very little will be bigger than the difference in income earned by both groups. A person who makes 10 times what another person makes will pay more than 10 times as much in taxes. If the tax system is regressive, then the opposite is true.

Most of you can already see where this is going. If you can't, you're not enough of a cynic, or in denial and trying to think up an excuse. But keep reading, because there is at least one real surprise in this post.

So here's a graph showing two curves. The first curve is the ratio of low income individuals (which I'm defining as those at the bottom quintile) to high income individuals (the top 5% of income earners). The second curve is the ratio of the tax burden imposed on the low income earners to the tax burden imposed on the high income earners.



What we see is this:

1. The ratio of incomes is lower than the ratio of tax burdens. As an example... in the year 2000, low income folks made 14.99% of the income of high income folks. (Those at the bottom made $24,000, those at the top made over $160,000) But the tax burden on low income folks was 20.65% of the tax burden on high income folks. (Those at the bottom had a 6.4% tax burden, and those at the top had a 31% tax burden.) Put another way... an increase in income leads to a less than proportional increase in the tax burden.
2. On the plus side, the system is heading in the direction of being progressive - and has continued to head in that direction even under GW! But that's a recent phenomenon. Under Reagan, the system became a lot more regressive, especially through 1986.
3. What happened from 1996 to 2000? I suspect the booming stock market coupled with cuts in the capital gains tax rate is a big one.

But the big take-away... the tax system is regressive. Its becoming less regressive, but its still regressive.

----------

Update... As noted at the very top of the post, I must have been hallucinating when I wrote this. Conclusions in this post are incorrect. Sorry about that.

Update....

Sheesh. I wake up this morning and my first thought is... what the heck was I thinking last night? I have to put a bit more thought into these things that I write at the end of the day.

We all make stupid mistakes and this qualifies as one of mine. I think its been a while since I put up something this dumb.

Sorry about that.

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I'm doing a bit of work on taxes and income right now, and I found something really uncool. First, this table shows us the income limits for families for each income quintile and the top 5% of income earners. Second, Table 1A of this CBO spreadsheet gives us the total effective federal tax burden of faced by folks in the various income quintiles, and the top 10%, 5%, and 1% of income earners. (Data for 2003 and 2004 come from this update.)

With this, we can measure the progressivity (or lack of it) of the tax system. See, if the system is progressive, then the difference between the tax burden imposed on people who earn a lot and the tax burden on people who earn very little will be bigger than the difference in income earned by both groups. A person who makes 10 times what another person makes will pay more than 10 times as much in taxes. If the tax system is regressive, then the opposite is true.

Most of you can already see where this is going. If you can't, you're not enough of a cynic, or in denial and trying to think up an excuse. But keep reading, because there is at least one real surprise in this post.

So here's a graph showing two curves. The first curve is the ratio of low income individuals (which I'm defining as those at the bottom quintile) to high income individuals (the top 5% of income earners). The second curve is the ratio of the tax burden imposed on the low income earners to the tax burden imposed on the high income earners.



What we see is this:

1. The ratio of incomes is lower than the ratio of tax burdens. As an example... in the year 2000, low income folks made 14.99% of the income of high income folks. (Those at the bottom made $24,000, those at the top made over $160,000) But the tax burden on low income folks was 20.65% of the tax burden on high income folks. (Those at the bottom had a 6.4% tax burden, and those at the top had a 31% tax burden.) Put another way... an increase in income leads to a less than proportional increase in the tax burden.
2. On the plus side, the system is heading in the direction of being progressive - and has continued to head in that direction even under GW! But that's a recent phenomenon. Under Reagan, the system became a lot more regressive, especially through 1986.
3. What happened from 1996 to 2000? I suspect the booming stock market coupled with cuts in the capital gains tax rate is a big one.

But the big take-away... the tax system is regressive. Its becoming less regressive, but its still regressive.

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Update... As noted at the very top of the post, I must have been hallucinating when I wrote this. Conclusions in this post are incorrect. Sorry about that.

A few commenters of my last post suggested that picking at the tax code can create big problems if you don't know what you're talking about. I agree. Why mess with what is working as evident in the data continuously collected and reported concerning the economy. But, in 1981 they did mess with it and in a very big way and it hasn't stopped. As the saying goes “everything changed”. Even under Clinton the share of income to the top 1% rose 6 points.
To recall, my point is that it's not just the rates that are the problem, it's the code.
One comment got me looking further.

Save the Rust Belt
“In general, the attempts by Congress in various bills to limit the deductibility of executive compensation caused the flood of executive stock options, and created a much bigger mess “
From a review by Peat, Marwick, Mitchell & Co.

The Economic Recovery Tax Act of 1981 is the most comprehensive tax reform
since 1954. It affects virtually every financial planning decision. The Act creates a "new” type of stock option known as an "Incentive Stock Option" under which favorable tax treatment will be afforded to the option holder if certain conditions are met. Under current law, employer stock options are not entitled to preferential treatment.
Observations
The incentive stock option will have a significant effect on compensation planning
for all companies, and these rules may be applicable to options already exercised in 1981. Incentive stock option plans will probably become the cornerstone of executive compensation plans involving capital accumulation.

(Within this report are the changes related to the savings and loan mess. Considering today's subprime problems, it is rather instructive as it relates to learning from history. Start on page 39 of the document.)


Thus, it was not the messing around that created stock options as a preferential means of payment. In the 1986 messing around they: eased the rules for exercise of Incentive Stock Option (ISO).

But, how was this 1981 act being portrayed by the CBO? Baseline Budget Projections for Fiscal Years 1983 – 1987 Report February 1982

The CBO baseline economic forecast shows an early end to the current recession and an acceleration of economic growth following the July tax cut.
Baseline revenue projections assume no change in current tax laws,... Under the CBO baseline economic assumptions, revenues are projected to rise from an estimated $631 billion in fiscal year 1982 to $882 billion in 1987. This represents an average growth of 6.9 percent a year, compared with an assumed average growth in nominal GNP of about 10 percent a year for the projection period. As a consequence, revenues as a proportion of GNP are projected to decline from 20.6 percent in 1982 to 17.7 percent in 1987—the smallest ratio since 1965.

Under current tax laws, the greatest growth in revenues will occur in social insurance taxes and contributions... The share of total revenues raised from this source will increase from 33 percent in 1982 to 38 percent by 1987... The share of total revenues raised from individual income taxes would decline from 47.5 percent to 45percent. Corporate income taxes under current laws and CBO's baseline economic assumptions are projected, to increase by 46 percent, ... and to maintain its 8 percent relative share of total revenues. Revenues raised from excise taxes and other sources are projected to remain at about the same level during the projection period. As a result, their relative share of total revenues would fall from 11 percent in 1982 to 8 percent in 1987.

How did this all work out? THE CHANGING DISTRIBUTION OF FEDERAL TAXES: A CLOSER LOOK AT 1980 Staff Working Paper July 1988

As reported in the earlier CBO study, total effective tax rates (the ratio of taxes from all four sources to family income) rose between 1977 and 1984 for the 10 percent of families at the lowest end of the distribution and fell for the 10 percent of families at the highest. Overall, the distribution of total federal taxes became less progressive.
Between 1977 and 1980, the total effective tax rate for all four taxes combined declined for the 20 percent of families in the bottom of the income distribution and generally rose for the 50 percent of families in the upper end, except for the 10 percent of families with the highest incomes. Total effective tax rates for other family income classes changed little between 1977 and 1980.

Between 1980 and 1984, the total effective tax rate for all families taken together dropped noticeably, from 23.3 percent in 1980 to 21.7 percent in 1984. The decline was not uniform across all income classes, however. Effective tax rates rose for the 30 percent of families at the lowest end of the income distribution and fell for the 70 percent of families in the upper end, with the size of the reduction increasing with family income. The 10 percent of families at the highest end of the distribution had both the largest percentage and the largest absolute decrease in effective tax rates.

The changes in effective rates under the individual income tax resulted largely from the Economic Recovery Tax Act of 1981 (ERTA). ERTA substantially cut statutory tax rates and increased allowable deductions, but it failed to offset the effect on low-income families of an inflation-induced decline in the real value of personal exemptions, zero bracket amounts (standard deductions), and the earned income credit.

By 1988, the distribution of combined federal taxes is projected to become more progressive than in 1984, but to remain less progressive than in either 1977 or in 1980. Although the combined effective tax rate for all families taken together is expected to drop slightly from 1980 to 1988, total effective federal tax rates are projected to be higher for families in the bottom half of the income distribution and lower for families in the top half. The largest reductions between 1980 and 1988 will be for the 1 percent of families with the highest incomes.

The question I guess is: did they know what they were doing? I suppose it depends on whether you think this results we have been living with since 1981 was intentional or not.


Just to cover the talking points:

The share of taxes paid by the 10 percent of families with the highest incomes rose by between 1.0 and 1.5 percentage points between 1980 and 1988. The increase in the share of taxes paid by this group resulted from a growth of nearly 3 percentage points in their share of pre-tax income between 1980 and 1988, more than offsetting the decline in their effective tax rate.

We changed everything.

A few commenters of my last post suggested that picking at the tax code can create big problems if you don't know what you're talking about. I agree. Why mess with what is working as evident in the data continuously collected and reported concerning the economy. But, in 1981 they did mess with it and in a very big way and it hasn't stopped. As the saying goes “everything changed”. Even under Clinton the share of income to the top 1% rose 6 points.
To recall, my point is that it's not just the rates that are the problem, it's the code.
One comment got me looking further.

Save the Rust Belt
“In general, the attempts by Congress in various bills to limit the deductibility of executive compensation caused the flood of executive stock options, and created a much bigger mess “
From a review by Peat, Marwick, Mitchell & Co.

The Economic Recovery Tax Act of 1981 is the most comprehensive tax reform
since 1954. It affects virtually every financial planning decision. The Act creates a "new” type of stock option known as an "Incentive Stock Option" under which favorable tax treatment will be afforded to the option holder if certain conditions are met. Under current law, employer stock options are not entitled to preferential treatment.
Observations
The incentive stock option will have a significant effect on compensation planning
for all companies, and these rules may be applicable to options already exercised in 1981. Incentive stock option plans will probably become the cornerstone of executive compensation plans involving capital accumulation.

(Within this report are the changes related to the savings and loan mess. Considering today's subprime problems, it is rather instructive as it relates to learning from history. Start on page 39 of the document.)


Thus, it was not the messing around that created stock options as a preferential means of payment. In the 1986 messing around they: eased the rules for exercise of Incentive Stock Option (ISO).

But, how was this 1981 act being portrayed by the CBO? Baseline Budget Projections for Fiscal Years 1983 – 1987 Report February 1982

The CBO baseline economic forecast shows an early end to the current recession and an acceleration of economic growth following the July tax cut.
Baseline revenue projections assume no change in current tax laws,... Under the CBO baseline economic assumptions, revenues are projected to rise from an estimated $631 billion in fiscal year 1982 to $882 billion in 1987. This represents an average growth of 6.9 percent a year, compared with an assumed average growth in nominal GNP of about 10 percent a year for the projection period. As a consequence, revenues as a proportion of GNP are projected to decline from 20.6 percent in 1982 to 17.7 percent in 1987—the smallest ratio since 1965.

Under current tax laws, the greatest growth in revenues will occur in social insurance taxes and contributions... The share of total revenues raised from this source will increase from 33 percent in 1982 to 38 percent by 1987... The share of total revenues raised from individual income taxes would decline from 47.5 percent to 45percent. Corporate income taxes under current laws and CBO's baseline economic assumptions are projected, to increase by 46 percent, ... and to maintain its 8 percent relative share of total revenues. Revenues raised from excise taxes and other sources are projected to remain at about the same level during the projection period. As a result, their relative share of total revenues would fall from 11 percent in 1982 to 8 percent in 1987.

How did this all work out? THE CHANGING DISTRIBUTION OF FEDERAL TAXES: A CLOSER LOOK AT 1980 Staff Working Paper July 1988

As reported in the earlier CBO study, total effective tax rates (the ratio of taxes from all four sources to family income) rose between 1977 and 1984 for the 10 percent of families at the lowest end of the distribution and fell for the 10 percent of families at the highest. Overall, the distribution of total federal taxes became less progressive.
Between 1977 and 1980, the total effective tax rate for all four taxes combined declined for the 20 percent of families in the bottom of the income distribution and generally rose for the 50 percent of families in the upper end, except for the 10 percent of families with the highest incomes. Total effective tax rates for other family income classes changed little between 1977 and 1980.

Between 1980 and 1984, the total effective tax rate for all families taken together dropped noticeably, from 23.3 percent in 1980 to 21.7 percent in 1984. The decline was not uniform across all income classes, however. Effective tax rates rose for the 30 percent of families at the lowest end of the income distribution and fell for the 70 percent of families in the upper end, with the size of the reduction increasing with family income. The 10 percent of families at the highest end of the distribution had both the largest percentage and the largest absolute decrease in effective tax rates.

The changes in effective rates under the individual income tax resulted largely from the Economic Recovery Tax Act of 1981 (ERTA). ERTA substantially cut statutory tax rates and increased allowable deductions, but it failed to offset the effect on low-income families of an inflation-induced decline in the real value of personal exemptions, zero bracket amounts (standard deductions), and the earned income credit.

By 1988, the distribution of combined federal taxes is projected to become more progressive than in 1984, but to remain less progressive than in either 1977 or in 1980. Although the combined effective tax rate for all families taken together is expected to drop slightly from 1980 to 1988, total effective federal tax rates are projected to be higher for families in the bottom half of the income distribution and lower for families in the top half. The largest reductions between 1980 and 1988 will be for the 1 percent of families with the highest incomes.

The question I guess is: did they know what they were doing? I suppose it depends on whether you think this results we have been living with since 1981 was intentional or not.


Just to cover the talking points:

The share of taxes paid by the 10 percent of families with the highest incomes rose by between 1.0 and 1.5 percentage points between 1980 and 1988. The increase in the share of taxes paid by this group resulted from a growth of nearly 3 percentage points in their share of pre-tax income between 1980 and 1988, more than offsetting the decline in their effective tax rate.

We changed everything.

One of my issues with our economy and the shift in share of income has been the tax code. I have consistently stated that something other than the tax rate changed in the code back in 1981 or so when the first change took place. Labor went from being an asset to a liability and thus the rush to reduce all cost related to employees. Messing with the rates won't do it. In fact, during Clinton's term the share of income to the top 1% rose 6 points. It only rose 4 points with Reagan/Bush.

Well I was right...sort of. Bill # H.R.3876:

To amend the Internal Revenue Code of 1986 to limit the deductibility of excessive rates of executive compensation.

10/17/2007--Introduced.

Income Equity Act of 2007 - Amends the Internal Revenue Code to: (1) deny employers a tax deduction for payments of excessive compensation to any employee (i.e., more than 25 times the lowest compensation paid any other employee); and (2) require such employers to file a report on compensation paid to their employees with the Secretary of the Treasury.

This will be put in under

:(a) In General- Section 162 of the Internal Revenue Code of 1986 (relating to deduction for trade or business expenses) is amended by inserting after subsection (h) the following new subsection:

So, back in 1986 when they raised the rates they also allowed the top to shift the income they were paid so that it would be taxed less. Yup that was real "fair" sharing of the Reagan debt.

It's not just about rates and it never has been. It is about definitions, and this makes me wonder what else is not in that tax code that use to be. All this bickering about entitlements, and the transfer of income, and welfare etc, etc, etc is just smoke and mirrors. The truth is we can solve our problems as soon as we go back to (return to the pre 1981 code) making it more profitable for the company to pay the help as oppose to keeping it for them self. And when I say for them self, listen to the big CEO's refer to the company as their company! It also means that any arguments suggesting there is a free market idealism practiced in the labor market are wrong. What is part of determining what a fair wage should be comes from the sections of the tax code that control the definitions of taxable income to whom.

I still believe there were things done in the first change. You can read the reps statement here.

Update: To be clear, the bill linked to here will undo the tax break of 1986 that promoted paying excessive income to the upper company employees. It is a start toward removing the economic royalty of our nation.

One of my issues with our economy and the shift in share of income has been the tax code. I have consistently stated that something other than the tax rate changed in the code back in 1981 or so when the first change took place. Labor went from being an asset to a liability and thus the rush to reduce all cost related to employees. Messing with the rates won't do it. In fact, during Clinton's term the share of income to the top 1% rose 6 points. It only rose 4 points with Reagan/Bush.

Well I was right...sort of. Bill # H.R.3876:

To amend the Internal Revenue Code of 1986 to limit the deductibility of excessive rates of executive compensation.

10/17/2007--Introduced.

Income Equity Act of 2007 - Amends the Internal Revenue Code to: (1) deny employers a tax deduction for payments of excessive compensation to any employee (i.e., more than 25 times the lowest compensation paid any other employee); and (2) require such employers to file a report on compensation paid to their employees with the Secretary of the Treasury.

This will be put in under

:(a) In General- Section 162 of the Internal Revenue Code of 1986 (relating to deduction for trade or business expenses) is amended by inserting after subsection (h) the following new subsection:

So, back in 1986 when they raised the rates they also allowed the top to shift the income they were paid so that it would be taxed less. Yup that was real "fair" sharing of the Reagan debt.

It's not just about rates and it never has been. It is about definitions, and this makes me wonder what else is not in that tax code that use to be. All this bickering about entitlements, and the transfer of income, and welfare etc, etc, etc is just smoke and mirrors. The truth is we can solve our problems as soon as we go back to (return to the pre 1981 code) making it more profitable for the company to pay the help as oppose to keeping it for them self. And when I say for them self, listen to the big CEO's refer to the company as their company! It also means that any arguments suggesting there is a free market idealism practiced in the labor market are wrong. What is part of determining what a fair wage should be comes from the sections of the tax code that control the definitions of taxable income to whom.

I still believe there were things done in the first change. You can read the reps statement here.

Update: To be clear, the bill linked to here will undo the tax break of 1986 that promoted paying excessive income to the upper company employees. It is a start toward removing the economic royalty of our nation.