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The Revenue Limits of Tax and Spend

Saturday, May 22nd, 2010
Whether rates are high or low, evidence shows our tax system won’t collect more than 20% of GDP.
By DAVID RANSON
Wall Street Journal – link to original
May 17, 2020
The Greeks have always been trendsetters for the West. Washington has repudiated two centuries of U.S. fiscal prudence as prescribed by the Founding Fathers in favor of the modern Greek model of debt, dependency, devaluation and default. Prospects for restraining runaway U.S. debt are even poorer than they appear.
U.S. fiscal policy has been going in the wrong direction for a very long time. But this year the U.S. government declined to lay out any plan to balance its budget ever again. Based on President Obama’s fiscal 2011 budget, the Congressional Budget Office (CBO) estimates a deficit that starts at 10.3% of GDP in 2010. It is projected to narrow as the economy recovers but will still be 5.6% in 2020. As a result the net national debt (debt held by the public) will more than double to 90% by 2020 from 40% in 2008. The current Greek deficit is now thought to be 13.6% of a far smaller GDP. Unlike ours, the Greek insolvency is not too large for an international rescue.
As sobering as the U.S. debt estimates are, they are incomplete and optimistic. They do not include deficit spending resulting from the new health-insurance legislation. The revenue numbers rely on increased tax rates beginning next year resulting from the scheduled expiration of the Bush tax cuts. And, as usual, they ignore the unfunded liabilities of social insurance programs, even though these benefits are officially recognized as “mandatory spending” when the time comes to pay them out.
The feds assume a relationship between the economy and tax revenue that is divorced from reality. Six decades of history have established one far-reaching fact that needs to be built into fiscal calculations: Increases in federal tax rates, particularly if targeted at the higher brackets, produce no additional revenue. For politicians this is truly an inconvenient truth.
The nearby chart shows how tax revenue has grown over the past eight decades along with the size of the economy. It illustrates the empirical relationship first introduced on this page 20 years ago by the Hoover Institution’s W. Kurt Hauser—a close proportionality between revenue and GDP since World War II, despite big changes in marginal tax rates in both directions. “Hauser’s Law,” as I call this formula, reveals a kind of capacity ceiling for federal tax receipts at about 19% of GDP.
What’s the origin of this limit beyond which it is impossible to extract any more revenue from tax payers? The tax base is not something that the government can kick around at will. It represents a living economic system that makes its own collective choices. In a tax code of 70,000 pages there are innumerable ways for high-income earners to seek out and use ambiguities and loopholes. The more they are incentivized to make an effort to game the system, the less the federal government will get to collect. That would explain why, as Mr. Hauser has shown, conventional methods of forecasting tax receipts from increases in future tax rates are prone to over-predict revenue.
For budget planning it’s wiser and safer to assume that tax receipts will remain at a historically realistic ratio to GDP no matter how tax rates are manipulated. That leads me to conclude that current projections of federal revenue are, once again, unrealistically high.
Like other empirical “laws,” Hauser’s Law predicts within a range of approximation. Changes in marginal tax rates do not make a perceptible difference to the ratio of revenue to GDP, but recessions do. When GDP falls relative to its potential, tax revenue falls even more. History shows that, in an economy with no “output gap” between GDP and potential GDP, a ratio of federal revenue to GDP of no more than 18.3% would be realistic.
In this form, Hauser’s Law provides a simple basis for testing the validity of any government’s revenue projections. Today, since the economy already suffers from a large output gap that is expected to take many years to close, 18.3% must be a realistic upper limit on the ratio of budget revenues to GDP for years to come. Any major tax increase will reduce GDP and therefore revenues too.
But CBO projections based on the current budget show this ratio reaching 18.3% as early as 2013 and rising to 19.6% in 2020. Such numbers implicitly assume that the U.S. labor market will get back to sustainable “full employment” by 2013 and that GDP will exceed its potential thereafter. Not likely. When the projections are tempered by the constraints of Hauser’s Law, it’s clear that deficit spending will grow faster than the official estimates show.
Mr. Ranson is the head of research at H. C. Wainwright & Co. Economics.
Copyright 2009 Dow Jones & Company, Inc. All Rights Reserved

The Revenue Limits of Tax and SpendWhether rates are high or low, evidence shows our tax system won’t collect more than 20% of GDP.By DAVID RANSONWall Street Journal – link to originalMay 17, 2020
The Greeks have always been trendsetters for the West. Washington has repudiated two centuries of U.S. fiscal prudence as prescribed by the Founding Fathers in favor of the modern Greek model of debt, dependency, devaluation and default. Prospects for restraining runaway U.S. debt are even poorer than they appear.
U.S. fiscal policy has been going in the wrong direction for a very long time. But this year the U.S. government declined to lay out any plan to balance its budget ever again. Based on President Obama’s fiscal 2011 budget, the Congressional Budget Office (CBO) estimates a deficit that starts at 10.3% of GDP in 2010. It is projected to narrow as the economy recovers but will still be 5.6% in 2020. As a result the net national debt (debt held by the public) will more than double to 90% by 2020 from 40% in 2008. The current Greek deficit is now thought to be 13.6% of a far smaller GDP. Unlike ours, the Greek insolvency is not too large for an international rescue.
As sobering as the U.S. debt estimates are, they are incomplete and optimistic. They do not include deficit spending resulting from the new health-insurance legislation. The revenue numbers rely on increased tax rates beginning next year resulting from the scheduled expiration of the Bush tax cuts. And, as usual, they ignore the unfunded liabilities of social insurance programs, even though these benefits are officially recognized as “mandatory spending” when the time comes to pay them out.
The feds assume a relationship between the economy and tax revenue that is divorced from reality. Six decades of history have established one far-reaching fact that needs to be built into fiscal calculations: Increases in federal tax rates, particularly if targeted at the higher brackets, produce no additional revenue. For politicians this is truly an inconvenient truth.

The nearby chart shows how tax revenue has grown over the past eight decades along with the size of the economy. It illustrates the empirical relationship first introduced on this page 20 years ago by the Hoover Institution’s W. Kurt Hauser—a close proportionality between revenue and GDP since World War II, despite big changes in marginal tax rates in both directions. “Hauser’s Law,” as I call this formula, reveals a kind of capacity ceiling for federal tax receipts at about 19% of GDP.
What’s the origin of this limit beyond which it is impossible to extract any more revenue from tax payers? The tax base is not something that the government can kick around at will. It represents a living economic system that makes its own collective choices. In a tax code of 70,000 pages there are innumerable ways for high-income earners to seek out and use ambiguities and loopholes. The more they are incentivized to make an effort to game the system, the less the federal government will get to collect. That would explain why, as Mr. Hauser has shown, conventional methods of forecasting tax receipts from increases in future tax rates are prone to over-predict revenue.
For budget planning it’s wiser and safer to assume that tax receipts will remain at a historically realistic ratio to GDP no matter how tax rates are manipulated. That leads me to conclude that current projections of federal revenue are, once again, unrealistically high.
Like other empirical “laws,” Hauser’s Law predicts within a range of approximation. Changes in marginal tax rates do not make a perceptible difference to the ratio of revenue to GDP, but recessions do. When GDP falls relative to its potential, tax revenue falls even more. History shows that, in an economy with no “output gap” between GDP and potential GDP, a ratio of federal revenue to GDP of no more than 18.3% would be realistic.
In this form, Hauser’s Law provides a simple basis for testing the validity of any government’s revenue projections. Today, since the economy already suffers from a large output gap that is expected to take many years to close, 18.3% must be a realistic upper limit on the ratio of budget revenues to GDP for years to come. Any major tax increase will reduce GDP and therefore revenues too.
But CBO projections based on the current budget show this ratio reaching 18.3% as early as 2013 and rising to 19.6% in 2020. Such numbers implicitly assume that the U.S. labor market will get back to sustainable “full employment” by 2013 and that GDP will exceed its potential thereafter. Not likely. When the projections are tempered by the constraints of Hauser’s Law, it’s clear that deficit spending will grow faster than the official estimates show.
Mr. Ranson is the head of research at H. C. Wainwright & Co. Economics.
Copyright 2009 Dow Jones & Company, Inc. All Rights Reserved

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Greek Wealth Is Everywhere but Tax Forms

Sunday, May 2nd, 2010

By SUZANNE DALEY
Published: May 1, 2010

The New York Times – link to original

Photo:  Signs of wealth abound in Athens, but only a few thousand Greeks out of 11 million declared an income of more than $132,000 last year, according to the Finance Ministry.
Photo:  Athenians declared taxes at a local office. Greek’s shadow economy represents 20 to 30 percent of its G.D.P.
ATHENS — In the wealthy, northern suburbs of this city, where summer temperatures often hit the high 90s, just 324 residents checked the box on their tax returns admitting that they owned pools.
Multimedia
So tax investigators studied satellite photos of the area — a sprawling collection of expensive villas tucked behind tall gates — and came back with a decidedly different number: 16,974 pools.
That kind of wholesale lying about assets, and other eye-popping cases that are surfacing in the news media here, points to the staggering breadth of tax dodging that has long been a way of life here.
Such evasion has played a significant role in Greece’s debt crisis, and as the country struggles to get its financial house in order, it is going after tax cheats as never before.
Various studies, including one by the Federation of Greek Industries last year, have estimated that the government may be losing as much as $30 billion a year to tax evasion — a figure that would have gone a long way to solving its debt problems.
“We need to grow up,” said Ioannis Plakopoulos, who like all owners of newspaper stands will have to give receipts and start using a cash register under the new tax laws passed last month. “We need to learn not to cheat or to let others cheat.”
On the eve of an International Monetary Fund bailout deal that is sure to call for deep sacrifices here, including harsh austerity measures, layoffs and steep tax increases, many Greeks say they feel chastened by the financial crisis that has pushed the country to the edge of bankruptcy.
But even so, changing things will not be easy. Experts point out that ducking taxes is part of a broader culture of bribery and corruption that is deeply entrenched.
Mr. Plakopoulos, who supports most of the government’s new efforts, admits that he and his friends used to chuckle over the best ways to avoid taxes.
To get more attentive care in the country’s national health system, Greeks routinely pay doctors cash on the side, a practice known as “fakelaki,” Greek for little envelope. And bribing government officials to grease the wheels of bureaucracy is so standard that people know the rates. They say, for instance, that 300 euros, about $400, will get you an emission inspection sticker.
Some of the most aggressive tax evaders, experts say, are the self-employed, a huge pool of people in this country of small businesses. It includes not just taxi drivers, restaurant owners and electricians, but engineers, architects, lawyers and doctors.
The cheating is often quite bold. When tax authorities recently surveyed the returns of 150 doctors with offices in the trendy Athens neighborhood of Kolonaki, where Prada and Chanel stores can be found, more than half had claimed an income of less than $40,000. Thirty-four of them claimed less than $13,300, a figure that exempted them from paying any taxes at all.
Such incomes defy belief, said Ilias Plaskovitis, the general secretary of the Finance Ministry, who has been in charge of revamping the country’s tax laws. “You need more than that to pay your rent in that neighborhood,” he said.
He said there were only a few thousand citizens in this country of 11 million who last year declared an income of more than $132,000. Yet signs of wealth abound.
“There are many people with a house, with a cottage in the country, with two cars and maybe a small boat who claim they are earning 12,000 euros a year,” Mr. Plaskovitis said, which is about $15,900. “You cannot heat this house or buy the gas for the car with that kind of income.”
The Greek government has set a goal for itself of collecting at least $1.6 billion more than last year — a modest goal, Mr. Plaskovitis believes. But European Union officials were so skeptical, Mr. Plaskovitis said, they would not even allow the figure to be included in the budget forecast used in negotiations over the bailout package.
“They said, ‘Yes, yes, we have heard that before, but it never happens,’ ” he said.
Over the past decade, Greece actually lost ground in collecting taxes, even as the economy was booming. A 2008 European Union report on Greece tax shortfalls found that between 2000 and 2007, the country’s average growth in nominal gross domestic product was 8.25 percent. Its taxes grew at just 7 percent.
How Greece ended up with this state of affairs is a matter of debate here. Some attribute it to Greece’s long history under Turkish occupation, when Greeks got used to seeing the government as an enemy. Others point out that, classical history aside, Greece is actually a relatively young democracy.
Whatever the reason, Kostas Bakouris, the president of the Greek arm of the anticorruption organization Transparency International, said that Greeks were constantly facing the lure of petty corruption. “If they go to the mechanic, it is one price without a receipt and quite a bit more with it,” Mr. Bakouris said.
He said his own sister had recently told him that she was uncomfortable asking her doctor for a receipt. “I said that’s crazy,” he said. “But still, that feeling is out there.”
Various studies have concluded that Greece’s shadow economy represented 20 to 30 percent of its gross domestic product. Friedrich Schneider, the chairman of the economics department at Johannes Kepler University of Linz, studies Europe’s shadow economies; he said that Greece’s was at 25 percent last year and estimated that it would rise to 25.2 percent in 2010. For comparison, the United States’ was put at 7.8 percent.
The Finance Ministry believes that the new tax laws, which also increased the weight on income and value-added taxes, have laid the legal groundwork for better enforcement. In the past, the tax code gave many categories of workers special status. Entire professions were allowed to file a set income. For instance, newsstand owners could simply claim that they earned an income of 12,000 euros (about $15,900) and no questions were asked.
Now, most of these exceptions have been eliminated and the tax code has been simplified. It also offers various incentives to make people collect receipts — an important step, officials say, in shrinking the off-the-books economy.
In addition, the tax department is being reorganized so that regional offices will have far less autonomy.
Mr. Plaskovitis said that tax collectors had already begun using technology to crosscheck claims and that they had taken steps like asking luxury car dealerships for list of their clients. A lot of Greeks, he said, listed luxury cars as company cars, a practice that would be challenged in the future. “We do not believe you need a Porsche to sell Coca-Cola,” he said.
Soon, Mr. Plaskovitis said, people will see results. “In the coming weeks,” he said, “we are going to be closing down companies, restaurants and doctors’ offices because they have not paid taxes.”
But how fast progress will come is an open question. The changes have provoked protests and deep resentment in some circles. For instance, the president of the union for doctors who work in state hospitals, Stathis Tsoukalos, 60, calls the loss of a special tax status for his doctors wrongheaded and unfair. He contended that the special low tax rate was given to make up for the fact that doctors received very low pay.
Speaking of the doctors in the Kolonaki neighborhood who claimed small incomes, he said, they may have just opened their practices or bought real estate there with help from their parents.
Whether the country’s tax collectors are up to the task is also unclear. Many Greeks say tax collectors have a reputation for being among the easiest officials to bribe. Some say tax troubles are usually solved in a three way split: You pay a third of what you owe to the government, a third to the collector and a third remains in your pocket.
Froso Stavraki, who has been a tax collector for 27 years and is now a high-ranking official in the union, readily concedes that there is some corruption in the ranks. But she contends that the politicians never wanted toughness.
“The orders from above were to do everyday tax processing,” she said. “We were busy going over forms, checking on those who pay taxes, not those who didn’t.”
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No recovery without small business

Sunday, November 22nd, 2009

By Thomas Oliver

The Atlanta Journal-Constitution - link to original

6:19 p.m. Thursday, November 19, 2009

You know things are awful when Washington politicians seem genuinely concerned about small business, rather than simply spouting the usual platitudes toward an amorphous group that typically lacks the political muscle of Wall Street or unions.

Within the last week, head honchos from the Federal Reserve, the Treasury, Goldman Sachs and Warren Buffett himself have expressed concern that small business isn’t responding as needed.

And it is needed.

Small business (defined as 500 or fewer employees) creates 60 to 80 percent of new jobs. So it’s not an exaggeration to suggest that without a healthy, growing small business sector, there will be no recovery.

Yet there is mounting evidence that small business has taken an unusually hard hit this recession.

In looking at data since 1992, Atlanta Fed economist Melinda Pitts wrote: “Firms with less than 50 employees have made up approximately one-third of the nation’s employment growth. During the employment declines associated with the 2001 recession, these firms made up only 9 percent of job losses. In the current recession, though, these very small firms have made up 45 percent of the nation’s job losses.”

Ouch. That’s five times the rate of job losses than in the previous recession, or over 3 million people dropped from payrolls of the smallest firms.

And to make matters worse, the financing needed to reverse that trend and fuel growth just isn’t there.

Treasury reported that the 22 largest banks receiving TARP money had cut $10.5 billion from their small business portfolio.

The Small Business Administration has approved one-third fewer loans this year than last.

Smaller banks, too, have clamped down on lending.

Add the fact that many small businesses are partly financed through their owners’ credit cards and home equity – two major lines of credit that banks have clamped down on — and the picture grows dim.

As if that wasn’t bad enough, Fed officials note a link between smaller banks, which normally supply small businesses their loans, and the commercial real estate crisis that is further curtailing lending.

In a recent speech to the Urban Land Institute’s Emerging Trends in Real Estate Conference in Atlanta, Dennis Lockhart, president of the Atlanta Fed, said banks with the most exposure to commercial real estate are the same banks that lend mostly to small businesses.

Those banks are hunkering down. They aren’t looking to help small business get back on track.

Jimmy Adams, executive vice president of the Atlanta-based Adams Transfer & Storage, said his bank is providing credit for continuing operations but nothing that would be associated with growth.

“Anything beyond the core that even remotely smells of investment, or something for which you don’t have a contract in hand to pay for it, and you aren’t going to get credit,” Adams said.

“We are all on the sidelines,” he added.

Growth does not occur on the sidelines. Nor does it feel like a recovery to those on the sidelines.

It feels fragile.

Like “any bump in the road will put us back in recession,” Adams said.

————

Thomas Oliver writes the Sunday business column. He can be reached at toliver.writeright@gmail.com.

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Washington’s Plans May Result in Even Higher Executive Pay

Saturday, October 24th, 2009
Washington’s Plans May Result in Even Higher Executive Pay
In 1992, Congress intervened in corporate compensation and messed things up. Now it’s the White House’s turn.
By JONATHAN MACEY
Wall Street Journal – link to original
Oct 23, 2009
Executive pay has emerged, once again, as a major issue in Washington. This week Treasury and the Federal Reserve announced new regulations designed to oversee and limit executive pay at thousands of financial institutions. This is deeply ironic, because today’s pay woes are the direct result of prior government intervention.
In 1992, Congress decided it would use the tax code to “improve” (i.e., reduce) executive compensation in publicly traded companies. Its vehicle was the Budget Reconciliation Act, a key provision of which became Section 162(m) of the Internal Revenue Code.
Noting that executive compensation levels had received negative “scrutiny and criticism” from the public, the new law targeted what it called “excessive employee remuneration.” It did so by limiting the ability of public companies to deduct executive compensation for its top employees unless the compensation was paid out in a form that Congress found acceptable. Salary was bad. Stock options were tax favored.
Specifically, corporations were barred by law from deducting as a normal business expense any salary payments of over $1 million. Stock options, however, qualified for the corporate tax deduction without limitation. Much maligned today, stock options then were said to be “performance based” and therefore exempt from the new tax rules.
The new tax law immediately led to a tectonic shift in the way CEOs and other top U.S. executives were paid. Stock and stock options became the dominant feature of executive compensation packages.
The impetus for changing the executive compensation laws back then was exactly the same as it is today. Politicians wanted pay lower and wanted to change the executive compensation model to “fix” the risk-taking proclivities of top managers.
In 1992, the government thought that managers were too risk averse. Stock options were seen as the magic bullet for making managers act more aggressively in the shareholders’ interests. Today, many in Congress are blaming U.S. executives for causing the financial crisis precisely by engaging in “excessive” risk-taking. What they fail to mention is that it was Congress’s own tinkering with the tax code that led to the very compensation packages that incentivized the risk-taking.
Fed Chairman Ben Bernanke asserted this week that “compensation practices at some banking organizations have led to misaligned incentives and excessive risk-taking, contributing to bank losses and financial instability.” Mr. Bernanke promised that the government “is working to ensure that compensation packages appropriately tie rewards to longer-term performance and do not create undue risk for the firm or the financial system.”
Other government interference has made the executive compensation problem even worse. A provision in the 1992 tax law required that executives meet certain “objective” performance measures in order to qualify for incentive-based (tax deductible) pay. In the scramble to come up with objective metrics on which to base executive pay, cottage industry “executive compensation consultants” emerged as the most important architects of executive compensation plans.
The compensation consultants promised to design pay programs that did things like “drive the right behaviors” by corporate management, which meant assuming more risk to maximize shareholder value. Public companies hired droves of consultants to analyze pay schemes and design pay packages that created incentives to maximize share prices. Consultants came to be viewed as essential to boards of directors that wanted to implement appropriate—and tax qualified—performance measures.
The most successful consultants are those who can justify the biggest salary increases for the top executives of the companies that hired them. Researchers at the University of Southern California recently found that the median CEO compensation is $1.5 million in companies not using executive compensation consultants, $3 million in companies that purchase general survey data from such consultants but do not directly retain them, and $4.2 million in companies that retain consultants.
Some companies use multiple consultants. The USC study found that the more consultants a company hires, the more it pays its top executives. About one-quarter of Fortune 250 companies hire multiple compensation consultants.
Activist investor Carl Icahn summed the situation up well when he recently observed on his Web site that “the use of these compensation consultants, gives both boards and CEOs the appearance of legitimacy for their decisions to award massive pay packages to lackluster CEOs, making it appear that these decisions are objective and scientific, which they absolutely are not.”
The government also has tried to regulate executive compensation by requiring greater disclosure of the details of compensation plans. Perversely, this too has contributed to an increase in executive pay.
How so? No self-respecting board of directors is willing to admit that their company’s CEO is below average. So anytime the new disclosures indicate that an executive’s pay is below average in any way, a pay increase is ordered.
Since the early 1990s, government regulation of executive compensation has encouraged greater share-price volatility and risk-taking by U.S. corporate executives and led directly to higher, rather than lower, levels of executive compensation. Nevertheless, the Obama administration is now seeking an even greater role in overseeing and regulating executive pay.
In June, Gene Sperling, a top aid to Treasury Secretary Tim Geithner, told the House Committee on Financial Services that “our goal is to help ensure that there is a much closer alignment between compensation, sound risk management and long-term value creation for firms and the economy as a whole.”
This is just what the regulators told us back in 1992. Current proposals will no doubt result in even higher percentages of executive compensation coming from stock and option schemes rather than from salaries. History teaches that the most profound consequences of new compensation regulation will be unintended. It also teaches that as bad as private ordering may have worked in getting executive compensation right, the results of central planning have been even worse.
Mr. Macey is a law professor at Yale and a member of the Task Force on Property Rights at Stanford University’s Hoover Institution.

In 1992, Congress intervened in corporate compensation and messed things up. Now it’s the White House’s turn.

By JONATHAN MACEY

Wall Street Journal – link to original

Oct 23, 2009

Executive pay has emerged, once again, as a major issue in Washington. This week Treasury and the Federal Reserve announced new regulations designed to oversee and limit executive pay at thousands of financial institutions. This is deeply ironic, because today’s pay woes are the direct result of prior government intervention.

In 1992, Congress decided it would use the tax code to “improve” (i.e., reduce) executive compensation in publicly traded companies. Its vehicle was the Budget Reconciliation Act, a key provision of which became Section 162(m) of the Internal Revenue Code.

Noting that executive compensation levels had received negative “scrutiny and criticism” from the public, the new law targeted what it called “excessive employee remuneration.” It did so by limiting the ability of public companies to deduct executive compensation for its top employees unless the compensation was paid out in a form that Congress found acceptable. Salary was bad. Stock options were tax favored.

Specifically, corporations were barred by law from deducting as a normal business expense any salary payments of over $1 million. Stock options, however, qualified for the corporate tax deduction without limitation. Much maligned today, stock options then were said to be “performance based” and therefore exempt from the new tax rules.

The new tax law immediately led to a tectonic shift in the way CEOs and other top U.S. executives were paid. Stock and stock options became the dominant feature of executive compensation packages.

The impetus for changing the executive compensation laws back then was exactly the same as it is today. Politicians wanted pay lower and wanted to change the executive compensation model to “fix” the risk-taking proclivities of top managers.

In 1992, the government thought that managers were too risk averse. Stock options were seen as the magic bullet for making managers act more aggressively in the shareholders’ interests. Today, many in Congress are blaming U.S. executives for causing the financial crisis precisely by engaging in “excessive” risk-taking. What they fail to mention is that it was Congress’s own tinkering with the tax code that led to the very compensation packages that incentivized the risk-taking.

Fed Chairman Ben Bernanke asserted this week that “compensation practices at some banking organizations have led to misaligned incentives and excessive risk-taking, contributing to bank losses and financial instability.” Mr. Bernanke promised that the government “is working to ensure that compensation packages appropriately tie rewards to longer-term performance and do not create undue risk for the firm or the financial system.”

Other government interference has made the executive compensation problem even worse. A provision in the 1992 tax law required that executives meet certain “objective” performance measures in order to qualify for incentive-based (tax deductible) pay. In the scramble to come up with objective metrics on which to base executive pay, cottage industry “executive compensation consultants” emerged as the most important architects of executive compensation plans.

The compensation consultants promised to design pay programs that did things like “drive the right behaviors” by corporate management, which meant assuming more risk to maximize shareholder value. Public companies hired droves of consultants to analyze pay schemes and design pay packages that created incentives to maximize share prices. Consultants came to be viewed as essential to boards of directors that wanted to implement appropriate—and tax qualified—performance measures.

The most successful consultants are those who can justify the biggest salary increases for the top executives of the companies that hired them. Researchers at the University of Southern California recently found that the median CEO compensation is $1.5 million in companies not using executive compensation consultants, $3 million in companies that purchase general survey data from such consultants but do not directly retain them, and $4.2 million in companies that retain consultants.

Some companies use multiple consultants. The USC study found that the more consultants a company hires, the more it pays its top executives. About one-quarter of Fortune 250 companies hire multiple compensation consultants.

Activist investor Carl Icahn summed the situation up well when he recently observed on his Web site that “the use of these compensation consultants, gives both boards and CEOs the appearance of legitimacy for their decisions to award massive pay packages to lackluster CEOs, making it appear that these decisions are objective and scientific, which they absolutely are not.”

The government also has tried to regulate executive compensation by requiring greater disclosure of the details of compensation plans. Perversely, this too has contributed to an increase in executive pay.

How so? No self-respecting board of directors is willing to admit that their company’s CEO is below average. So anytime the new disclosures indicate that an executive’s pay is below average in any way, a pay increase is ordered.

Since the early 1990s, government regulation of executive compensation has encouraged greater share-price volatility and risk-taking by U.S. corporate executives and led directly to higher, rather than lower, levels of executive compensation. Nevertheless, the Obama administration is now seeking an even greater role in overseeing and regulating executive pay.

In June, Gene Sperling, a top aid to Treasury Secretary Tim Geithner, told the House Committee on Financial Services that “our goal is to help ensure that there is a much closer alignment between compensation, sound risk management and long-term value creation for firms and the economy as a whole.”

This is just what the regulators told us back in 1992. Current proposals will no doubt result in even higher percentages of executive compensation coming from stock and option schemes rather than from salaries. History teaches that the most profound consequences of new compensation regulation will be unintended. It also teaches that as bad as private ordering may have worked in getting executive compensation right, the results of central planning have been even worse.

Mr. Macey is a law professor at Yale and a member of the Task Force on Property Rights at Stanford University’s Hoover Institution.

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Taxes, Depression, and Our Current Troubles

Friday, September 25th, 2009
Taxes, Depression, and Our Current Troubles
Tariffs, rising state and federal taxes, and currency devaluation ruined the 1930s, and they could do the same today.
By ARTHUR B. LAFFER
Wall Street Journal – SEPTEMBER 22, 2009 – link to original
The 1930s has become the sole object lesson for today’s monetary policy. Over the past 12 months, the Federal Reserve has increased the monetary base (bank reserves plus currency in circulation) by well over 100%. While currency in circulation has grown slightly, there’s been an impressive 17-fold increase in bank reserves. The federal-funds target rate now stands at an all-time low range of zero to 25 basis points, with the 91-day Treasury bill yield equally low. All this has been done to avoid a liquidity crisis and a repeat of the mistakes that led to the Great Depression.
Even with this huge increase in the monetary base, Fed Chairman Ben Bernanke has reiterated his goal not to repeat the mistakes made back in the 1930s by tightening credit too soon, which he says would send the economy back into recession. The strong correlation between soaring unemployment and falling consumer prices in the early 1930s leads Mr. Bernanke to conclude that tight money caused both. To prevent a double dip, super easy monetary policy is the key.
While Fed policy was undoubtedly important, it was not the primary cause of the Great Depression or the economy’s relapse in 1937. The Smoot-Hawley tariff of June 1930 was the catalyst that got the whole process going. It was the largest single increase in taxes on trade during peacetime and precipitated massive retaliation by foreign governments on U.S. products. Huge federal and state tax increases in 1932 followed the initial decline in the economy thus doubling down on the impact of Smoot-Hawley. There were additional large tax increases in 1936 and 1937 that were the proximate cause of the economy’s relapse in 1937.
In 1930-31, during the Hoover administration and in the midst of an economic collapse, there was a very slight increase in tax rates on personal income at both the lowest and highest brackets. The corporate tax rate was also slightly increased to 12% from 11%. But beginning in 1932 the lowest personal income tax rate was raised to 4% from less than one-half of 1% while the highest rate was raised to 63% from 25%. (That’s not a misprint!) The corporate rate was raised to 13.75% from 12%. All sorts of Federal excise taxes too numerous to list were raised as well. The highest inheritance tax rate was also raised in 1932 to 45% from 20% and the gift tax was reinstituted with the highest rate set at 33.5%.
But the tax hikes didn’t stop there. In 1934, during the Roosevelt administration, the highest estate tax rate was raised to 60% from 45% and raised again to 70% in 1935. The highest gift tax rate was raised to 45% in 1934 from 33.5% in 1933 and raised again to 52.5% in 1935. The highest corporate tax rate was raised to 15% in 1936 with a surtax on undistributed profits up to 27%. In 1936 the highest personal income tax rate was raised yet again to 79% from 63%—a stifling 216% increase in four years. Finally, in 1937 a 1% employer and a 1% employee tax was placed on all wages up to $3,000.
Because of the number of states and their diversity I’m going to aggregate all state and local taxes and express them as a percentage of GDP. This measure of state tax policy truly understates the state and local tax contribution to the tragedy we call the Great Depression, but I’m sure the reader will get the picture. In 1929, state and local taxes were 7.2% of GDP and then rose to 8.5%, 9.7% and 12.3% for the years 1930, ‘31 and ‘32 respectively.
The damage caused by high taxation during the Great Depression is the real lesson we should learn. A government simply cannot tax a country into prosperity. If there were one warning I’d give to all who will listen, it is that U.S. federal and state tax policies are on an economic crash trajectory today just as they were in the 1930s. Net legislated state-tax increases as a percentage of previous year tax receipts are at 3.1%, their highest level since 1991; the Bush tax cuts are set to expire in 2011; and additional taxes to pay for health-care and the proposed cap-and-trade scheme are on the horizon.
In addition to all of these tax issues, the U.S. in the early 1930s was on a gold standard where paper currency was legally convertible into gold. Both circulated in the economy as money. At the outset of the Great Depression people distrusted banks but trusted paper currency and gold. They withdrew deposits from banks, which because of a fractional reserve system caused a drop in the money supply in spite of a rising monetary base. The Fed really had little power to control either bank reserves or interest rates.
The increase in the demand for paper currency and gold not only had a quantity effect on the money supply but it also put upward pressure on the price of gold, which meant that dollar prices of all goods and services had to fall for the relative price of gold to rise. The deflation of the early 1930s was not caused by tight money. It was the result of panic purchases of fixed-dollar priced gold. From the end of 1929 until early 1933 the Consumer Price Index fell by 27%.
By mid-1932 there were public fears of a change in the gold-dollar relationship. In their classic text, “A Monetary History of the United States,” economists Milton Friedman and Anna Schwartz wrote, “Fears of devaluation were widespread and the public’s preference for gold was unmistakable.” Panic ensued and there was a rush to buy gold.
In early 1933, the federal government (not the Federal Reserve) declared a bank holiday prohibiting banks from paying out gold or dealing in foreign exchange. An executive order made it illegal for anyone to “hoard” gold and forced everyone to turn in their gold and gold certificates to the government at an exchange value of $20.67 per ounce of gold in return for paper currency and bank deposits. All gold clauses in contracts private and public were declared null and void and by the end of January 1934 the price of gold, most of which had been confiscated by the government, was raised to $35 per ounce. In other words, in less than one year the government confiscated as much gold as it could at $20.67 an ounce and then devalued the dollar in terms of gold by almost 60%. That’s one helluva tax.
The 1933-34 devaluation of the dollar caused the money supply to grow by over 60% from April 1933 to March 1937, and over that same period the monetary base grew by over 35% and adjusted reserves grew by about 100%. Monetary policy was about as easy as it could get. The consumer price index from early 1933 through mid-1937 rose by about 15% in spite of double-digit unemployment. And that’s the story.
The lessons here are pretty straightforward. Inflation can and did occur during a depression, and that inflation was strictly a monetary phenomenon.
My hope is that the people who are running our economy do look to the Great Depression as an object lesson. My fear is that they will misinterpret the evidence and attribute high unemployment and the initial decline in prices to tight money, while increasing taxes to combat budget deficits.
Mr. Laffer is the chairman of Laffer Associates and co-author of “The End of Prosperity: How Higher Taxes Will Doom the Economy—If We Let It Happen” (Threshold, 2008).Tariffs, rising state and federal taxes, and currency devaluation ruined the 1930s, and they could do the same today.Tariffs, rising state and federal taxes, and currency devaluation ruined the 1930s, and they could do the same today.

Tariffs, rising state and federal taxes, and currency devaluation ruined the 1930s, and they could do the same today.

By ARTHUR B. LAFFER

Wall Street Journal – SEPTEMBER 22, 2009 – link to original

The 1930s has become the sole object lesson for today’s monetary policy. Over the past 12 months, the Federal Reserve has increased the monetary base (bank reserves plus currency in circulation) by well over 100%. While currency in circulation has grown slightly, there’s been an impressive 17-fold increase in bank reserves. The federal-funds target rate now stands at an all-time low range of zero to 25 basis points, with the 91-day Treasury bill yield equally low. All this has been done to avoid a liquidity crisis and a repeat of the mistakes that led to the Great Depression.

Even with this huge increase in the monetary base, Fed Chairman Ben Bernanke has reiterated his goal not to repeat the mistakes made back in the 1930s by tightening credit too soon, which he says would send the economy back into recession. The strong correlation between soaring unemployment and falling consumer prices in the early 1930s leads Mr. Bernanke to conclude that tight money caused both. To prevent a double dip, super easy monetary policy is the key.

While Fed policy was undoubtedly important, it was not the primary cause of the Great Depression or the economy’s relapse in 1937. The Smoot-Hawley tariff of June 1930 was the catalyst that got the whole process going. It was the largest single increase in taxes on trade during peacetime and precipitated massive retaliation by foreign governments on U.S. products. Huge federal and state tax increases in 1932 followed the initial decline in the economy thus doubling down on the impact of Smoot-Hawley. There were additional large tax increases in 1936 and 1937 that were the proximate cause of the economy’s relapse in 1937.

In 1930-31, during the Hoover administration and in the midst of an economic collapse, there was a very slight increase in tax rates on personal income at both the lowest and highest brackets. The corporate tax rate was also slightly increased to 12% from 11%. But beginning in 1932 the lowest personal income tax rate was raised to 4% from less than one-half of 1% while the highest rate was raised to 63% from 25%. (That’s not a misprint!) The corporate rate was raised to 13.75% from 12%. All sorts of Federal excise taxes too numerous to list were raised as well. The highest inheritance tax rate was also raised in 1932 to 45% from 20% and the gift tax was reinstituted with the highest rate set at 33.5%.

But the tax hikes didn’t stop there. In 1934, during the Roosevelt administration, the highest estate tax rate was raised to 60% from 45% and raised again to 70% in 1935. The highest gift tax rate was raised to 45% in 1934 from 33.5% in 1933 and raised again to 52.5% in 1935. The highest corporate tax rate was raised to 15% in 1936 with a surtax on undistributed profits up to 27%. In 1936 the highest personal income tax rate was raised yet again to 79% from 63%—a stifling 216% increase in four years. Finally, in 1937 a 1% employer and a 1% employee tax was placed on all wages up to $3,000.

Because of the number of states and their diversity I’m going to aggregate all state and local taxes and express them as a percentage of GDP. This measure of state tax policy truly understates the state and local tax contribution to the tragedy we call the Great Depression, but I’m sure the reader will get the picture. In 1929, state and local taxes were 7.2% of GDP and then rose to 8.5%, 9.7% and 12.3% for the years 1930, ‘31 and ‘32 respectively.

The damage caused by high taxation during the Great Depression is the real lesson we should learn. A government simply cannot tax a country into prosperity. If there were one warning I’d give to all who will listen, it is that U.S. federal and state tax policies are on an economic crash trajectory today just as they were in the 1930s. Net legislated state-tax increases as a percentage of previous year tax receipts are at 3.1%, their highest level since 1991; the Bush tax cuts are set to expire in 2011; and additional taxes to pay for health-care and the proposed cap-and-trade scheme are on the horizon.

In addition to all of these tax issues, the U.S. in the early 1930s was on a gold standard where paper currency was legally convertible into gold. Both circulated in the economy as money. At the outset of the Great Depression people distrusted banks but trusted paper currency and gold. They withdrew deposits from banks, which because of a fractional reserve system caused a drop in the money supply in spite of a rising monetary base. The Fed really had little power to control either bank reserves or interest rates.

The increase in the demand for paper currency and gold not only had a quantity effect on the money supply but it also put upward pressure on the price of gold, which meant that dollar prices of all goods and services had to fall for the relative price of gold to rise. The deflation of the early 1930s was not caused by tight money. It was the result of panic purchases of fixed-dollar priced gold. From the end of 1929 until early 1933 the Consumer Price Index fell by 27%.

By mid-1932 there were public fears of a change in the gold-dollar relationship. In their classic text, “A Monetary History of the United States,” economists Milton Friedman and Anna Schwartz wrote, “Fears of devaluation were widespread and the public’s preference for gold was unmistakable.” Panic ensued and there was a rush to buy gold.

In early 1933, the federal government (not the Federal Reserve) declared a bank holiday prohibiting banks from paying out gold or dealing in foreign exchange. An executive order made it illegal for anyone to “hoard” gold and forced everyone to turn in their gold and gold certificates to the government at an exchange value of $20.67 per ounce of gold in return for paper currency and bank deposits. All gold clauses in contracts private and public were declared null and void and by the end of January 1934 the price of gold, most of which had been confiscated by the government, was raised to $35 per ounce. In other words, in less than one year the government confiscated as much gold as it could at $20.67 an ounce and then devalued the dollar in terms of gold by almost 60%. That’s one helluva tax.

The 1933-34 devaluation of the dollar caused the money supply to grow by over 60% from April 1933 to March 1937, and over that same period the monetary base grew by over 35% and adjusted reserves grew by about 100%. Monetary policy was about as easy as it could get. The consumer price index from early 1933 through mid-1937 rose by about 15% in spite of double-digit unemployment. And that’s the story.

The lessons here are pretty straightforward. Inflation can and did occur during a depression, and that inflation was strictly a monetary phenomenon.

My hope is that the people who are running our economy do look to the Great Depression as an object lesson. My fear is that they will misinterpret the evidence and attribute high unemployment and the initial decline in prices to tight money, while increasing taxes to combat budget deficits.

Mr. Laffer is the chairman of Laffer Associates and co-author of “The End of Prosperity: How Higher Taxes Will Doom the Economy—If We Let It Happen” (Threshold, 2008).

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On soaking the rich

Sunday, September 6th, 2009

by Jeff Jacoby

The Boston Globe – link to original

September 2, 2009

 

IN APRIL, the British government decided to recoup revenues lost in the current recession by raising the country’s top income tax rate from 40 percent to 50 percent. That decision turned out to be a body blow to England’s Premier League, the professional soccer association that includes such storied teams as Manchester United and Arsenal.

As Jonathan V. Last recounts in The Weekly Standard, the hike in the tax rate has led top soccer stars to decline lucrative offers to join or remain with England’s most celebrated teams. Christiano Ronaldo, Jermaine Pennant, Karim Benzema, and David Villa are among the illustrious players who have spurned the Premier League in order to play in Spain. Why Spain? Because under Spanish tax law, they qualify as “foreign executives,” a status that caps their income tax rate at just 24 percent. The tax differential “has become an almost insurmountable advantage for Spanish soccer teams,” Last writes, which is why Britain’s domination of European soccer is coming to an end.

 

High taxes can have unwelcome, and unintended, consequences.

Governments delude themselves when they imagine they can easily raise all the money they want by soaking the rich. The rich always have other options. When taxes grow too onerous, high earners can adjust their economic behavior. Some move to Spain to play soccer for La Liga. Others, less glamorously, cut back on their investments, forgo new business opportunities, seek out tax havens, or work fewer hours. The impact is felt not only in lower-than-expected tax revenues, but in lower rates of growth, productivity, and — since jobs are disproportionately created by those who have money — job-creation. “You can’t have employment and despise employers,” Massachusetts Senator Paul Tsongas used to say. “No goose, no golden eggs.”

But that isn’t the prevailing attitude today in Washington, where the Obama administration and congressional Democrats are playing soak-the-rich with a vengeance.

President Obama, who said last year that he would use the presidency to “spread the wealth around,” is seeking to raise the top marginal income tax rate from 35 percent to 39.6 percent, and to collect even more tax revenue by limiting the deductions high earners can take for mortgage interest and charitable contributions. The Democratic health-care bill taking shape on Capitol Hill, meanwhile, calls for even steeper taxes on the well-to-do. To help finance their trillion-dollar health-insurance overhaul, House Democrats are proposing an income surtax on US households earning more than $350,000 a year – a surtax that would boost the top federal rate to 45 percent, higher than it has been in more than 20 years.

The administration justifies such drastic tax increases with class-war rhetoric that is startling in its severity.

“While middle-class families have been playing by the rules, living up to their responsibilities as neighbors and citizens, those at the commanding heights of our economy have not,” charges Obama’s 2010 budget. “Too many cut corners as they racked up record profits and paid themselves millions of dollars in compensation and bonuses. There’s nothing wrong with making money, but there is something wrong when we allow the playing field to be tilted so far in the favor of so few.” Accordingly it vows “to restore a basic sense of fairness to the tax code” and to ensure “that the wealthiest pay more.”

The belief that the tax code is skewed to benefit the rich is one that many Americans share. When pollsters ask whether high-income people are paying too much, too little, or their fair share in federal taxes, 60 percent or more of respondents routinely answer: too little.

But the data tell a different story.

By any reasonable standard the rich pay far more than their fair share. According to the latest (2007) IRS data, the top 1 percent of US taxpayers earn 22.8 percent of adjusted gross income but pay 40.4 percent of all federal income taxes. By contrast, the bottom 95 percent of taxpayers, who earn 62.5 percent of the income, pay just 39.4 percent of the income tax burden. That bears repeating: The income tax burden of the top 1 percent, who comprise just 1.4 million taxpayers, now exceeds that of the bottom 134 million combined.

While envy and economic resentment make a potent political brew, the hangover it leaves can be fierce. Democrats should resist the clamor to soak the rich. Better instead to remember Paul Tsongas’s admonition: “No goose, no golden eggs.”

(Jeff Jacoby is a columnist for The Boston Globe. To follow him on Twitter, click here.)

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Overtaxed homeowners will hit the road

Wednesday, September 2nd, 2009

Letters to the Editor - link to original

The Miami Herald – Sept 2, 2009

Tell us it was a misprint or perhaps a belated April Fool’s joke. In a recent Home & Design’s How Does Your Home Compare, the real-estate taxes on a home in El Portal that sold for $232,500 were listed at $11,866. Another home in North Miami sold for $595,000 with taxes at $21,264. But a home in Bal Harbour, which sold for $1.3 million, had taxes of $7,668. Bal Harbour gets, by far, superior services and schools than El Portal and North Miami, so why are the taxes so drastically different?

Two of the homes had no previous sales listed, so the argument that the homes were taxed based on previous sale prices cannot apply. In another recent How Does Your Home Compare a home in South Miami that sold for about $300,000 listed taxes of more than $11,000 a year. These taxes are a mortgage payment by themselves, particularly when considering the lousy pay scales in Miami-Dade County.

These exuberant taxes go to districts with low-rated schools, cities with poor services and a county that pays low-ranking administrators the kind of salaries deserving teachers can only dream of.

It is this outrageous and immoral taxation and cost of insurance that are driving the middle class out of South Florida. If this doesn’t change there will soon be long lines of cars on 1-95 heading north for good.

RAYMOND FIGUEROA, Biscayne Park

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‘Kennedy’ once meant ‘tax-cutter’

Tuesday, September 1st, 2009

by Jeff Jacoby

The Boston Globe - link to original

August 30, 2009

“It is a paradoxical truth,” he once told the Economic Club of New York, “that tax rates are too high today and tax revenues are too low and the soundest way to raise the revenues in the long run is to cut the rates now.” What he had in mind, he said, was not “a ‘quickie’ or a temporary tax cut.” He wanted nothing less than “an across-the-board, top-to-bottom cut in personal and corporate income taxes.”

Those were not the words of Senator Edward Kennedy. The speaker – in December 1962 — was President John F. Kennedy, and his ringing call for tax cuts was no anomaly.

 

In a televised address from the Oval Office four months earlier, JFK had called high tax rates a danger to “the very essence of the progress of a free society: the incentive of additional return for additional effort.” In his 1963 State of the Union message, he said his first priority was “the enactment this year of a substantial reduction and revision in federal income taxes.” In the speech he was scheduled to deliver to the Texas Democratic State Committee on Nov. 22, 1963, Kennedy planned to report proudly: “We have proposed a massive tax reduction, with particular benefits for small business.”

In recent days, Ted Kennedy has been justly acclaimed as a lion of the Democratic Party. But how different the party mourning Kennedy today is from the one that first nominated him in 1962!

The reversal on taxes is one vivid example. When Ted Kennedy entered the Senate in 1963, JFK was leading a campaign for sweeping tax relief that would eventually slash the top marginal rate by a huge 21 percentage points, from 91 to 70. But Democrats have long since become the party that resists lower taxes. In our era, it has been Republicans like Ronald Reagan and George W. Bush who have championed JFK-style rate cuts — cuts that Democrats now condemn as “tax breaks for the wealthy.”

On civil rights, too, there has been a sea change.

Liberal Democrats in the 1960s upheld the colorblind ideal — the conviction that Americans should be judged not by the color of their skin, but by the content of their character. Far from supporting racial quotas and preferences, civil-rights Democrats of that generation flatly rejected them. Senator Hubert Humphrey famously vowed that if anyone could find anything in the 1964 Civil Rights Bill that would compel employers to hire on the basis of race or national origin, “I will start eating the pages one after another, because it is not in there.” In a 1963 press conference, President Kennedy explicitly opposed racial preferences: “We are too mixed, this society of ours, to begin to divide ourselves on the basis of race or color.”

But in the years that followed, as such preferences became entrenched in hiring and education, liberal Democrats became their doughtiest supporters. Senator Kennedy was “a leader in congressional efforts to preserve federal affirmative action,” his Senate website notes. When the Supreme Court ruled against the racial classification of schoolchildren in a 2007 case — “The way to stop discrimination on the basis of race is to stop discriminating on the basis of race,” the court frankly advised — Kennedy blasted the decision as one that “turns back the clock on equality.”

Especially dramatic has been the Democratic Party’s metamorphosis on foreign affairs.

“There are some who say that communism is the wave of the future: Let them come to Berlin,” declared President Kennedy, a staunch Cold Warrior, in his great Berlin Wall speech in 1963. “There are some who say, in Europe and elsewhere, we can work with the Communists: Let them come to Berlin.” But by 1987, when another American president journeyed to Berlin to challenge Moscow to “tear down this wall,” such muscular anti-Communism had all but vanished from Democratic Party thinking.

JFK likewise spoke for mainstream Democrats when he asserted that America would “pay any price, bear any burden” to spread freedom and democracy in the world. He was a hawk who pressed for higher defense spending and American military superiority. The Democratic Party of more recent years — the party of “come home, America” and a nuclear freeze — was one he wouldn’t have recognized.

All political parties alter over time, of course. Today’s Republican Party is not a carbon-copy of Eisenhower’s: It is more internationalist, more religious, more Southern. But a resurrected Eisenhower would still recognize the GOP, and still command its esteem.

The Democrats’ transformation has been much more profound. Over the course of Ted Kennedy’s long Senate career, his party’s ideological center shifted hard to the left. It goes without saying that a JFK today could never be the Democrats’ candidate for president. The question is, would he still be a Democrat?

(Jeff Jacoby is a columnist for The Boston Globe. To follow him on Twitter, click here.)

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