Ted Rall consumed by economic illiteracy
UPDATE: I don’t know how this happens but I actually just sat in one spot for 3 hours and hammered out nearly 3 thousand words on tax policy. I’d love feedback on this but I’m curious if anyone will have the temerity to read it.
Ted Rall has a unique reputation as an idiot amongst the blogosphere, and he hasn’t been doing himself any favors since gaining it. Those who follow my del.icio.us links in the right column of this blog will have seen a few links to information about the FairTax proposal for a nationwide consumption tax in America as a replacement for income tax. I’ve had consumption taxes on the brain for over a year since reading about a progressive consumption tax proposal in the center-liberal Atlantic Monthly, and I actually first encountered a similar proposal in Frank Zappa’s autobiography (a fantastic book) which I read in high school. I’m still humbled by the scope of such a change. It’s hard to get ones head around the implications of such a major shift in taxation.
Most economists tend to agree on many of the benefits of such a move. The closing of loopholes and creation of a fair playing field for entrepreneurs is a massive gain, the beneficial results of which can be heard to quantify, the reduction of moral hazard is clear. Similarly, the inevitable increase in personal savings and more competitive tax environment for business are also no-brainers, providing solid regulators for the trade deficit, consumer debt burden, and capital flight. The incredible savings in productivity from a drastically simplified tax code boggle the mind. Increasing the tax base to cover purchases made with illegally (and therefore untaxed) income is another enormous benefit.
It’s no wonder Alan Greenspan recently opined that if the tax system were being redesigned today it would make sense to start with a consumption tax. The benefits seemingly so stark, and the objections so deftly handled.
But what of the particulars. A consumption tax can be regressive, or not, it depends on how it is setup, what sort of rebates are offered, and how the tax is collected. Currently there is a serious debate about what proportion of taxation should be collected from investment income vs. wage income. Many economists argue that punishing investment with high or double taxation (taxing both corporate profits and dividends) moves capital out of equity markets where it does the most good towards increasing national productivity (which after all is the only thing that increases national prosperity). It’s a compelling argument. Economic populists like John Edwards argue that hard work is an important American value, and that Americans should be encouraged to work by being punished less than investors (although investing is hardly easy work itself!). Edwards also notes that the America which works is larger than the America which simply works its money. Rewarding this group can help maintain a strong middle class which should benefit the long term prospects for the country.
This all gets far more complex though, when you consider the growing percentage of Americans who hold equities, “58 percent of adult Americans now hold some stock either directly or indirectly, up from 44 percent in 1997 and 32 percent in 1987″ (ref).
Throw in some personal savings accounts as a result of partial social security privatization (at what rate of participation? at what rate of income?) and the whole picture becomes even more uncertain. The broader trends seem to favor encouraging investment, but exactly what sort of results one might expect are definitely hard to ascertain. It’s the sort of complex issue that really can’t be boiled down to simplistic sloganeering, though the danger of debate around such an issue degrading into such is great since, unlike me, a lot of people aren’t turned on by such economic discussion. I would love to read some hard hitting independent analysis of various consumption tax proposals. Enter Ted Rall.
Rall typifies the worst aspects of extremist journalism. He doesn’t reference any actual proposals for a consumption tax, a few of which are quite well developed, researched, and nuanced, but instead imagines the most personally distasteful version he can and then proceeds to attack it on the basis of partisanship and ad hominem attacks. He does give a conservative (dictionary definition) defense of the development of income tax, basically opining, why try to fix a system that has made America a super-power? And clearly he falls on the side of the debate that believes the broad benefits of encouraging greater investment are overshadowed by potential income disparities.
All this is fine, and if he had shown a little more intellectual honesty in examining how consumption tax proponents would handle some of these concerns the article would only be middling. As it is Rall does leftists a disservice by confirming the stereotype that they haven’t got a clue when it comes to basic economic principles.
There are, if you open your mind, other options. For example, a six percent tax on purchases of stocks, bonds and other securities would allow the complete elimination of individual income taxes: no more 1040s, no more H&R Block. Even the rich wouldn’t have to pay. (Here’s the math: in 2004 the feds collected $809 billion in individual income taxes. Transactions on the New York Stock Exchange alone totaled $12.6 trillion.) Investors wouldn’t come out ahead until the value of their securities increased by at least six percent, but that’s also true about real estate. The standard six percent broker’s fee doesn’t seem to hurt the housing market.
Where to start on this one? You don’t have to have taken economics 101, or even read a single article written by a real economist to understand that transactions on the New York Stock Exchange would not be anywhere near $12.6 trillion if you imposed a 0.5% penalty on them let alone a 6% one. You would reduce financial transactions to a mere fraction of their current levels.
We have historical examples of what even marginal changes to the cost of trading can do to volumes. Up until regulatory reform in 1975 the SEC mandated minimal per share commissions. There are other factors coinciding with this, including technological advances that dramatically reduced the cost per trade. Regardless of the factors involved the average turnover rate of equities in the NYSE exploded past its range of 12-24% in the sixties and the early seventies gradually increasing to its zenith of 105% in 2002. The turnover rate last year was 99%. This increase corresponded with increased opportunities for small retail investors to enter the market and increase their personal wealth, which further increases liquidity, reducing overall transactional costs, and opening opportunities for more and more people in a virtuous cycle. The transaction costs of equity trades today are virtually nil for someone with a modicum of experience.
As high as average transaction costs once were (and I’d love for a loyal reader to find this data), one assumes that they never approached 6%. Rall’s contention that a 6% brokers fee on house purchases is comparable to stock purchases is particularly incredulous. The reality is that stocks are rarely held for 30 years, while it’s pretty normal for a house to be.
One assumes that Rall is proposing that people simply hold onto equities for a longer period of time and restrict turnover rates. There are a number of reasons why this is a particularly maniacal suggestion. Unfairly taxing and discouraging those investing closer to retirement is simply stupid and would only worsen whatever potential crisis we face with an aging population. Discouraging small investors from entering the market is patently undemocratic and hugely regressive–not simply in applying one rate to all investors but in the lost opportunity costs that would be inflicted upon small investors who would not participate in the market. Larger institutions would be the ones most likely to be able to manage the costs of these transactions since they essentially lack a risk horizon which can force liquidation at innopportune times; natural human beings can’t escape this (given limited life span). It doesn’t have to be said given all this, but a sudden dramatic reduction in liquidity in the stock market would sink the world into a global depression.
I could go on and on (I’m not even going to try out the credible liberal arguments against limiting the tax base so drastically). Rall goes from simply disagreeing with a good deal of economists to completely disregarding the whole body of economic knowledge developed over the last several hundred years. Not just that, but he tosses common sense and consistent thought out the window when he implies that people should spread out transactions as they do with real estate, he tacitly admits that the turnover rate would plummet, he even encourages it. I suppose when the number of transactions on the market drops to ten percent of its current level Rall would have the government tax security transactions by 60% to make up the difference. It’s unclear where this death spiral would end, but it would definitely result in the end of broad public participation in capital markets, which would only serve to sharply centralize the instruments of wealth creation in America–a real path to the world of robber barons that he rails against in the first half of his article. Of course Rall has a solution for such an outcome.
Or, given the rising disparity of wealth since 1975, we could restore the maximum 90 percent income tax on the wealthiest Americans. We had that during the 1950s, when the American century hit its zenith. We could hike taxes on corporations, and ban the creation of phony offshore headquarters whose sole purpose is the avoidance of taxes.
But this belies the history and reasoning behind cuts in high marginal rates. It also displays an ignorance of the actual affect on tax revenue, and more importantly with regards to Rall’s argument about increasing progressive aspects of taxation. The politicians of the 20s, as well as both Kennedy and Reagan realized that the incentive to hide income and wealth created by high top marginal rates can get out of control. The reasoning behind reducing top marginal rates wasn’t to reduce the tax bill paid by the rich, it was to in fact increase it. Here’s what a quick google search on the subject turned up:
The tax cuts of the 1920s
The share of the tax burden paid by the rich rose dramatically as tax rates were reduced. The share of the tax burden borne by the rich (those making $50,000 and up in those days) climbed from 44.2 percent in 1921 to 78.4 percent in 1928.The Kennedy tax cuts
Just as happened in the 1920s, the share of the income tax burden borne by the rich increased following the tax cuts. Tax collections from those making over $50,000 per year climbed by 57 percent between 1963 and 1966, while tax collections from those earning below $50,000 rose 11 percent. As a result, the rich saw their portion of the income tax burden climb from 11.6 percent to 15.1 percent.The Reagan tax cuts
The share of income taxes paid by the top 10 percent of earners jumped significantly, climbing from 48.0 percent in 1981 to 57.2 percent in 1988. The top 1 percent saw their share of the income tax bill climb even more dramatically, from 17.6 percent in 1981 to 27.5 percent in 1988.
Now, caution on this. Tax rates are just one part of the puzzle in an economy, and this shouldn’t automatically imply that even lower top marginal rates, or even a flat tax, would be good for the economy overall, or for mean incomes. Clinton increased the top marginal rate from 31% to 39.6% in the 1993 budget and it didn’t result in economic catastrophe, though one has to wonder how the share of taxes paid changed, and if it didn’t ultimately result in a lot of rich people putting a lot of capital towards non-productive use as it did in other historical periods (look this up later -Ed.). But let’s stress this again, a reduction in top marginal rates from extremely high levels actually reduced the total share the poor paid in taxes. We know that a 90% top marginal rate actually does massive damage to the economy and slows down productivity and prosperity gains. It’s possible that Clinton’s 40% is an optimal top marginal rate, maybe it’s higher and maybe lower. It’s really hard to say without further research, and it’s clear that further research into economic issues does not interest Rall.
Even the sparing data quoted above should provide enough ammunition to make clear that Rall either has very little clue what he is talking about or is willfully misrepresenting reality. Part of the reasoning behind a national consumption tax (which can still contain progressive elements, remember) is the elimination of loopholes and disincentives to making productive use of wealth. The argument to simplify the tax code and reduce inefficiencies introduced by politically motivated policy is strong even with current levels of taxation, and tax evasion. But as complex as taxes are today, and as much incentive and opportunity there is for the rich to do everything legally possible to evade top marginal rates (and it’s only the rich who can afford to hire professionals to effectively confront the complexity of the US tax code), a 90% top marginal rate would be a disaster. Every developed country in the world has abandoned such punishing tax rates, and reaped benefits and broader participation in domestic economies by doing so.
Rich or poor, corporate or individual, government will collect its revenues from whomever screams the least. The howls of the rich and powerful for a consumption tax have disproportionate influence upon our supposed elected representatives. But the rest of us can scream too–and there are a lot more of us.
To an extent this is true, but it avoids an understanding of how money moves through the economy. The FairTax advocates note that if corporate income taxes were eliminated (as they propose as part of thier plan) then the costs of domestically produced goods would drop a commensurate amount. Savings would seem to initially result in higher profits but these would be quickly eaten up through competition between firms for customers and labour. Putting aside the savings from decreased administration costs, and a broader tax base, a family spending all of its income under an income tax system or a revenue-neutral consumption tax system should see nearly the same proportion of its income go towards taxes. The difference would be that they would face a greater incentive to save, invest, and earn more money since consumption would be punished. It’s not just money that would be saved, but there would also be an incentive to save resources. Large purchases such as furniture or vehicles would be made more wisely, and people would look to invest in goods that are built better and last longer. Yes a consumption tax has a large green aspect built in to it.
If one imagines the entire tax burden is shifted to corporate profits as Rall might suggest, then it’s pretty clear that the costs of goods would increase. Net corporate profits must be at a certain level to reward the risk associated with investment, and recall that more and more consumers are also investors now. Consumers would pay more for goods and services as a result, and something like a consumption tax would be in place. The tax would simply be hidden, and the distorting effect on the economy would be different because of the point where taxes are directly inflicted. It isn’t hard to see that there would be a disincentive to investing in US companies, and capital would flow out of the country. Some one with a very naive view of global financial workings and the monetary system might try to solve this by banning capital from leaving the country. Even if this were possible without essentially installing a totalitarian isolationist state, you’d have no ethical way of keeping the enormous amount of foreign capital invested in the US from fleeing to other jurisdictions.
The incentive for firms to grow, innovate, and increase productivity would be diminished regardless. Perhaps the most destructive aspect of such a move would be the disincentive for small business creation, as people would be potentially be punished for profiting from thier own labour within a corporate structure over being a wage earner.
The point I want to end with here is that regardless of where the taxes are collected along the flow of cash through the economy, we all end up paying for it sooner or later. If it’s hidden in the price of goods, it still gets paid. And if it discourages investment, we all feel the effects of lower productivity growth. To imagine that one can tax only one portion of society is a fallacy. The question that arises in deciding what mix of consumption. wage income, and investment income taxation should contribute to the total tax base is one of efficiency and effects on economic incentives.
One can imagine tax reform schemes that could produce transparency regardless of where taxes are collected. The point at which taxes are collected though, does affect the way society works by disrupting the economy. The decisions individuals make within the market as they move to reduce their direct tax load have large and sometimes counter-intuitive effects. Given that lack of savings and over-consumption of resources are a couple of the larger long-term problems facing America, a consumption tax would appear to disrupt the economy in a compelling way.
But I’m not an economist; I’m also not totally convinced about the merits of a total consumption tax because there is a paucity of data out there given that no country to my knowledge has ever attempted such a thing. There are a lot of factors that come into play, including the long-term distribution of wealth across society, broad economic growth through investment, and effects on long-term productivity. There is probably no man-made system on earth as complex as a mature market economy, and anyone who claims certainty as to what effects unprecedented policies might have on the economy had better have an incredible base of economic knowledge, a good dose of humility, credible alternate proposals if he or she predicts disaster, or at the very least, a modicum of honesty and common sense, if they are to be taken seriously. Ted Rall fails on all of these counts.