Should the Fed be Subject to Audit?

No, says Fred Thompson:

Keep the GAO away from the Fed

Socialist Sen. Bernie Sanders' and House libertarian Republican Ron Paul’s proposal to audit the Federal Reserve looks like it is moving toward enactment. It has gained the backing of Senate Majority Leader Harry Reid, Banking Committee chair Chris Dodd, and the White House and has been attached to the Wall Street reform bill. The proposal amends a 1978 law that prohibits the General Accountability Office (GAO, the audit, evaluation, and investigative arm of the U.S. Congress) from looking at deliberations and actions on monetary policy matters by the Federal Reserve.

This proposal:

• Requires a one-time GAO audit of the Federal Reserve’s loans and other financial assistance provided between December 1, 2007 and date of enactment, to assess: (1) operational integrity, accounting, financial reporting, and internal controls of the credit facility; (2) the effectiveness of the collateral policies established for the facility in mitigating risk to the relevant Federal reserve bank and taxpayers; (3) whether the credit facility inappropriately favors one or more specific participants over other institutions eligible to utilize the facility; (4) the policies governing the use, selection, or payment of third-party contractors by or for any credit facility; and (5) whether there were conflicts of interest with respect to the manner in which such facilities was established or operated;

• Requires a GAO audit of the governance of the Federal reserve bank system, including how bank directors are appointed; and

• Requires the Federal Reserve to publish information on its website on all loans and financial assistance provided between December 2007 and date of enactment under a number of Fed facilities.  The information would be required to provide the identify of those receiving assistance, the type of assistance provided, the value of assistance, the date of assistance, the terms of repayments required from the assistance recipient, and the rationale for providing the assistance.  Such information would need to be provided by December 1, 2010.

• Requires the GAO “to investigate what appear to be enormously disturbing conflicts of interest affecting Federal Reserve loans to failed financial institutions.”

In addition to raising concerns about conflict of interest on the part of the Federal Reserve, advocates of this proposal make the following factual claims:

“In the last two years, the Federal Reserve Board has lent several trillion dollars to banks and other private companies, financial and non-financial institutions. This exceeds the annual budget of the United States.”

“It has guaranteed trillions of dollars of liabilities and also made hundreds of billions of dollars available to foreign central banks through currency swap arrangements.”

“Neither the public nor members of Congress have any information about who benefited from these loans, guarantees, and swap arrangements.”

These claims are all true, especially the last. Unlike US government spending, which is governed by an appropriations process that is primarily concerned with who gets money and where it is spent and an accounting system designed to make sure that Congressional preferences have been satisfied, the Fed is a bank, governed by FASB rules, so its quarterly reports show its assets (primarily its loans) and its liabilities in considerable detail (things most government agencies cannot tell you), but not arrayed by client (although that info is obviously in its chart of accounts), income and expenses (things that most government agencies do not measure, but which are a lot more important than who, “got the money,” except maybe to a politician who is concerned about passing out favors), and a detailed flow of funds statement (something no federal government agency can provide). These general-purpose financial statements are independently audited and verified by the US Treasury.

The Federal Reserve has the information Congress wants, but does not want to make it public because, “who benefits,” is precisely the question that politicization of the Federal Reserve would entail.

Proponents  of GAO audits of the Federal Reserve make several additional claims that are not entirely true:

“There is no information available on the specific terms of the loans – the interest rate charged, the collateral posted, and whether or not they were repaid.”

These are almost all open market operations (not informal guarantees), so the terms are publicly available (you can bid against the Fed if you want).

“There is no information available on how it was decided who would qualify for the Fed’s help and who would be denied assistance.”

The Fed has announced its policies. I presume it complies with them; I don't really know. Its general-purpose financial statements will show the results of those policies and, to my way of thinking, that is what matters most. Indeed, it would be lovely if most of the agencies of the Federal government were equally transparent and could on occasion tell us what they have actually accomplished.

In other words, I am not a fan of this proposal. Normally, however, I wouldn’t have paid it much attention. But right now I am particularly sensitive to congressional use of the GAO to enforce fairness and to police conflicts of interest. For the past year, my colleague, Steve Maser, several students, and I have been studying the federal bid-protest mechanism, which gives any person with a pecuniary interest in the outcome of a source-selection standing to protest government’s choice of a supplier and often the power to delay execution of contractual relationships. The primary venue for bid protests is the GAO, although protests may also be made to the Court of Federal Claims and the district courts. We present our findings at the 7th Annual Acquisition Research Symposium this week in Monterey, CA.

Our main aim in studying bid protests is to identify changes that might make them more effective or mitigate the burdens they impose upon government’s suppliers, public officials charged with executing government contracts, and, ultimately, taxpayers. However, one significant finding that emerged as a by-product of this effort is that the GAO appears to be highly responsive to congressional constituency interests; its decisions appear to be biased in favor of domestic producers and a fortiori the constituents of pertinent congressional leaders in a way that the decisions of the courts are not.

Why did Congress designate the GAO, a congressionally affiliated agency, to execute the bid-protest process? The standard answer is that Congress did not trust the executive branch or even the courts to avoid conflicts of interest. A better answer might be that they didn’t trust them to attend to the right interests. One should be skeptical of congressional claims about the pursuit of broad public interests, especially where distributional issues are involved. Indeed, assigning the GAO to protect us against parochial political interests looks a lot like asking the fox to guard the hen house.

If Congress uses the GAO to influence government source selection decisions, why would that not also be the case with respect to the Federal Reserve’s loans and guarantees? Requiring the Fed to identify those receiving (and not receiving) support from the Federal Reserve, the type of support provided, its value, date, terms of repayments, and the Fed’s rationale for providing assistance seems to invite the same type of congressional intervention one observes with respect to source selections. That might not be bad, but it certainly wouldn’t be apolitical.

Fred Thompson: Once More on Taxes, Oregon and Economists

Note, this document with tables and was long and complicated to plunk directly into the blog, so I had to resort to Scribd.  


Fred Thompson checks in with some final thoughts on the tax battles...

Fred Thompson 4/6/10

Fred Thompson on Measures 66 and 67

Fred Thompson checks in with his take on 66 & 67:

Most of the public debate about Measures 66 and 67 is not very edifying.

Will passing Measures 66 and 67 cost a lot of jobs? Probably not.

They may retard the expansion to full employment and, once there, reduce average job quality, but people who want to work at the compensation levels offered will; others will drop out of the job market or go elsewhere, but 70k? I don’t see it. Moreover, proponents of these measures are almost certainly correct when they argue that cutting state spending would cause more fiscal drag than the tax increases would.

I am especially skeptical of Bill and Randy’s estimates. Even if their analytical assumptions were valid (and I am not persuaded that they are), their estimates would still be off by a factor of two, maybe more. Here, I am talking about their willingness to take the state’s revenue estimates at face value. That is naïve. Measure 67 has two main components: a substantial increase in the minimum corporate income tax and an increase in statutory rates on corporate income. The primary effect of the increase in the minimum tax would be to reduce the ability of corporations to defer tax liabilities.

Accelerating tax payments will increase state tax receipts considerably in the near run, but the discounted present value of all future increases is likely to be small. The increase in the statutory rate will motivate businesses to find new ways to recognize revenue in jurisdictions with lower rates and, if yes on 67 wins, Oregon will be surrounded by them. My hunch is that the estimate of the revenue gain from increasing statutory rates is at least 20 percent too high.

The problem with 66 opponents’ analysis of the effects of the increase in personal income tax rates is double counting. They assume both that the tax will be collected and that a lot of folks with high incomes will find ways to report their incomes in jurisdictions with lower rates, some by moving away (or just not moving here). Both assumptions cannot be true.

Will the fiscal policy effects of Measure 66 be worse than those of Measure 66. Probably. What I don’t like about 66’s personal income tax increases, both in the statutory rate and through the reduction in the federal tax exclusion, is that they are permanent. Most economists accept some version of the permanent income hypothesis.

Consequently, we believe that most of a temporary tax cut will be saved, while most of a permanent tax cut will be spent, which is why a dollar of government spending provides more fiscal stimulus than a dollar tax cut. The opposite is true of tax increases. Temporary tax increases mostly reduce savings; permanent ones mostly reduce consumption, therefore more fiscal drag. Not good. At least not at this time.

Is Federal tax deductibility regressive? Not very.

In Oregon It applies only to the first $10K of federal taxes paid for a married couple filing jointly and the first $5k on an individual filer. The effect of raising this cap from $3K and $1.5K a few years back had little effect on the progressivity of the state's income tax, although it may have slightly reduced the progressivity of the state and local tax structure as a whole. The adjustment to the Federal tax exclusion in Measure 66 is distinctly progressive, tacked on to a marginal rate increase, even more progressive. And all of this piled on top of a state tax structure that is already arguably the nation’s most progressive.

If these measures fail, will Oregon have to cut vital services? Probably not.

Oregon’s Constitution requires the enactment of a balanced budget, not a balanced budget. Were the choice between raising taxes or cutting spending, raising taxes is probably the better option, but that is not the only alternative. Oregon's Constitution requires the Governor to submit and the Legislature to enact a balanced budget. They did. If Measures 66 and 67 are rejected by the voters, the state may legally borrow to make up the shortfall, just as it did in 2003 and 2004, when broader tax increases were rejected by the voters.

Wouldn’t that cause the interest rates the state pays on the bonds to jump? It could. But we could fix that by dedicating future kicker funds to repayment of state debt.

I’ll probably hold my nose and vote for 67 and cross my fingers and vote against 66.

The Tax Increases: Letter and Rebuttal

Recently I was asked if I was interested in being a signatory to a letter proposed by the OCPP. I have posted it below, but the essence is that there is a good economic justification for the tax increases passed by the legislature to deal with the current economic crisis. I believe there is so I signed the letter. Though I would prefer that all of the tax increases were temporary and that the state deal with the overall revenue situation in a comprehensive way after the crisis, I do support the increases. Quite simply I believe that the negative consequences of the increases (and there will be negative consequences) are far outweighed by negative consequences of inaction - particularly the long-term consequences of inadequate school funding.

Letter From Economists

Fred Thompson has a very interesting response to the letter in which he argues that now that the legislature has enacted a balanced budget, it is free to engage in deficit spending if the revenues don't materialize - which they won't if voters overturn the tax increases. Fred is much more informed than I of the intricacies of the state budgeting process, but I think most economists would agree that in a crisis, deficit spending is the preferred solution over tax increases. Here is Fred's full response:

Thompson Response

I am skeptical that deficit spending on the scale required to fill the gap would happen if the tax increases fail to materialize so I am not ready to suggest voting against the tax increases, but it is a very interesting argument. What do you think?

Fred also asks about the opinion of other economists in the state, if they or any other economist would like to participate in this discussion, I offer this blog as a forum.

Beer Tax Redux: Fred Thompson Weighs In

Fred Thompson, friend of the blog and resident tax and budget expert, sends along his take on the beer tax idea:

Jeff Alworth of Blue Oregon blogged very informatively the other day on the proposed increase in Oregon’s beer tax: Brewing Beer is Not a Sin. To an economist, specific excises raise two additional questions that Jeff did not address: substitution and incidence.

Let’s look at substitution first. As Patrick recently observed, one justification for taxing beer, wine and spirits is that their consumption produces bads and taxing them reduces consumption. People drink beer, wine or spirits to get drunk, which can mean anything from a pleasant buzz to total stupor. For example, although moderate alcohol consumption appears to be good for you, excessive consumption is not. Moreover, even moderate alcohol consumption can lead to negative externalities like dangerous driving. While taxes on beer, wine and spirits are a blunt instrument, the evidence is that they work to reduce the damage associated with alcohol consumption (there is some evidence, that their effects on the benefits of alcohol consumption are disproportionately high, but this evidence is by no means conclusive).

However, if reducing the damage associated with alcohol consumption is the justification for taxing booze, the tax should reflect its potential for doing damage. That means the tax should be based primarily on alcohol content and should be the same for beer, wine and spirits. That is not now the case in Oregon. The alcohol in beer and wine is implicitly taxed at lower rates than the alcohol in spirits (and the tax on spirits is based on the price of the drink not on alcohol content).

The other justification for taxing beer, wine and spirits is that booze taxes generate lots of tax revenues: a means of plucking the goose with the minimum amount of hissing. Booze is an inferior good. Its price elasticity of demand is less than 1, which means that a one percent increase in the price of alcohol will decrease its consumption by less than one percent. Of course, that’s not equally true of all populations. Price affects the consumption of occasional drinkers and teenagers much more than of alcoholics. (Teenagers tend to substitute pot and other tax-free but illegal recreational drugs for alcohol when taxes are increased on beer, which is less harmful for a variety of reasons.)

Since the flip side of price inelasticity is income inelasticity, this takes us to the incidence question. One can estimate the income elasticity of a tax using ordinary-least squares regression according to the following specification: ln(Ci) = a + b(lnYi) + e, where C is tax payment, Y is family income and i represents the ith family. Here, b shows the percentage change in tax payments as a result of a one percent change in family income, which is income elasticity. Elasticities greater than one mean that the tax is progressive; less than one, regressive. It isn’t possible to compute the income elasticity of the alcohol tax in Oregon, but we can use household accounts from the US census to estimate the income elasticity of alcoholic beverage purchases, which indicates that b is approximately equal to .6. That is, a one percent increase in income increases purchases of alcoholic beverages less than one percent, which implies that the tax is regressive.

But, wait, there’s more. There is also some evidence that most of the increase in alcoholic beverage purchases as income increases is not reflected in greater alcohol consumption, but a preference for up-market drinks – Beefeaters instead of Potters gin, fine wines rather than cheap plonk, and designer brews rather than Bud. Consequently, it is likely that a tax on alcohol is not only regressive, but highly regressive.

Is this bad? Hard to say. However, it is somewhat anomalous that the same people who want to increase taxes on alcohol are also big fans of minimum wage increases. One hand gives; the other takes away.

Fred Thompson on the Bailout Plan

For the last week or so, I have been following the comments on the bailout/rescue plan on BlueOregon and Oregon Catalyst, which reflect local left/right thinking. The comments have been running 10/1 against. And, presumably, this has something to do with the negative votes of the majority of the folks in our congressional delegation. However, most of the comments just don’t make sense. They remind me of Howard Beale standing up during the middle of his newscast crying, "I'm as mad as Hell, and I'm not going to take this anymore!"

The Paulson Plan is quite simple. Both the Fed and the Treasury see the immediate problem as one of monetary contraction. As the value of bank assets drop, so too does their ability to extend credit. Why is the value of their assets dropping? No one knows what they are worth, so they aren’t worth much. Buyers won’t sell; sellers won’t buy except at extremely distressed prices.

If the immediate problem is preventing monetary contraction, the solution is to buck up bank balance sheets. That can be done by swapping T-Bills for the commercial. Moreover, if the Treasury makes the swaps by reverse auction they will also jump-start the market for the assets not offered for sale. It should work.

What are the disadvantages of this plan (all plans have disadvantages – there are no free lunches)? One is stressed by libertarian monetary theorists like many of the 200 signers of the economists’ petition against the bailout: the monetary /banking system is prone to excess, because it is so interconnected, politically responsive (corrupt), and debt dependent. We ought to let the market sort things out. If it takes a depression, so be it. We’ll be better off as a result. This view has some merit, but I’d prefer not to run the risk.

On the other hand, folks like Paul Krugman want to go even further than Treasury. Rather than relying on open market operations, something the Treasury knows how to do. They want the Treasury to take an equity position in failing banks as the Swedes have or Treasury did with Fanny-Mae and Freddy-Mac. This would minimize the risk to the public fisc, but probably also deter private investors from making investments in this sector.

The Paulson plan does not rule out this option, but neither does it require it. It is a sensible, prudent middle-of-the-road proposal.

In the mean time, three cheers for Darlene Hooley. It is nice to be represented by an adult.

Fred Thompson on the Minimum Wage

Editor's Note: A thousand thanks to Fred Thompson and his contributions to this blog during a time when I have been unable to provide much content. Fred promises to take a breather for a while and, based on this contribution especially, I hope he doesn't really mean it. For what it is worth, I think this post pretty accurately describes mine and many other economists preference for extra-market transfers in lieu of market distorting taxes and rigidities (see: my rants abut the prohibition on self-service gas). Take it away Fred...

__________________________________________________________

Last week, at Blue Oregon, Chuck Shekatoff of the Oregon Center for Public Policy (OCPP) accused the communications and lobbying firm Conkling Fiskum & McCormick (CFM) of slipping into “into Political BS (Bogus Statement) mode. The CFM article asserted ‘[h]owever, for the majority of that time [since 2002] the state unemployment rate has remained higher than the national average.’ The suggestion by CFM and business groups that a relatively high minimum wage and higher-than-average unemployment levels are related is Political BS.”

Shekatoff asserts that Oregon’s typically higher-than-national-average unemployment is due to population growth and the structure of our economy and cites an OCPP report and economists at the Oregon Employment Department in support of this claim. When, however, one checks the OCPP report (Who’s Getting Ahead) the evidence cited is short discussion of the issues by an Oregon Employment Department economist, Art Ayre, “Why Does Oregon Have a High Unemployment Rate?” published April 27, 2005. This is, indeed, a very nice discussion of the issues. It correctly observes that “economists usually speak of unemployment as having three components: frictional, cyclical, and structural. All three contribute to Oregon's higher-than-national rate.” However, while it is clear that Ayre has a keen grasp of the issues and the Oregon labor market. The evidentiary basis for his claims is simply not reported.

Indeed, it is hard to see how two of the factors he cites, the structure of the economy and population growth could explain Oregon’s RELATIVE unemployment when compared with the rest of the United States. The structure of Oregon’s economy is essentially a constant. It is axiomatic that a variable that doesn’t vary cannot explain any variance, although it might explain the intercept in an empirical model (which is how I understand Ayre’s claim, although I would stress that ‘might’ leaves a powerful lot of wiggle room). But if you take population growth as the independent variable in an empirical model and relative unemployment (or employment growth) as the dependent variable, one actually obtains a negative relationship. Now I don’t believe for a moment that population growth really causes unemployment to fall (or employment to grow). My hunch is that the causal arrow goes in the opposite direction.

The main driver of unemployment in Oregon is America’s business cycle. America’s booms and busts are also Oregon’s. But what explains Oregon’s RELATIVE unemployment. As a classroom exercise, I have had my students look at this issue several times over the past decade or so, using monthly data, the difference in unemployment (or employment growth) between Oregon and the US as the dependent variable and anything they could think of as independent (or causal) variables. The two variables that seem to explain Oregon’s relative unemployment best are the dollar’s exchange rate with other currencies and the state government's stop and start spending behavior.

The fact is that Oregon industry and agriculture are highly affected by foreign trade. When the dollar is low, they do well, at least so long as the rest of the world isn't in the tank. When it is high, they don't. This is a structural factor that varies measurably over time. Moreover, the state relies on a highly progressive tax structure. Progressive taxes are necessarily volatile revenue sources. Revenue volatility encourages spending volatility, making our booms and busts bigger than elsewhere. This is a cyclical factor unique to Oregon.

Early this year, I took a spreadsheet from the work of one of my better students and tossed a dummy variable representing Oregon’s adoption of a premium minimum wage into her model. The effect was statistically significant, as was the increase in the adjusted coefficient of determination. However, from the standpoint of relative unemployment (or the relative change in total employment), the negative effect was very small. This isn’t a very good test. It’s not a good econometric model. Moreover, using the change in Oregon’s minimum wage relative to the national average would have been better. But when I did the analysis, I lacked that data. Nevertheless, I think its results are likely to be correct. Oregon’s high minimum wage almost certainly makes relative unemployment worse, but the effect is probably not very big, at least not compared to other significant factors.

The reason I believe this is because it is consistent with what most other economists, who have looked closely and carefully at this issue, have found. My reading of contemporary research that the effect of high minimum wages on low-income employment is far more likely to be negative than neutral. Of course, employers can increase prices. But, other things equal, increased prices mean lower sales volume and fewer employees (otherwise, presumably, those employers would have already raised prices). High minimum wages also lead to rationing inefficiencies, which are probably more important than the job losses, but that is another story. One can recognize that high minimum wages have adverse effects and still support minimum wages, even high minimum wages. The consensus among labor economists is that minimum wages help many more low-wage workers than they hurt.

But its supporters shouldn't fool themselves that its effects are entirely benign. If anything is political BS, that is.

Obama proposes to raise the national minimum wage to $9.50 per hour in 2011 and index it to inflation. He also wants to increase the Earned Income Tax Credit (EITC) for working Americans with no children and for those with three or more children and a tax credit of up to $500 per person or $1,000 per couple. This would be a rebate of the worker’s Social Security contribution on the first $8,100 of earnings. Like the EITC, this helps low-income working families without creating employment disincentives.

Most economists believe that we could get more equality at a lower cost by focusing on bottom-end personal income tax brackets and expanding the EITC than by raising minimum wages. Consequently, I’d prefer it if Obama were less enthusiastic about increasing minimum wages and more committed to across-the-board increases in the EITC. Here in Oregon, one thing that we could do is to eliminate the first two brackets of the state personal income tax. Failing the better, however, we should probably, as Chuck Shekatoff proposes, celebrate the pretty good.

Disclosure, Gary Conkling of FSM is my colleague at the Atkinson Graduate School of Management.

Fred Thompson on Taxes, Part 2

In my last blog I suggested that tax shifting caused by the 1986 federal tax reform act accounts for two well-noted recent phenomena: the increasing concentration of personal income and the declining rates of corporate profitability. At the federal level, this means that households in the top percentile of the income distribution, especially "small business" owners (a majority of the folks in this income group), pay more federal income taxes than they once would have, a lot less corporate income taxes, and, consequently, end up with a whole lot more money in their pockets.

What the feds did also affected state-level fiscal outcomes in Oregon. Because Oregon’s statutory tax rates were unchanged at 6.6 percent for corporations and 9 percent for individuals, tax shifting in response to changes in the federal tax code probably caused the owners of its 6,000 or so biggest small businesses to increase their personal income tax payments by more than they reduced their corporate income tax payments. This is probably the main reason Oregon’s corporate income tax revenues have dropped relative to its personal income tax revenues, as has happened all over the country.

Of course, the state corporate income tax hits big publicly owned corporations as well as smaller closely held corporations. The reported profits of big publicly owned corporations have boomed in recent decades. But, while they must pay state income taxes somewhere, they aren’t paying higher corporate income taxes in Oregon. The reason for this is somewhat counterintuitive. Corporations that operate in several states can often find ways to have their income taxed in low-tax states rather than in high-tax states. And, if they can, they do, and have for years. Oregon’s statutory corporate income tax rate is among the highest in the US and this has long given big corporations an incentive to go tax shopping.

There’s more: we recently made tax shopping easier for big businesses. Once, the proportion of a firm’s profits that Oregon taxed depended the average of its employees, its assets, and its final sales located within the state relative to the total number of its employees, assets, and final sales. Now we look only at sales. This approach works fairly well for retailers, hotel and restaurant chains, utilities, and the like. But it allows most other big corporations, especially those selling goods and services to other businesses, to pay state taxes wherever they want to and that’s not here. This is the second reason for the drop in Oregon’s corporate income tax revenues relative to its personal income tax revenues: we have sent the revenues to other states.

So, if what we want is to increase Oregon’s tax take, why don’t we just cut the corporate income tax rate and go back to the old tripartite system of tax apportionment? (To be frank, it is by no means clear to me that Oregon’s revenues are inadequate. True, the state has had to borrow $3-4 billion to deal with revenue shortfalls. But over the last two business cycles (1994-present) the state has also rebated $6-7 billion to personal and corporate income taxpayers.)

Lane Shetterly’s Revenue Restructuring Task Force seems to want to increase Oregon’s tax take or, at least, its potential to do so. They have looked at a variety of tax swaps intended to do lots of things, but the one big thing they seem to be working toward is increasing the state’s capacity to raise revenue when it is needed.

Here, I want to look at their most attractive option: swapping the state’s corporate income tax for a transactions tax. To draw precise conclusions about the benefits and costs of a transactions tax one would need to look closely at the details of its administration. Nevertheless, one can make some broad claims about transactions taxes in general with reasonable accuracy.

First, transactions taxes are no more paid by businesses than are corporate income taxes. People pay taxes. The important question is, "which people?" (Economists refer to this as tax incidence question.)

Who bears the burden of Oregon’s corporate income tax? The owners, mostly.
Who would bear the burden of a transactions tax? Customers, ultimately consumers, mostly.

A transactions tax is basically a tax on receipts or sales. Indeed, if the only entities covered were suppliers selling to consumers, then a transactions tax would be identical to a retail sales tax. If it included all goods and service providers regardless of their customers, as in Washington State, for example, it would still probably be like a sales tax in its incidence, but it would have several perverse consequences. For example, it would provide an incentive to businesses to buy their supplies from out of state firms and encourage vertical integration of supply chains. However, these effects would likely be insignificant as long as the transaction-tax rate remained low.

So, as a first approximation, this swap would increase revenues a little bit by shifting taxes from mostly rich owners to mostly not rich consumers.
One could maintain the overall progressivity of Oregon’s tax structure by simultaneously increasing the top bracket of the state’s personal income tax from 9 percent to about 9.5 percent and dropping the bottom two brackets altogether (full disclosure: I think this is a good idea, in any case). But as noted above, one can get an almost identical result to that contemplated by the tax swap plus the change in personal income rates merely by cutting the state’s corporate tax rate to ≥ 5 percent and reverting to the old system of apportionment. Why do something difficult and complicated when something far easier and much simpler will suffice?

What my discussion to this point omits is the option value of a transactions tax. Increasing state income tax revenues is not easy now; it will be practically impossible in the future when the federal government increases personal income and payroll tax rates. Establishing a well-designed transactions tax would, therefore, give the state the potential capacity (or option) to:

· Generate large amounts of revenue.
· Extract payment from individuals with high capacity to pay taxes, but low current income, including those successfully evading the personal income tax, and
· Diversify the revenue base (reduce the volatility of the state revenue stream).

All of these things imply tax rates that would be high enough to bite, however. In that case, the perverse incentives associated with a gross receipts tax would become a serious matter.

The conclusion I draw from this is that, if the balancing factor is the transactions tax’s option value, we ought to adopt a design that would avoid its perverse effects, if that option were struck and the program expanded. That is, the tax should apply only to the increment in value contributed by tax unit at each stage in the process of production, distribution, and delivery, so that an entity’s taxable transactions would be equal to the difference between its sales or gross receipts and its purchases of inputs from other entities, i.e., the tax unit’s earnings before interest, depreciation, and taxes, plus employee compensation.
….
By the way, we call what I have described a value-added tax.

You can track the Comprehensive Revenue Restructuring TaskForce's agendas at the state legislature's web site:<http://www.leg.state.or.us/07reg/agenda/webagendas.htm>

The Legislative Revenue Committee is staffing the task force. Paul Warner is the main staff contact. Documents, etc. can be gotten from Anna Grimes 986-1271. Exhibits can also be retrieved on the Legislative Revenue web page <http://www.leg.state.or.us/comm/lro/> at: <http://www.leg.state.or.us/comm/lro/task_force_exhibits.htm>

Fred Thompson: Taxation and Inequality

Editor's Note: Once again Fred Thompson rescues this over-burdened blogger with an interesting and detailed discussion of tax policy and income inequality.

The most conclusive evidence showing that that families within the top 1 percent of the income distribution experienced very large gains relative to the average since 1980 comes from Piketty-Saez, who use tax data to construct their inequality estimates.

Piketty-Saez further show that much of the increased concentration of personal income occurred between 1986 and 1988. They accept that much of that increase was a consequence of the 1986 Tax Reform Act, which reduced the difference between personal tax rates and corporate tax rates, thereby causing a shift of income to the personal tax base from the corporate tax base. Indeed, they acknowledge that tax shifting could easily account for two well-noted phenomena of recent decades: the increasing concentration of personal income and the declining rates of corporate profitability. Nevertheless, they argue that if that tax reform was all that was going on then the upper-percentile income share would have shrunk down to its 1986 level over the following decade and, needless to say, the share did not.

However, I think Piketty-Saez are wrong in assuming that shift in income from corporations to individuals caused by the 1986 TRA was a one shot deal. In the first place, corporate profitability (based on the federal flow of funds accounts) dropped significantly in 1982 and in 1986 and has subsequently continued its downward trend, despite the fact that America’s biggest firms earned record profits during this period. Where did the missing income go? Many tax experts believe that much of what is now reported as personal income was previously reported as corporate income.

Not only did the 1986 TRA reduce the difference between personal tax rates and corporate tax rates, it also made it easier for the owners of S corporations and most professional corporations to treat profit from their businesses as personal rather than corporate income and arguably increased the incentives of the owners of closely-held C corporations to treat corporate income as personal income, in part by severely restricting the use of tax shelters and requiring businesses to treat most benefits they provided in-kind to their owners as ordinary personal income (even funds deposited by these businesses in tax-deferred retirement accounts, a sum of $17 trillion in 2007, are now counted as personal income when earned, where once they were treated as a business expense until they were distributed). Consequently, the number of S and professional corporations shot up after 1986 and has continued to grow at a steady rate as a percentage of all corporations in the US ever since.

A lot, maybe most, of the discussion of high earning individuals is misleading. It focuses on the CEOs of big corporations, sports stars, and entertainers. But those folks represent a tiny proportion of the 1 million-plus families in the top 1 percent of the income distribution. Most high-income families have high incomes because they own businesses, farms, or legal, medical, or financial service providers. For example, it has been estimated that the CEOs of the 500 biggest corporations in American and the 500 highest paid athletes and entertainers earn about $25 million on average. That adds up to $25 billion. In contrast, it looks like the 570,000 small-business owners in the top 1 percent of the income distribution may have shifted $300 billion from their corporate accounts to their personal accounts in 1995 more than they would have if the 1986 TRA had never been enacted into law. This implies that they paid about $40-$50 billion more income tax that year than otherwise, but, perhaps, as much as $100 billion less in corporate income taxes, maybe more.

In other words, what the 1986 TRA allowed them to do was keep a lot more of what they earned. Consequently, the effects of the 1986 TRA were reflected in reduced corporate incomes, which in turn reduced corporate income tax payments. Of course, this is not the only reason for declining corporate income tax payments, especially at the state level, but it is probably the main reason. The effects of the 1986 TRA were also reflected in higher reported personal incomes and, despite reductions in marginal rates, increases in personal income tax payments.

This last fact accounts for the claim that Laffer was right, tax rate cuts produced increased government revenue. However, that claim ignores the effect on corporate income tax revenues. Almost no serious student of public finance believes that, tax rate cuts produce increased government revenue at current rates, or is even close to being true.

On the other hand, every serious student of public finance knows that taxes create wedges and most accept that dead-weight losses increase as an exponential function of marginal tax rates. The interesting question is how much of the relative increase in the income reported by Piketty-Saez is due to income shifting, how much is due to reduced corporate tax payments, and how much is due to a reduction in the tax wedge.

The Tax Foundation got blasted for suggesting that the answer to the last part of this question is 20-40 percent. Those do not seem like completely unrealistic numbers to me. Moreover, that is probably also the upper limit of the real increase in the gains in pre-tax income accruing to the top 1 percent of the income distribution relative to the average.



Figure 2. Tax Wedges on Labor Income Showing How an Increase in Tax Rates can Reduce Revenues by Increasing Deadweight Losses

It is a striking fact that the fraction of total wealth held by the rich has not changed noticeably in the last 70-80 years. As Saez observes” “A jump in reported wage income with no change in wealth is consistent with the income-shifting explanation, since all that is changing is where income is reported, not how much income is earned.” We could say the same thing about the consumption of families in the top 1 percent of the income distribution, although this may be an artifact of the methods the census bureau uses to survey consumption levels.

These issues may seem more relevant to federal tax policy than to state tax policy and, indeed, most of the discussion about them is in that context. But Oregon is currently addressing some fundamental issues about its tax structure that reflect the issues addressed here. One prominent proposal involves substituting a transaction tax (probably like a sales tax in its incidence) for the existing state corporate income tax (which this argument suggests is much more like the personal income tax in its). This analysis goes directly to an assessment of the likely consequences, both in terms of adequacy and fairness, of those alternatives, especially given the kinds of changes to federal income taxes we can anticipate under either Obama or McCain.

See Irwin Diewert, Denis A. Lawrence, and Fred Thompson. The Marginal Costs of Taxation and Regulation, in Handbook of Public Finance. F. Thompson and M. Green (eds). New York: Dekker, 1998: 135-173.

Thomas Piketty and Emmanuel Saez "Income Inequality in the United States, 1913-1998" with, Quarterly Journal of Economics, 118(1), 2003, 1-39 (Longer updated version published in A.B. Atkinson and T. Piketty eds., Oxford University Press, 2007) (TABLES AND FIGURES UPDATED TO 2006 in Excel format, July 2008).

Emmanuel Saez “Income and Wealth Concentration in a Historical and International Perspective.”

Also useful:
economistsview.typepad.com/economistsview/2007/01/thomas_piketty_.html
economistsview.typepad.com/economistsview/2006/12/reynolds_rap_on.html
delong.typepad.com/sdj/2007/01/thomas_piketty_.html

C-NIC OREGON: Fred Thompson, Guest Blogger

Ed. Note: Once again Fred Thompson checks in with an in-depth discussion of a local issue.


The legislature is currently holding hearings on the State of Oregon’s computing and networking infrastructure consolidation (C-NIC) project, the most ambitious technology project ever undertaken by the state (Statesman-Journal, 14 Aug 2008, p. 1). This topic deserves our attention. More than half of the activities performed by the state involve information processing, storage, manipulation, and analysis. How well the state government does its work ultimately depends upon the quality and effectiveness of its Information and communications technology.

Most of the scrutiny directed at C-NIC has zeroed in on the fact that it was over budget and behind schedule. The business case for the project looked primarily at operating cash flows and depended primarily upon personnel reductions. Bob Cummings, the information technology analyst for the Legislative Fiscal Office, has subsequently acknowledged that it was unrealistic for state officials to think they could cut staffing while consolidating complex operations. In any case, C-NIC’s is currently $67 million over budget (Statesman-Journal, 14 Aug 2008, p. 1). Some of us said so at the outset.

Construction of the hardened facility, installation of mainframes, and configuration of the new network architecture was supposed to be complete by the end of 2005, with migration of operations from the three largest existing data centers to the consolidated data completed by the end of 2006. As it happens the project is still not entirely complete, which has doubled transition costs and substantially delayed benefit flow from the project. Moreover, payback depended upon the project staying on schedule and being completed on time. That was also unlikely, although not necessarily for the reasons given.

Nevertheless, knowing what we now know, if we treat the project as a standard capital budgeting problem with a life of 25 years and a discount rate of five percent, it looks better than break even, even before taking account of benefits accruing from greater security, substantially increased peak capacity, learning-curve effects, or buying power. Moreover, according to DAS Director Scott Harra, consolidation has generated an additional benefit: "Departments can focus on their core business.” Department of Revenue Director Elizabeth Harchenko agrees, she no longer has “to worry about having her own agency maintain the necessary staff, software and equipment to do the work” (Statesman-Journal, 14 Aug 2008, p. 1). So by any reasonable standard, C-NIC has been a qualified success, which is occasion for self-congratulation, especially given Oregon’s history of IT fiascos.

Nevertheless, instead of patting ourselves on the back, we ought to ask what can be learned from this experience.

For students of e-government C-NIC reflects two noteworthy design choices. First, its designers chose to break no new ground, but, instead, they were content with paving the existing cow paths, justifying their effort in terms of standardization, departmentalization, and operational cost-efficiency. Consequently, C-NIC architecture reflects existing agency databases, which are built around general ledgers rather than geographic locations, and make limited use of meta-data and intelligent agents, unlike the systems implemented by governments on the leading edge of IT development. Moreover, the project’s governing board evidently never considered making database information available to the public. Instead, they redefined the security challenge C-NIC was meant to address. Rather than a terrorist attack, they now emphasize C-NIC’s capacity to maintain data confidentiality.

Second, the project’s governors chose to consolidate all of the state’s data processing and storage at a single hardened site. Indeed, the only alternative they formally considered was consolidating processing at two locations, the primary location and a backup, which they rejected for reasons of cost. The consolidation option was largely driven by fairly mundane considerations: the existing data centers were highly vulnerable to physical attack, existing server capacity was often underutilized, but was insufficient to meet peak demands as configured.

However, given this problem diagnosis, the best prescription would seem to be grid computing, which would distribute computing power throughout the state, In that case, over half of the nodes in the state could be destroyed and the system would continue to operate. Instead, we chose to put all our eggs in one basket.

The implicit decision to ignore these basic, conceptual design issues was never seriously questioned. Why didn’t the dog bark? One answer is that the project’s governors, the heads of participating agencies, were largely unfamiliar with digital organization or even the basics of IT -- when the project began, fewer than half of the board members answered their own e-mails. It probably never occurred to them to consider these alternatives. Moreover, as the State’s former IT manager, Mike Freese, explained (October 4, 2005), Oregon lacked “the technical expertise to implement grid computing.” He continued, “The best solution to an IT problem is useless if it cannot be implemented, so we looked for an 80 percent perfect answer that we could actually pull off – from this perspective, consolidation was a no-brainer.” One cannot fault Freese’s logic, but the proper lesson to be drawn here is somewhat different. If one accepts that information management is a core function of government and that Oregon hasn’t developed the necessary capability to perform that function, it follows that Oregon lacks the capacity to perform one of its core functions. It needs to develop that capacity. Further, top managers who do not understand the IT function shouldn’t be top managers.

In this case, legislative interest in consolidation preceded executive commitment to shared services. According to the Statesman-Journal (14 Aug 2008, p. 1), the 2005 Legislature approved C-NIC’s two-year budget of $100 million, including money for a new building on Airport Road SE in Salem, “with little opposition.” This means that C-NIC missed the legislative scrutiny an administrative proposal of its magnitude would normally receive prior to authorization. Again, one suspects that the legislature failed to scrutinize this project because it lacked the expertise to do so.

Most of the delays associated with the C-NIC project resulted from governance failures. These have been manifested in an inability to make timely decisions, but the dithering over policies and priorities seems to reflect deeper difficulties.
First, there was the conflict over the independence of the data center and the governance role of shared-services board. C-NIC’s designers drew a sharp distinction between shared and centralized provision of support services. They assumed that data processing would be consolidated into a stand-alone business unit that would be owned by its clients and whose only mission would be client service. They further assumed that the consolidated data center would negotiate service-level agreements, specifying standardized services and mutually agreed upon rates, with each agency, relying on quasi-market mechanisms to link the center to its clients or customers

By making data processing the unit’s sole purpose, they hoped “to elevate the importance of this back-office function to front-office status” and, thereby, “increase customer focus and employee motivation and ownership.” This logic was outlined in the shared-services governing board’s initial report, Shared
Services: A Strategy for Reinventing Government (DAS, August 2004).

Nominally all of the members of the shared services governing board endorsed this vision. However, DAS was responsible for managing the C-NIC project. DAS is not only Oregon’s central control agency (budget and financial management); it also supplies other agencies with a variety of support services – space and facilities, maintenance and landscaping services, utilities, the motor pool, etc. As it happened, project management gradually evolved into program management and, whether by accident or design, the consolidated data center came to be treated a simply another arm of DAS.

Unfortunately, customer service is rarely if ever a high priority of control agencies. DAS is no exception to this rule. Its priorities are central control, economy and efficiency, and adherence to rules. Even if DAS had in this instance been truly concerned with providing the consolidated data center’s clients with the best possible service, past experience with its service delivery practices might have led them to doubt its good intentions. Consequently, DAS’s unilateral rejection of the shared services concept, which had led to the creation of the shared service board in the first place, disgruntled some of the agencies represented on it.

Second, establishing a program management (as opposed to a project management) office was repeatedly delayed. The program management office was supposed to be put together from personnel drawn from longstanding functional units, who had worked with different kinds of data and applications processing styles. C-NIC’s designers assumed that personnel from different processing centers could be gradually integrated into a single functioning team with a common mission, regardless of their prior task-orientation or role. Cross-functional integration proved very difficult for the C-NIC project management team. This too was partly due to agency distrust of DAS. As it became increasingly clear that things were going to be done DAS’s way or not at all, their erstwhile partners turned increasingly uncooperative.
The third lesson, there is a fundamental conflict between DAS’s service-delivery mission and its fiscal-control mission. The time has come for Oregon to assign those missions to different agencies.

Energy Policy: Fred Thompson, Guest Blogger

Once again, The Oregon Economics Blog welcomes Fred Thompson writing about something I have been thinking of writing about for a while - energy policy.  Hopefully, if I can find the time, I will share some thoughts as well.  Here's Fred:

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

A friend and former boss, who is also now a serious mover and shaker
the energy biz, recently privately opined:

"This country has had no energy policy for almost three decades.
Both parties are equally culpable for a situation that places our
economy in peril for many years to come. My answer for a
comprehensive energy policy:

1. Incentives and requirements for bio-fuels and alternative energy
sources now.

2. Revitalizing our nuclear energy program, ala France.

3. Opening up off-shore and ANWR drilling. (I am not convinced that
the shale program is feasible.)

4. Immediate construction of refinery capacity.

5. Immediate regulation of hedge fund investing in commodities that
have driven prices up for all commodities with no economically
productive purpose. (I don't completely buy into the argument that
these markets provide stability required by the refiners.)

There is no silver bullet, no single answer. Also, no short-term
solution. We are going to be in the energy soup for several years.
But we can find a way out of this mess with boldness and patience."

I have been hesitant to weigh in on this topic. I don’t have any
professional competence in the area of energy policy. However, these
are my thoughts.

It is true that last time (perhaps the only time) we had an energy
policy was during the Carter administration – remember the moral
equivalent of war? Those of you who are old enough will. The results
were not pretty.

The reason for current high energy prices mostly goes to supply and
demand for oil – energy prices are up because of booming demand for
oil from China, India and the Middle East and supply shortfalls in
the US, Mexico, Venezuela, Nigeria, Iran and Russia, not to say
Iraq. Moreover, while there are many substitutes for oil and gas,
few if any are cheaper, instead high oil and gas prices have merely
raised the prices of those alternatives. As my friend correctly
opines: “There is no silver bullet, no single answer. Also, no
short term solution.”

So, what about his proposals:

1. Incentives and requirements for bio-fuels and alternative energy
sources now.

I agree, we don’t do enough to promote energy conservation.
Moreover, what we do – direct regulation, for the most part, e.g.
the CAFE standards – is pretty inefficient. Most of our conservation
promotion programs seem ill designed from a behavioral standpoint.
On the other hand, we probably have sufficient incentives for the
production of wind and solar power right now, although only recently
have folks started to engage in serious genetic engineering to
reconfigure biological processes to generate increased energy from
solar power. Those programs should be accelerated, but it is
unlikely they will have a substantial payoff any time soon. In the
short run, it looks like Brazil has the capacity to increase sugar
cane ethanol production. Most developed countries won’t import it,
the US included. That is simply foolish. But I see no sense in the
multibillion-dollar government subsidies for domestic ethanol. Why
are higher food prices better than higher energy prices?

2. Revitalizing our nuclear energy program, ala France.

Absolutely. The French use half the oil per-capita we do. Nuclear
technology has advanced considerably in the last 30 years. It is
safer and cheaper. The lack of trained nuclear engineers is a
serious bottleneck, however.

3. Opening up off-shore and ANWR drilling. (I am less convinced
that the shale program is feasible.)

Makes sense to me. Again we know a lot more about off-shore drilling
now than we did when the Santa Barbara spill occurred. Listening to
the folks who are opposed, their main objection is to the
consumption of oil, not the danger to the environment from drilling.
I doubt that that argument has political legs. In the short run, I
agree with Nick about the shale program. One reason the tar sands in
Alberta work now and oil shale doesn’t is that the Canadians have
plenty of water in the right places. However, I have heard some
ideas about nuclear power/oil shale cogeneration that might solve
some of these problems, although this is certainly not a quick fix.

4. Immediate construction of refinery capacity.

Duh. Same goes for oil and gas pipelines and LNG terminals – some
environmentalists may not to see it, but these are primarily
conservation measures. Unfortunately, immediate construction in this
instance is something of an oxy-moron.

5. Immediate regulation of hedge fund investing in commodities that
have driven prices up for all commodities with no economically
productive purpose. (I don't completely buy into the argument that
these markets provide stability.)

I disagree. Hedging produces significant benefits for the risk
averse. Moreover, I don’t see how that options and futures trading
can distort spot prices without physical hoarding. Show me the
inventories and I'll reconsider the point. I would also note that
futures markets are different from carry-trade speculation
(borrowing at low interest rates to invest at higher rates).
Carry-trade speculation is dangerous, because you are betting
against the law of one price (uncovered interest-rate parity), in
other words, betting on your ability to time the market – when the
market turns, the herd stampedes. Moreover, in commodity trading
there is a counter position for every long position and, while you
can buy on the margin, you must mark to margin every day.

My big disagreement is with a point that is only implicit in my
friend’s comments. I want energy to carry a high price. That is the
best way I know to promote energy conservation and abate greenhouse
gases. Moreover, people will make the necessary investments in
plant, equipment, and lifestyle changes required to reduce energy
consumption substantially only if they expect energy prices to
remain high. Since there is but one thing more certain than taxes, I
think a high carbon tax is a great idea. Besides I’d rather the IRS
collected the rent than the Saudis, Russians, Nigerians,
Venezuelans, or even the Canadians. One could use the revenues to
offset social security and medi-care taxes on say the first $50k
(real $) of earned income as suggested by Irwin Seltzer, for
example. Actually, I think that is a marvelous idea for all sorts of
reasons. But that is a different story.

Fred Thompson - Econ 101: Economic Growth

I was desperately trying to find time to post and, hooray, along comes Fred Thompson to save the day with a great post on economic growth theory. Thanks Fred.

Patrick Emerson in an earlier blog post wrote:

“But children are also resources in and of themselves: they are the ones who will have to come up with the solutions to the resource issues and I have faith that they can and will do it. Within each child comes the potential for being a vital part of the world's human capital resource that will solve global warming, find new renewable energy technologies, will invent more efficient ways to produces goods and services that use fewer resources, and so on. They are the ones that will create the new resources with which humanity will thrive. In fact, during the recent explosion in human population, living standards have risen considerably.”

Patrick eloquently explains the conclusions of contemporary economic growth theory. I am going to ratchet this up a bit and try to explain the theory itself and how these conclusions were reached.

This story begins with the notion that capital and labor are combined to produce goods and services. The more goods and serves you can produce/consume the wealthier you are. We call the mathematical representation of this process a production function. Once upon a time, most economists believed that the rate of capital accumulation determined the productivity and wealth of an economy. That is, if you added more tools, plant, and equipment, you could make the labor force more productive. The faster you accumulate capital the faster economic output will grow.

Then, in the early 1950s, a guy named Robert Solow was playing around with production functions and discovered something very interesting about them. Beyond a certain point you cannot increase output per unit of labor input by adding more capital. The implication is that once the optimal labor capital combination has been reached an economy can grow no faster that the rate at which the labor force expands. Moreover, in the real world, where resources can and throughout history have been depleted, this implies that output per worker must fall, ultimately to below subsistence levels.

However, when Solow looked at the available data he found that output actually grew faster than could be explained by the growth in labor and capital. In mathematics a result that isn’t explained by a model’s variables is called a residual, in this case, unexplained growth. By definition a residual must be explained by a variable that is outside (or exogenous to) the model. Solow hypothesized that this particular residual was due to technological improvements that made capital and labor more productive. The implication is that, if technology complements labor and capital in a production function, as long as it grows faster than the rate of resource depletion, the economy can continue to grow in wealth and population.

So what determines the rate at which technology grows? In exogenous growth theory, once you have reached the limits of investment in human as well as physical capital, the rate of technological innovation ought to be about the same as the rate of population growth. Ultimately, however, this implies that, since the rate of resource depletion speeds up as the labor force grows, while technology is a linear function of population size, all technological innovation does is to put off the eventual crash to a later date. This is, of course, the kind of model that drove the Club of Rome’s doomsday results. Folks talk about these formulations in terms of limits to growth (in wealth and population). In fact, almost any kind sustainable human future is incompatible with this kind of model. Every conceivable set of choices eventually leads to declining wealth and eventually a population crash.

Unsatisfied with this approach, economists, including, most prominently Paul Romer, built mathematical models (or production functions) that included (or endogenized) technological advancement as an explanatory variable. In so doing they made a surprising discovery: the payoff to investment in technological advancement is different than the payoff to investment in capital. Because in theory, technological advancement can be freely shared with all users, it is characterized by increasing returns to scale. This means that even if the rate of technological innovation is a direct or linear function of the size of the population and, thereby, the workforce, its payoff increases at an increasing rate when you increase workforce size.

For example, if every unit of the workforce invents something that makes work ten percent more productive and you have one workforce unit, productivity is increased ten percent. If you have two units, you can produce 21 percent more stuff; ten units, 160 percent; and 100 units, 1,378,000 percent.

The implication of this theory is that population growth is not inimical to increased economic wealth. Moreover, there are almost an infinite number of sustainable growth paths both in terms wealth and population (although not all growth paths are sustainable). I think the best growth paths are those in which everyone is well educated and technologically innovative. Indeed, where being smart, technologically literate, and innovative are universally admired personal qualities. But the status quo will probably suffice.

I also like plenty of open spaces, clean rivers, blue skies, old-growth forests, and pristine beaches. I don’t like crowds and can barely tolerate cities. But these are aesthetic preferences, not matters of survival. We all have to make trade offs, individually and collectively. Generally, however, richer is better. And, because aesthetic preferences are normal goods, richer also means that they are more likely to be realized.

Fred Thompson, Guest Blogger: Oregon State and Local Taxes

The Oregon Center for Public Policy (OCPP) has once again announced that that a study conducted by the Institute on Taxation and Economic Policy shows that Oregon state and local taxes hit poor and middle class harder than rich. This is an annual phenomenon.
But the conclusions of the study are almost certainly wrong, although the reality is nonetheless dismaying.

http://www.ocpp.org/cgibin/display.cgi?page=nr20080424whopay
http://www.ocpp.org/resources/2008WhoPays20080424.pdf

The weaknesses of the Institute on Taxation and Economic Policy Micro-simulation model are well known (it was roundly criticized by the discussants when it was presented at the National Tax Association meeting and the paper upon which the presentation was based was not selected for inclusion in the National Tax Journal). Its weaknesses derive from the arbitrary calculation of property-tax incidence and top coding of expenditures combined with the tiny sample sizes of the top two income categories in the sample (this may not be a significant weakness for the country as a whole, but it is for Oregon, which represents 1 percent of the total population in the sample).

The Institute on Taxation and Economic Policy estimates the property tax burden on renters based upon household rental expenditures. However we know this is wrong on the face of it. In the first place it leads to an estimate of property taxes paid on rental properties in Oregon that is greater than the total property tax levied on those properties. Moreover, it assumes that property taxes on rental properties are shifted forward to renters rather than paid by the property owners, which is inconsistent with what we know about the administration of property taxes on commercial properties in this state. A more realistic estimate of the property tax burden of the bottom quintile of the population is probably closer to 2 percent of income than 4.6 percent. Indeed, adjusting for this error would have the effect of reducing the total tax burden on the bottom quintile to about 6.6 percent, the second quintile to about 7.3 percent, the third to about 7.9 percent, and the fourth to about 8.8 percent.

The problem of top coding is harder to sort out, but we know the total property tax levy and total state income taxes paid as well as the adjusted gross incomes of the top quintile as well as the total income and property taxes they reported on their federal income taxes. The income tax results reported by the Institute on Taxation and Economic Policy are roughly consistent with these sources, but the property tax figures are not.

The conclusion I draw is that the overall property tax burden on the top quintile of Oregon households is understated considerably in the Institute on Taxation and Economic Policy study and the state income tax burden may be understated as well, although not by much. In which case, the average burden for the top quintile would be approximately 9 percent.

http://www.taxpolicycenter.org/taxtopics/statelocalgovernment.cfm

The Institute on Taxation and Economic Policy study has a couple of other weaknesses that deserves a look. It excludes user fees, which is now the main source of local revenue in Oregon, fines, and lottery revenues. These three categories of revenue now equal nearly 5 percent of total state disposable income. I would guess that the incidence of the first is probably progressive; we know that the incidence of the latter two revenue categories is regressive. Their effect deserves a visit. Finally, the underlying expenditure data used in the micro-simulation (not the income data) are also now over ten years old and should be updated.

Nevertheless, the Institute on Taxation and Economic Policy study’s results for excises are probably still reasonably accurate (at least for the first five income categories
reported) and quite informative. Folks should bear these figures in mind when they contemplate increases in consumption taxes. Unfortunately, this is where most state tax increases have been concentrated in recent years.

Moreover, I would stress that OCPP’s policy conclusions make a lot of sense, even if we adjust the Institute on Taxation and Economic Policy’s figures to make them more realistic. These include "making our tax system more fair by expanding the Earned Income Credit" and that "Oregon’s income tax brackets and rates are flat compared to the federal system." It is unconscionable that Oregon’s lowest tax bracket starts at $2,750 and its highest at $6,851 of earned income. The minimum should be at least $10,000 or $20,000 for a household filing jointly. That would leave us with a flat tax on incomes above those levels. Increasing that rate roughly .5 percent would offset the revenue loss of so doing. The effect would be to make the state income tax at least as progressive as the federal income tax and somewhat more progressive than total federal taxes.

Fred Thompson
http://www.willamette.edu/~fthompso/

Oregon's Fiscal Policy: Fred Thompson, Guest Blogger

Finals are around the corner and I have been busy so I have been lax in my bloggitorial duties, fortunately Fred Thompson is here to rescue me:

According to the Pew Center on the States, a part of the Pew Research Center at Harvard’s Kennedy School of Government, only eight states fared worse than Oregon in a study of government money management practices. They are about half right and pretty much all wrong. They are right that we haven’t faced up to one very big, long standing problem: the extreme volatility of state government’s revenue structure. They are wrong when they confuse policy advocacy with problem diagnosis.

What don’t they like about us? We don’t have a sales tax; our ‘rainy-day’ fund is insufficient; and we have the kicker. All true; but adopting a sales tax and eliminating the kicker would still leave us with a revenue volatility problem, which is the main concern driving the Pew Center’s assessment, and it is too late to build a big enough‘rainy-day’ fund to make a significant difference the next time revenues go south(probably, next fiscal year), even if that were a good idea, which it is not. Moreover, as my previous column noted, we can deal with the revenue volatility problem directly.The great things about Oregon’s revenue structure are that it is fair and adequate.

The Pew Center damns Oregon’s professional money managers with faint praise, saying thestate “employs an impressive number of talented individuals. Unfortunately for them, allthe good intentions in the world can't overcome the state's thoroughly unwieldy fiscalstructure.” Frankly, their accomplishments deserve better than that. Oregon’s Treasury functions (investment management, debt management, and cash management) are among the best in the nation (as judged by their treasury officers in other states and financial analysts in the private sector). Oregon’s budgeters and revenue forecasters are equally respected. The state’s accountants and internal auditors consistently produce the top-rated general-purpose financial statements and a squeaky-clean, government largely free of financial scandal. Much the same thing can be said of many of Oregon’s state agencies and departments, including the often-maligned Department of Human Services,which has recently made dramatic improvements in its money management practices.

Oregon’s fiscal structure is a lot of things, but unwieldy it’s not.