Joe Biden's new task force on Issues of the Middle Class will be considering ways to improve living standards for Americans. It might be worth pointing them in one direction that they might otherwise overlook: There is considerable evidence that reductions in the tax on capital income can have a pronounced positive effect on living standards.
The U.S. tax system taxes capital income in a number of different ways. Capital income can be subject to the corporate tax, investor level taxes on dividends and capital gains, and the estate tax. Indeed, investment in the corporate sector can be subject to three different layers of tax, first at the company level under the corporate income tax, then at the investor level through the taxes on dividends and capital gains, and, then yet again upon death of the investor through the estate tax.
Reducing any of these taxes can help reduce the negative effect of taxing the return to saving and investment on the economy. Consider the following dynamic analysis of various approaches to reducing the tax on capital income produced by the U.S. Treasury Department over the past several years:
- Permanently extending the lower tax rates on dividends and capital gains can be expected to increase the size of the economy by 0.3 percent in the long run. This result holds up whether financed with a future increase in taxes (a 0.3 percent increase in output) or lower government spending (a 0.4 percent increase in output) (see Table 3 of the July 2006 Treasury Report). (Note that the model used for this analysis got to about three quarters of the long-run result within ten years.)
- Replacing the income tax with a progressive consumption tax could increase output in the long-run by 2.8 percent. (See Table 3 of the May 2006 Treasury Report).
- Replacing the corporate income tax with a consumption-based tax, such as a business transfer tax or value-added tax, could increase output by 2.0 to 2.5 percent in the long-run. (See page 22 of the December 2007 Treasury Report or page 32 of the printed version).
- Repeal of the estate tax could increase output by 0.7 percent in the long-run assuming repeal is financed with an offsetting increase in taxes generally. The increase is 1.1 percent if repeal is financed with lower government spending. (Craig Johnson and David Joulfaian, "A Dynamic Analysis of Estate Tax Repeal," U.S. Department of the Treasury, Office of Tax Analysis, (unpublished manuscript), November 2008).
- Broadening the business tax base by eliminating most special business tax preferences and lowering the business tax rate (the tax rate applied to both corporations and pass-through entities) could increase long-run output by 0.5 percent. (See page 49 of the December 2007 Treasury Report or page 69 of the printed version).
The common theme that runs through all of these policies is that by lowering the tax on capital income they encourage additional saving and investment and increase capital formation. The higher level of capital formation increases labor productivity and when workers have more capital with which to work, real wages and living standards rise.
Hopefully, Vice-President Biden's Task Force will take a look at how the current tax system hinders economic growth and how living standards, an issue of vital interest to the middle class, can be further increases by fundamental reform.
On Friday, Mayor Mike Bloomberg's administration released a preliminary fiscal 2010 budget plan. The plan includes sales tax increases and expansions to raise $894 million annually, while leaving the income tax untouched—though some politicians, including city council Speaker Christine Quinn and Comptroller William Thompson, are encouraging a look at higher income taxes in lieu of the sales tax changes.
When I previewed the mayor's plans in November, they included higher property taxes (since enacted) with the possibility of future sales or income tax hikes. Bloomberg is "willing" to substitute an income tax hike for the sales tax increases, if that's more palatable to the state legislature, which would have to approve either move. As unappealing as higher sales taxes are, switching to a higher income tax would be a major mistake.
While New York City has a high sales tax, its income tax is already astronomical: the top city-state rate of 10.498% is higher than any other jurisdiction in the country. Further increases as previously outlined by the mayor could push the rate as high as 11.375% (including a proposed regional payroll tax for transportation). Such a move would be much more damaging than the sales tax rate increase.
Just last month, arguing against a proposal for higher income taxes at the state level, Mayor Bloomberg said the following: "Raising taxes on those with the flexibility to move their businesses—as was done in previous crises—will lead to an exodus that will hurt us for decades and have devastating consequences for the entire state." The same logic applies to the city income tax. Here's hoping Mayor Bloomberg holds the line against those who would make NYC even more of an income tax outlier.
Details of the Mayor's tax proposal
The proposed revenue increase of $894 million for fiscal year 2010 comes from three sources: elimination of the sales tax exemption for clothing ($394 million); a rise in the city sales tax rate from 4% to 4.25%, thus increasing the total rate to 8.625% ($302 million); and sales tax base expansions that Governor David Paterson has proposed at the state level, which if enacted would automatically apply to the city sales tax ($198 million).
Last month, I discussed Governor Paterson's proposed sales tax base expansions. Paterson-plan sales tax base expansions that would carry over to New York City's sales tax include a narrowing of the tax exemption for capital improvements to real property, and expansion of the sales tax to certain entertainment services (movie admissions, sporting event tickets) and transportation services (taxis, limos and buses). Other services that Paterson has proposed to tax at the state level (including personal services like barbering and massage) are already subject to NYC sales tax.
Generally, extending the sales tax to more consumer goods and services is an improvement in the tax code's structure. Unfortunately, while proposing to eliminate the tax exemption for clothing, Mayor Bloomberg has decided to match Governor Paterson's call for two, one-week sales tax holidays for clothing. New York's own Department of Taxation and Finance studied the state's 1997 clothing sales tax holiday and found it didn't generate economic activity—so why repeat the mistake?
Unlike the base expansions, the rate increase is a clear negative that will put the city even further out of step with its neighbors on tax burden. With the increase, NYC's 8.625% rate will tie Nassau and Suffolk Counties for the highest sales tax in the region. Sales tax is 7.375% in Westchester County, though it's higher in some cities, including White Plains; the rate is 6% throughout Connecticut and 7% in New Jersey, with a special 3.5% rate in designated "Enterprise Zones."
Image courtesy of the Office of the Governor of New York.
Gov. Arnold Schwarzenegger's "nickel a drink" liquor tax increase proposal (which is a hefty increase; the tax on wine would go from 4 cents to 29.6 cents), has some worried: A proposal to raise the state tax on wine to a level more than six times higher to help close California's giant budget deficit would kill the $1.99 price for Charles Shaw wine, said Fred Franzia, who created the famous label sold by the Trader Joe's grocery chain.
Charles Shaw, of course, is the formal name for the California wines sold since 2002 that are now widely known by their nickname Two Buck Chuck.[...]
Franzia said he wasn't sure what the new price would be -- it would have to be worked out with retail partner Trader Joe's -- but $2.29 or $2.49 Chuck would not be a surprise, according to industry analysts.
Trader Joe's, which introduced the wine seven years ago and has never raised the price, declined to say whether it had a stand on the proposed tax and would not talk about its plans for the wine.
Charles Shaw fans are divided on whether the tax is a good idea.
"Two Buck Chuck is a nice wine, and the price is wonderful. You can drink it or use for cooking, and it's not very expensive," Jim Elsten of Long Beach said while shopping at a Trader Joe's in Long Beach last week. "I think it would still be a good deal at $2.29 or $2.49. Wine is a luxury, and I don't see an extra tax as a problem."
But Huntington Beach resident Jamie Kaiser questions the wisdom of placing an extra tax on wine.
"I would still buy it," Kaiser said as she loaded a case of Charles Shaw Chardonnay into her car, "but it seems like they are just taxing everything now and nothing with the state budget ever changes."
The full Los Angeles Times article here.
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