There’s an old joke about a proposal for a new short-short U. S. Form 1040:
- Write down your total wages, interest, dividends, and any other form of income.
- Send it in!
Silly as that might be IMO any income tax scheme that is much more complicated than that will lend itself towards gaming, manipulation, and other forms of avoidance. Human beings are purposeful actors if not always fully rational or intelligent and they will respond to any strategy that policy-makers can devise with strategies of their own, sometimes startling strategies with unforeseen and disastrous consequences. That any system of taxation that is as convoluted, obtuse, and lengthy as ours is lends itself so handily to gaming, manipulation, and other forms of avoidance that if I didn’t know better I might think that was the intention all along is a topic for another post.
That’s the essential message of Arthur Laffer’s op-ed in the Wall Street Journal:
The composition of wealth also responds to incentives. And it’s also simple enough for most people to understand that if the government taxes people who work and pays people not to work, fewer people will work. Incentives matter.
People can also change the timing of when they earn and receive their income in response to government policies. According to a 2004 U.S. Treasury report, “high income taxpayers accelerated the receipt of wages and year-end bonuses from 1993 to 1992—over $15 billion—in order to avoid the effects of the anticipated increase in the top rate from 31% to 39.6%. At the end of 1993, taxpayers shifted wages and bonuses yet again to avoid the increase in Medicare taxes that went into effect beginning 1994.”
Just remember what happened to auto sales when the cash for clunkers program ended. Or how about new housing sales when the $8,000 tax credit ended? It isn’t rocket surgery, as the Ivy League professor said.
He also predicts unforeseen and potentially disastrous consequences:
Now, if people know tax rates will be higher next year than they are this year, what will those people do this year? They will shift production and income out of next year into this year to the extent possible. As a result, income this year has already been inflated above where it otherwise should be and next year, 2011, income will be lower than it otherwise should be.
Also, the prospect of rising prices, higher interest rates and more regulations next year will further entice demand and supply to be shifted from 2011 into 2010. In my view, this shift of income and demand is a major reason that the economy in 2010 has appeared as strong as it has. When we pass the tax boundary of Jan. 1, 2011, my best guess is that the train goes off the tracks and we get our worst nightmare of a severe “double dip” recession.
The emphasis is mine. Other than that employment is a lagging indicator does anyone else have a better explanation for the mystifying proposition that by the numbers the economy is in recovery but unemployment is virtually unchanged, retail sales remain sluggish, and new construction is pretty flat?
BTW, the number of bank failures is larger right now than it was last year at this time. See also here. Are increasing bank failures the sign of a recovering economy?
So simple it’s probably not even true! There was a great analysis of this at angrybear where he considered all the types of workers and found there are very few who can afford to do “not work” because of taxation. Most of us are replaceable. It could just be that Europeans value leisure far more than we do.
Oh sure, there are people who can’t move income around like that. But to the extent that it can be done and to the extent that income will take a hit next year due to taxes, all else being equal, its not a bad point to bring up. Problem is the profligacy of our recent politicians not raising taxes carries with it its own problems.
Seriously if you are going to reply to a claim, at least reply to the claim not one you make up. The claim isn’t that everyone moves income and work/productivity, but that those who can will and it could have consequences for the economy.
“People can also change the timing of when they earn and receive their income in response to government policies.”
Whenever I read something like this, it always strikes me that the people the writer is referring to are not the people I worked with my entire adult life. We, as Sam said above, could not afford to forgo paydays because we thought that would somehow maximize our utility vis-a-vis the taxman (which I take it is the “official” economist’s version of the shifting of wages and bonuses gambit). Of course, Laffer is writing in the WSJ, and I’m sure his observation received knowing nods from the readership. From me and my friends, not so much.
sam, the people who can move income around and who can respond strategically to tax increases are paying an increasing proportion of income taxes. The proof for that isn’t hard to come by.
That means that their actions can have a substantial effect on revenues.
Included in that number are millions of physicians and attorneys, for example. The average wage for physicians is something like $280,000 per year and in all honesty they work darned hard for it, in many cases 200 hours or more a month. Will they work as hard to make significantly less? They probably can’t work a great deal harder to make up for the difference.
The issue Laffer cites is occurring on a grand scale in the M&A world as we write.
Business owners are selling businesses to avoid cap gains rate increases. Private equity organizations are timing exits to avoid carried interest tax rate increaes. And how many people want to bet the public equity markets won’t experience a tax driven sell off sometime this year?
As for people with fewer options, it doesn’t mean they won’t try, or they do not react. As noted, bonuses will be accelerated. And ever hear of barter? Greater incentive to not report income? Ever looked at the amount of business activity at a cigarette or liquor store just across a low vs high tax state line? How about gasoline? Last week I went down to Indianapolis for the race. Premium gas was $2.75/gal vs $3.50 in IL. I’ll bet there are more than a few state line jumpers filling their tanks.
And so it goes. To be sure there are limits, but people are very resourceful when it comes to money.
To the Two Sams,
Are you guys even familiar with the word evidence? How about data. See what Dave wrote above. Its true.
The upper end of the income distribution is paying more and more of the tax revenue. This is also the same group of people that have more capability of moving money around. Accelerating or decellerating when they take their income.
So AngryBear or one of his co-bloggers notes that the people who pay a relatively small share of the income tax revenue can’t and don’t shift income. Whoopee-f**kin-doo.
Another group that can move income around…corporations.
So we have a blogger who shows that for most people (i.e. those paying a relatively small share of the income tax) don’t move income. We have a noted economist pointing to a Dept. of Treasury report that for those people who can move income, do.
Now will it lead to a double dip recession? IDK, maybe. This year we had two programs that were designed to prop up industries that probably need further downsizing: housing and automobile manufacturing. To the extent that we’ve over invested in housing we need to adjust current spending in this industry. If we have an over-supply of housing stock, which depreciates very slowly, then we don’t need nearly as many people working in that industry. Prices need to decline to force firms, workers and other resources out of that industry and into ones where they will be better employed. The policies propping up these industries undoubtedly added to GDP, but right now they aren’t going to be around next year. And if they are, they are just kicking the can down the road.
Really, we tried the same thing during the Great Depression. Slaughtering pigs and destroying harvested crops to try and prop up prices all at a time when many were going without. All it did was keep wages and prices high, increase unemployment, and decrease output. It was stupid then and it is stupid now.
I know its the cheap way out. But…..what Steve V said.
Because its true.