The President's new budget

President Obama is about to submit to the Congress the new budget proposal, the key feature of which is higher taxes on "the rich":
"The president’s blueprint calls for reductions in spending on federal health programs and the military, a small raise for federal workers and more than $1.5 trillion in new taxes on corporations, hedge-fund managers and the wealthy, in part through the expiration of the George W. Bush-era tax cuts on annual incomes of more than $250,000.

Obama also has called for changes to the tax code that would require households earning more than $1 million a year to pay at least 30 percent of their income in federal taxes, but senior administration officials said Friday that the blueprint will provide no additional details on how such a levy would be structured."


My comments:
1. Regardless of whether one supports higher taxes or not, we are all aware that none of these tax proposals has a chance to be approved by the Congress. Hence, expect the next round of the government near-shutdowns, credit downgrade threats and so on. At best this is simple politicking, at worst - political extremism.

2. Pay attention how the language regarding the "Buffet tax" transforms as the tax creeps into the tax code: while previously it was about taxing the fortunate individuals, who make more than a million a year, now it is about households, which more often than not consist of several individuals (e.f. parents and children) with income per person much less than a million.

Income inequality: an intelligent look from the left

Here is a relatively balanced article on the growing income inequality. The author is left-leaning (you will agree with me , if you look into his recommendations), but he provides a fair analysis. If you want an intelligent look from the left rather than the usual "beat the rich/tax the corporate jets" stuff, then I recommend reading it.

I quote only one paragraph (that should make an intelligent liberal to think):
"The market system distributes rewards increasingly inequitably. On one side, the debate is framed in zero-sum terms, and the disappointing lack of income growth for middle-class workers is blamed on the success of the wealthy. Those with this view should consider whether it would be better if the United States had more, or fewer, entrepreneurs like those who founded Apple, Google, Microsoft and Facebook. Each did contribute significantly to rising inequality. It is easy to resent the level and extent of the increase in CEO salaries, but firms that have a single owner, such as private equity firms, pay successful chief executives more than public companies do. And for all their problems, American global companies have done very well compared with those headquartered in more egalitarian societies over the past two decades. Where great fortunes are earned by providing great products or services that benefit large numbers of people, they should not be denigrated."

At least two points that the authors omits:
1. There is no discussion of how the economic growth, prompted by reducing taxes on the highest earners could reduce the income inequality.
2. More importantly, he frames discussion as if "the rich" are only the 1% of the higher earners, whereas for the tax purposes they still remain all those who earn more than $250,000 a year, i.e. small business.

He does however stress the that the reason for the growing inequality might be precisely too much government interference into the free market:
"First, government must not facilitate increases in inequality by rewarding the wealthy with special concessions. Where governments dispose of assets or allocate licenses, preference should be on the use of auctions to which all have access. Where government provides implicit or explicit insurance, premiums should be based on the market rather than in consultation with the affected industry. Government’s general posture should be standing up for capitalism rather than for well-connected capitalists."

US congress raises taxes...

...on China. Indeed, the Senate is about to impose tariffs on the goods imported from China (i.e. a tax on Chinese produce sold in the US.)

The economists typically oppose such restrictions on the free trade, since such restrictions result in domestic consumer having to pay higher prices. The question is however complicated, with many strong arguments for protectionism, nicely summarized in Chapter 9 of Greg Mankiw's economics textbook. The argument used here is "The jobs argument", as well as "The infant industry argument", as some of the economists pointed out that "losing manufacturing meant losing our [US] edge in innovation."

The preservation of the manufacturing has been a hot topic lately, due to the apparently quick surge from the recession by the countries with a strong manufacturing base, most notably Germany.

The emphasis on manufacturing explains why the higher tariffs have bi-partisan support: while it is usually the Democrats who favor higher taxes and oppose free trade/free market, it is the Republicans who are most concerned about the manufacturing and the workers employed in the private industry.

Current situation and Romney's economic plan

New Greg Mankiw's article in New York Times. Don't disregard it as merely "conservative thinking" - the first half of the article is an overview of the current economic situation which is unbiased and enlightening.

In the second part of the article Mankiw does express his view on the economic recovery: he opposes the "traditional fiscal stimulus", and instead argues for 1) lower taxation of income from corporate capital; 2) more pro-business policies, such as passing the free trade agreement with South Korea and reigning in the National Labor Relations Board, i.e. reducing unions's interference with businesses.

One may recognize the points of the economic plan recently unveiled by Mitt Romney - and indeed, Mankiw is apparently advising Romney's campaign on the economic matters.  

Taxes on the "rich": Common sense versus Economic analysis

Below are some additional thoughts regarding the ongoing debate on whether the "rich" should pay higher taxes in order to provide for the well-being of the "poor". I previously touched on the subject here.

(I put "rich" and "poor" in the quotation marks, since in the modern developed countries most of those who qualify for tax purposes as rich/poor are really the members of the middle class.)  

The common sense point of view is based on the concept of "social justice" - some people are more fortunate and should share with those who happened to be less lucky. This point can be perhaps made stronger by noting that the "rich" and their furtunes benefit from the protection of the state that they live in and therefore the state may demand from them to contribute a higher share.

Of course, the opposite argument can be made, based on the concept of "individual freedom": very often  wealth is a result of hard work put into earning and maintaining this wealth, so why should anyone share the results of his/her hard labor with others?

Of course, both of these points are philosophical and can hardly be convincing for the opponents of either. In addition, the debate nowadays is really not about whether the "rich" should help the "poor", but to which extent they should help: the tax-based government assistance ranges rom providing food and shelter to those who are truly poor to funding university scholarships and house-mortgages, which are really the benefits enjoyed by the middle class (although someone truly poor may call them "luxuries")

There are however some economic arguments which make clear that the "tax the rich" debate is not merely a matter of moral attitudes (as could be concluded from the political debates, where each side often blames the opponents for denying "social justice" or "personal freedom" .)

Here are two points to consider:

1. Tax incidence Who pays the tax? Most of the modern "rich" are owners of businesses who benefit from using other people's labor and selling the produce of their enterprize. The businesses minimize the reduction of their profits due to taxation by raising the prices, and lowering the wages or reducing the number of their employees. Thus, a part of the tax levied on the "rich" really falls on consumers and workers. How big is that part is apparently still debated by the economists. Yet, one should be aware that the "tax on rich" may really be more of a burden the "poor"

2. Laffer curve Raising the tax rates does not necessarily increase he revenue that the government receives from the taxes. This is exemplified by so-called "Laffer curve", which is based on a very simple logical argument:

Laffer curve

"The curve is constructed by thought experiment. First, the amount of tax revenue raised at the extreme tax rates of 0% and 100% is considered. It is clear that a 0% tax rate raises no revenue, but the Laffer curve hypothesis is that a 100% tax rate will also generate no revenue because at such a rate there is no longer any incentive for a rational taxpayer to earn any income, thus the revenue raised will be 100% of nothing. If both a 0% rate and 100% rate of taxation generate no revenue, it follows that there must exist at least one rate in between where tax revenue would be a maximum." [Emphasis mine]

If the tax rates are on the downward slope of the curve, then the way to increase the tax revenue is by reducing the rates rather than by increasing them! This observation led to what has become known as the "supply side economics", which was the basis for the tax policies of Ronald Reagan. The policies did not succeed, since every group of the society responds to tax insensitives differently: as the result of the Reagan's policies the revenues did not increase, but decreased. With the government spending on the same level as before this lead to the growing national deficite. 

Yet, Laffer curve may work, if the lower tax rates are applied to certain groups of society that respond to tax insensitives, and such a group of the society turns out to be... the "rich". Here is what Greg Mankiw's economics textbook says on the subject:

"Yet Laffer’s argument is not completely without merit. Although an overall cut in tax rates normally reduces revenue, some taxpayers at some times may be on the wrong side of the Laffer curve. In the 1980s, tax revenue collected from the richest Americans, who face the highest tax rates, did rise when their taxes were cut. The idea that cutting taxes can raise revenue may be correct if applied to those taxpayers facing the highest tax rates. In addition, Laffer’s argument may be more plausible when applied to other countries, where tax rates are much higher than in the United States. In Sweden in the early 1980s, for instance, the typical worker faced a marginal tax rate of about 80 percent. Such a high tax rate provides a substantial disincentive to work. Studies have suggested that Sweden would indeed have raised more tax revenue if it had lowered its tax rates." [Emphasis mine]

Thus, astonishingly, the tax cuts aimed specifically at the "rich" may raise tax revenue to the greater benefit of the "poor"!

In conclusion, I would like to reiterate my main point: the question of whether the rich should pay higher taxes is more than a philosophical discussion of "social justice" versus "individual freedom". Deeper economic arguments can be made to support the point of view that lower taxes on the wealthier members of the society can be beneficial to the poorer ones. In fact, we have to separate the question into two: i) whether the "rich" should be responsible for the well-being of the "poor", and, ii) if "yes", whether the greater benefit to the "rich" (i.e. lower tax rates on high-income earners) and the greater benefit to the poor (more government services due to the higher tax revenue) are mutually exclusive.