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Donald Marron

Women prepare to compete in a race in high heels in central Moscow in this file photo. (Sergei Karpukin/Reuters/File)

A tax on high heels?

By Guest blogger / 04.06.12

Among my idiosyncracies are two footwear anti-fetishes: I hate flip flops and high heels. I have never mastered the dark art of walking in flip flops, and I have always been troubled when women teeter at the edge of falling because of shoes designed for fashion (allegedly) rather than function.

Nonetheless, I enjoyed Thursday’s Wall Street Journal piece about the engineering, some would say architecture, of contemporary high heels. I was also pleased that columnist Christina Binkley emphasized some of the negatives early in her piece:

High heels can exact a heavy toll on the body, pushing weight forward onto the ball of the foot and toes and stressing the back and legs. Most doctors recommend a maximum height of 2 inches.

But with heels, many women trade comfort for style. Women spent $38.5 billion on shoes in the U.S. last year, according to NPD Group, and more than half of those sales were for heels over 3 inches high. High heels are seen as sexy and powerful. Stars on the red carpet clamor for the highest heels possible–leading designers who want their shoes photographed into an arms race for height.

That “arms race” comment got me to thinking. Perhaps there’s an externality here? Are women trying to be taller than other women? If Betty has 2 inch heels, does that mean Veronica wants 2 and a half inch heels? And that Betty will then want 3 inch heels? If so, high heels are an example of the kind of pointless competition that Robert Frank highlights in his recent book, “The Darwin Economy“. As noted in the book description:

[Such] competition often leads to “arms races,” encouraging behaviors that not only cause enormous harm to the group but also provide no lasting advantages for individuals, since any gains tend to be relative and mutually offsetting. The good news is that we have the ability to tame the Darwin economy. The best solution is not to prohibit harmful behaviors but to tax them. By doing so, we could make the economic pie larger, eliminate government debt, and provide better public services, all without requiring painful sacrifices from anyone.

Hence today’s question: Are high heels an example of such misguided competition? If so, should we tax them? (Bonus question: Should we tax noisy flip flops?)

P.S. The book description is not correct about the absence of “painful sacrifice.” Someone out there will still purchase such goods (otherwise there would be no revenue to ”eliminate government debt”), and there’s a good chance they will view their tax payments as a sacrifice.

A stack of Dictionaries of American Regional English, volume V: SI-Z, sit atop a desk during a press conference in Washington earlier this month. Marron argues that the words used to describe an economic policy may be justy as important as the policy itself. (Kevin Lamarque/Reuters)

Fiscal policy and the importance of word choice

By Guest blogger / 03.22.12

Rhetoric matters in economic policy debates. Would allowing people to purchase health insurance from the federal government be a public option, a government plan, or a public plan? Would investment accounts in Social Security be private accounts, personal accounts, or individual accounts? (See my post on the rule of three.) Are tax breaks really tax cuts or spending in disguise? Is the tax levied on the assets of the recently departed an estate tax or a death tax?

In an excellent piece in the New York TimesEduardo Porter describes another important example, how we characterize differences in income:

Alan Krueger, Mr. Obama’s top economic adviser, offers a telling illustration of the changing views on income inequality. In the 1990s he preferred to call it “dispersion,” which stripped it of a negative connotation.

 In 2003, in an essay called “Inequality, Too Much of a Good Thing” Mr. Krueger proposed that “societies must strike a balance between the beneficial incentive effects of inequality and the harmful welfare-decreasing effects of inequality.” Last January he took another step: “the rise in income dispersion — along so many dimensions — has gotten to be so high, that I now think that inequality is a more appropriate term.”

The Nasdaq Composite stock market index is seen inside their studios at Times Square in New York in this file photo. Marron argues that linking financial managers' pay so closely with market performance is unwise because of the amount of luck involved in market fluctuations. (Shannon Stapleton/Reuters/File)

Why finance heads shouldn't be judged by the market

By Guest blogger / 03.05.12

Harvard Business School professor Mihir Desai believes American companies and investment firms have erred–horribly–by linking manager compensation so tightly to financial market performance. In the current Harvard Business Review, he identifies this as a giant FIB, a Financial Incentive Bubble:

American capitalism has been transformed over the past three decades by the idea that financial markets are suited to measuring performance and structuring compensation. Stock-based pay for corporate executives and high-powered incentive contracts for investment managers have dramatically altered incentives on both sides of the capital market. Unfortunately, the idea of compensation based on financial markets is both remarkably alluring and deeply flawed: It seems to link pay more closely to performance, but it actually rewards luck and can incentivize dangerous risk-taking. This system has contributed significantly to the twin crises of modern American capitalism: governance failures that cast doubt on the stewardship abilities of U.S. managers and investors, and rising income inequality.

Mihir has nothing against well-functioning financial markets. He emphasizes that they “play a vital role in economic growth by ensuring the most efficient allocations of capital,” and he believes that capable managers and investors should be “richly rewarded” when their talents are truly evident.

The problem is that incentive compensation based on financial performance does a lousy job of distinguishing skill from luck. In finance-speak, managers and investors often get rewarded for taking on beta, when their pay really ought to be linked to alpha. In practice, luck gets rewarded with undeserved windfalls (that are by no means offset by negative windfalls for the unlucky). And that, he argues, results in an important ”misallocation of financial, real, and human capital.”

Well worth a read.

This file photo shows the Hortus Bulborum, a museum garden in Limmen Village, The Netherlands. In his book 'The Benefit and the Burden,' Bruce Bartlett suggests that the tax code needs constant tending, like a garden. (Dean Fosdick/AP/File)

How to design a coherent tax system

By Guest blogger / 02.27.12

The tax code is like a garden. Without regular attention, it grows weeds that will soon overwhelm the plants and flowers. Unfortunately, no serious weeding has been done to the tax code since 1986. In the meantime, many new plants and flowers have been added without regard to the overall aesthetic of the garden. The result today is an overgrown mess. There is a desperate need to pull the weeds, cut away the brush, and rethink some of the plantings to restore order, beauty, and functionality to the garden.

So begins Bruce Bartlett’s The Benefit and the Burden, an excellent guide to the promise and peril of tax reform.

Beauty is too much to ask of any tax system, but order and functionality are fair aspirations. As Bruce documents, however, we fall far short. Our code is too complex, unfair, and economically harmful. And it doesn’t raise enough revenue to pay the government’s bills.

Bruce takes readers on a tour of many crucial issues in designing a coherent tax system. How should we measure income? Should capital gains count? How should the tax burden vary with income? Are all tax cuts and increases created equal? What can we learn from other nations? Should we tax income or consumption? How should we think about the inevitable politics of choosing winners and losers?

Bruce’s writing is clear, concise, and crisp. And he provides excellent suggestions for further reading for those who want to delve deeper (I found several items to add to my reading list).

Highly recommended for anyone wanting a pithy introduction to the challenges of designing a tax system we can be proud of.

This chart shows the average tax rates faced by corporations in various industries, using data from the U.S. Department of the Treasury's Office of Tax Analysis for the years 2007-2008. (Donald Marron)

What we need to fix in the corporate tax code

By Guest blogger / 02.24.12

The President’s new Framework for Business Tax Reform is two documents in one. The first diagnoses the many flaws in America’s business tax system, and the second offers a framework for fixing them.

Much of the resulting commentary has focused on the policy recommendations. But I’d like to give a shout out to the diagnosis. The White House and Treasury have done an outstanding job of documenting the problems in our business tax system.

As the Framework notes, our corporate tax system pairs a high statutory tax rate with numerous tax subsidies, loopholes, and tax planning opportunities. Our 39.2 percent corporate tax rate (including state and local taxes) is the second-highest in the developed world, and will take over the lead in April when Japan cuts its rate. But our tax breaks are more generous than the norm.

That leaves us with the worst possible system – one that maximizes the degree to which corporate managers have to worry about taxes when making business decisions but limits the revenue that the government actually collects. It’s a great system for tax lawyers, accountants, and creative financial engineers, and a lousy system for business leaders and ordinary Americans. Far better would be to fill in the Swiss cheese of the tax base and move to a lower statutory rate, just as the President proposes (albeit with much more clarity about the rate-cutting than the cheese-filling and with proposals that would make some of the holes bigger).

A related problem is that our corporate tax system plays favorites among different businesses and activities, often with no good reason. To illustrate, Treasury’s Office of Tax Analysis calculated the average tax rates faced by corporations in different industries. As you can see in the chart above, the corporate tax really tilts the playing field.

I am at a loss to understand why the tax system should favor utilities, mining (which includes energy extraction), and leasing, while hitting services, construction, and wholesale and retail trade so hard. Why should the average retailer pay 31%, while the average utility pays only 14%?

These disparities are unfair and economically costly. Investors recognize these differences and allocate their capital accordingly. More capital flows to industries on the left side of the chart and less to those on the right. Far better would be a system in which investors deployed their capital based on economic fundamentals, not the distortions of the tax system.

The chart highlights one of the key battlegrounds in corporate tax reform. Leveling the playing field (while maintaining revenues) will require that some companies pay more so others can pay less. The U.S. Chamber of Commerce announced Wednesday that it “will be forced to vigorously oppose pay-fors that pit one industry against another.” But such pitting is exactly what will be necessary to enact comprehensive corporate tax reform.

P.S. The full names of the sector names I abbreviated in the chart are: Transportation and Warehousing; Agriculture, Forestry, Fishing, and Hunting; Finance and Holding Companies; and Wholesale and Retail Trade.

Senate Majority Leader Harry Reid is seen during a news conference to talk about an accord on the payroll tax cut negotiations, Thursday, Feb., 16, 2012, on Capitol Hill in Washington. Tax reform has been a hotly contested issue on Capitol Hill. (Pablo Martinez Monsivais/AP)

Five principles for fixing America's tax system

By Guest blogger / 02.17.12

The International Economy recently invited me to contribute to a forum on how best to fix America’s tax system. Here’s my piece; for eleven other views, check out the complete forum.

America’s tax system is a mess. It’s needlessly complicated, economically harmful, and often unfair. And it doesn’t raise enough money to pay our bills. That’s why almost everyone agrees that tax reform should be a top priority. Democrats, Republicans, and independents. Accountants, lawyers, and economists. Elected officials and ordinary citizens. All know our tax system is deeply flawed.

Unfortunately, they don’t agree on how to fix it. Some want revenue-neutral tax reform, while others want higher revenues to cut deficits and pay for rising entitlement spending. Some want to fix the income tax, while others want to tax consumption. Some want to cut tax rates across the board, while others would lift rates for high earners.

Public discourse, meanwhile, is hung up on the idea of attacking “loopholes” when the real action is in tax breaks that benefit millions of taxpayers. Tax reform isn’t just about corporate jets or carried interest. It’s about the mortgage interest deduction, the tax exemption for employer provided health insurance, and generous tax incentives for debt-financed corporate investment. Those policies have major flaws, but they are not loopholes. They reflect fundamental economic and social choices, and they benefit well-defined constituencies.

Tax reform will thus involve a prolonged political struggle, as reformers seek some compromise that can attract enough support to overcome the inevitable inertia against change. That won’t be easy, but given our sky-rocketing debt, weak recovery, and flawed tax system, it’s clearly worth the effort.

Even as they seek a reasonable compromise, reformers should continue to articulate their visions of an ideal tax system. Mine would reflect five principles. First, the government should raise enough money to pay its bills. That likely means higher revenues, relative to GDP, than we’ve had historically. Second, it’s better to tax bads rather than goods. That means greater reliance on energy and environmental taxes. Third, it’s better to tax consumption than income; policymakers should thus limit how much they tax saving and investment. Fourth, the tax burden should be shared equitably both across income levels and among people of similar means who make different choices (for example, renting versus owning a home).

Finally, the best tax systems have a broad base and low rates. Policymakers should thus emphasize cutting tax breaks rather than raising tax rates. Indeed, some rates, like the 35 percent rate on corporate profits, should come down.

To afford such cuts, policymakers should go after the dozens of deductions, credits, exclusions, and exemptions that complicate the code and narrow the tax base, often with little economic or social gain. Many of these provisions have been sold as tax cuts, but are really spending in disguise. They should get the same scrutiny that policymakers devote to traditional spending programs.

Berkshire Hathaway Chairman Warren Buffett wanders at the company trade show before his company's annual meeting in Omaha, Nebraska in this file photo. Increasing taxes on the wealthy would bring fairness to U.S. taxpayers across the board, billionaire investor Buffett has said. (Rick Wilking/Reuters/File)

How would the 'Buffett rule' affect marginal tax rates?

By Guest blogger / 02.16.12

President Obama’s latest budget endorses a “Buffett rule” – a new floor on taxes paid by folks with very high incomes. His rule would require that “those making over $1 million should pay no less than 30 percent of their income in taxes.”

The president didn’t offer many specifics about how the rule would actually work. Up on Capitol Hill, however, Senator Sheldon Whitehouse and Representative Tammy Baldwin have  introduced legislation that would implement a 30% minimum tax. That legislation addresses key technical issues such as which taxes to include, what measure of income to use, and how to phase-in the tax so that there isn’t a giant spike when someone’s income rises from $999,999 to $1 million. For more information, including TPC’s estimates of the distributional impacts, please see this post by TPC’s Roberton Williams.

TPC”s Daniel Baneman has examined how the PFSA would affect marginal tax rates — i.e., the effective tax rate that would apply if a person earned an additional dollar. Here’s his chart comparing the PFSA to current policy (i.e., the taxes that would be in effect if all the expiring tax cuts get extended at the end of the year, except for the payroll tax holiday):

As you can see, the Buffett rule would have little effect on the tax rate on wages and salaries. The real action is in capital gains:

Effective marginal tax rates on capital gains would nearly double from 18 percent (under current policy) to 34 percent for taxpayers with incomes between $1 million and $2 million, and would climb to 29 percent for taxpayers with incomes over $2 million. That jump shouldn’t come as a surprise. As Warren Buffett has been telling us, high-income taxpayers who face low tax rates tend to have lots of capital gains, which are currently taxed far below the fair share tax rate of 30 percent. (If you’re wondering, taxpayers with incomes between $1 million and $2 million face a higher effective marginal rate than taxpayers with incomes over $2 million because the fair share tax phases in over that range.)

If investors ever expect that the Buffett rule will actually go into effect, expect them to realize lots of capital gains early. Update (I forgot to include the second half of that thought): After that, realizations will be significantly lower than they would be under current tax rules. That cuts into the potential revenue from the Buffett rule.

A postal worker walks through falling snow to deliver mail in the Chinatown neighborhood of New York. According to a recent CBO report, federal workers, make more on average than theri private sector counterparts . (Mary Altaffer/AP)

Do federal workers get paid more than private ones?

By Guest blogger / 01.31.12

Yes, according to a new report by the Congressional Budget Office. As always in such comparisons, however, there are some caveats.

CBO summarizes its main results in this handy chart.

Report author Justin Faulk summarizes the findings as follows:

Differences in total compensation—the sum of wages and benefits—between federal and private-sector employees also varied according to workers’ education level.

Federal civilian employees with no more than a high school education averaged 36 percent higher total compensation than similar private-sector employees.

Federal workers whose education culminated in a bachelor’s degree averaged 15 percent higher total compensation than their private-sector counterparts.

Federal employees with a professional degree or doctorate received 18 percent lower total compensation than their private-sector counterparts, on average.

Overall, the federal government paid 16 percent more in total compensation than it would have if average compensation had been comparable with that in the private sector, after accounting for certain observable characteristics of workers.

Of course, a lot is riding on the phrase “certain observable characteristics.” CBO did an extremely careful job of measuring total compensation and of controlling for observable factors such as education, age, and occupation. But many other factors are impossible to measure. CBO’s summary mentions effort and motivation. There are also issues such as job security and developing valuable skills and knowledge.

In this file photo students from the University of Rochester graduate at the Eastman Quadrangle in Rochester, NY. Professor Sebastian Thrun aims to teach a class of 500,000 students. (Melanie Stetson Freeman/The Christian Science Monitor/File)

Can one professor teach 500,000 students at once?

By Guest blogger / 01.27.12

That’s what former Stanford professor Sebastian Thrun aims to do.

Sound impossible? Well, he’s already taught a class of 160,000 students. As Felix Salmon recounts:

Thrun told the story of his Introduction to Artificial Intelligence class, which ran from October to December last year. It started as a way of putting his Stanford course online — he was going to teach the whole thing, for free, to anybody in the world who wanted it. With quizzes and grades and a final certificate, in parallel with the in-person course he was giving his Stanford undergrad students. He sent out one email to announce the class, and from that one email there was ultimately an enrollment of 160,000 students. Thrun scrambled to put together a website which could scale and support that enrollment, and succeeded spectacularly well.

Just a couple of datapoints from Thrun’s talk: there were more students in his course from Lithuania alone than there are students at Stanford altogether. There were students in Afghanistan, exfiltrating war zones to grab an hour of connectivity to finish the homework assignments. There were single mothers keeping the faith and staying with the course even as their families were being hit by tragedy. And when it finished, thousands of students around the world were educated and inspired. Some 248 of them, in total, got a perfect score: they never got a single question wrong, over the entire course of the class. All 248 took the course online; not one was enrolled at Stanford.

And I loved as well his story of the physical class at Stanford, which dwindled from 200 students to 30 students because the online course was more intimate and better at teaching than the real-world course on which it was based.

 Inspired by that experience, Thrun has now founded Udacity, a private online university. As Nick DeSantis of the Chronicle of Higher Education reports:

One of Udacity’s first offerings will be a seven-week course called “Building a Search Engine.” It will be taught by David Evans, an associate professor of computer science at the University of Virginia and a Udacity partner. Mr. Thrun said it is designed to teach students with no prior programming experience how to build a search engine like Google. He hopes 500,000 students will enroll.

Teaching the course at Stanford, Mr. Thrun said, showed him the potential of digital education, which turned out to be a drug that he could not ignore.

“I feel like there’s a red pill and a blue pill,” he said. “And you can take the blue pill and go back to your classroom and lecture your 20 students. But I’ve taken the red pill, and I’ve seen Wonderland.”

That Wonderland will be a serious challenge to traditional chalk-and-talk universities — and a wonderful opportunity to democratize knowledge around the globe.

Republican presidential candidate Mitt Romney delivers his rebuttal to U.S. President Barack Obama's State of the Union address at American Douglas Metals in Orlando, Florida. Romney expects to be taxed at the 15% rate this year. (Brian Snyder/Reuters )

The days of the 15 percent tax rate are numbered

By Guest blogger / 01.25.12

The top tax rate on long-term capital gains is currently 15%. That’s why Mitt Romney is spending so much time talking about his tax returns.

That revelation has set off a familiar debate about whether that low rate is appropriate. Often overlooked in these discussions, however, is the fact that the days of the 15% tax rate are numbered. As of this posting, it has only 342 left.

On January 1, 2013, capital gains taxes are scheduled to go up sharply.

First, the 2001 and 2003 tax cuts are scheduled to expire. If that happens, the regular top rate on capital gains will rise to 20%. In addition, an obscure provision of the tax code, the limitation on itemized deductions, will return in full force. That provision, known as Pease, increases effective tax rates on high-income taxpayers by reducing the value of their itemized deductions. On net, it will add another 1.2 percentage points to the effective capital gains tax rate for high-income taxpayers.

And that’s not all. The health reform legislation enacted in 2010 imposed a new tax on the net investment income of high-income taxpayers, including capital gains. That adds another 3.8 percentage points to the tax rate.

Put it all together, and the top tax rate on capital gains is scheduled to increase from 15% today to 25% on January 1. That’s a big jump. If taxpayers really believe this will happen, expect a torrent of asset selling in November and December as wealthy taxpayers take final advantage of the lower rate.

Of course, the tax cuts might get extended for all Americans, including high-income taxpayers. That’s what happened in 2010. In that case, the increase in the capital gains rate will be smaller. Because of the health reform tax, the top capital gains tax rate will increase from 15% to 18.8%. That’s still a notable increase, but would likely set off much less tax-oriented selling this year.

The only way that the top capital gains tax rate remains at 15% will be if the tax cuts are extended for high-income taxpayers and the new health reform tax gets repealed. That’s a key distinction in the election: President Barack Obama opposes those steps, while the GOP presidential candidates favor them (and some candidates would cut the capital gains tax rate even further).

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