Tax VOX
A stock trader checks out a graph showing activity of the euro currency against the US dollar in a business bank in Paris in December. France now discourages some forms of high-frequency trading by imposing a tax on trades that are created and then canceled. (Michel Euler/AP/File)
In France, high-frequency traders now get taxed for fictitious orders
Following the 2008 financial sector collapse, Europeans have been slowly moving, somewhat in concert, towards new financial transactions taxes. Last week, France jumped the gun: it initiated a package of financial transaction taxes all on its own that includes a novel tax on high frequency stock orders.
The high frequency tax applies to traders that (1) use computer algorithms to determine the price, quantity, and timing of their orders (2) use a device to process these orders automatically, and (3) transmit, modify, or cancel their orders within half a second (the half a second has been set by draft administrative guidance). The high frequency tax is .01% on the amount of stock orders modified or cancelled that exceeds 80% of all orders transmitted in a month (under the draft administrative guidance). In effect, France now may tax orders that are not filled. It has created a “non-transaction” tax.
France’s high frequency tax would effectively limit a variety of “layering” techniques, which high frequency traders sometimes use to manipulate the market. For instance, traders may enter multiple fictitious orders to drive a stock price up or down, and then cancel their orders.
Because the high frequency tax targets activities that may harm markets, but leaves other activities untaxed, the levy is more focused than a conventional financial transactions tax. However, it taxes only some trading activities but not others, such as fat fingers or momentum trading, which might be viewed as harmful. Also, the new high frequency tax applies only to operations in France (conducted through a permanent establishment or a subsidiary), and few high frequency traders operate in France. More thought on the scope and the application of a high frequency tax might be worthwhile.
France also adopted a more conventional financial transactions tax, at a rate of .20%, which is higher than the .10% recommended by the European Commission to the EU (and the .03% proposed by Harkin/DeFazio in the U.S.). However, the French transactions tax is much narrower than other proposed financial transaction taxes: the French tax applies only to stock in large capitalized French companies, and not to bonds or derivatives (other than certain credit default swaps on sovereign debt). France was eager to move a financial transactions tax forward, but not at the price of losing its entire financial sector.
For an earlier blog on financial services taxes and background material from our panel discussion on these taxes, click here.
Team USA celebrate at the victory ceremony after winning the gold medal at the women's eight finals rowing event during the London 2012 Olympic Games Last week. Gleckman argues that Olympics earnings should be taxed like any other income. (Darren Whiteside/Reuters/File)
Tax-exempt Olympic medals? That's silly.
President Obama and conservative GOP senator Marco Rubio (R-FL) agree: Olympic medals and the cash awards that go with them should be tax-exempt. This is the dumbest idea of the summer—and in our overheated campaign season, that’s saying something.
The idea seems to have originated with anti-tax advocate Grover Norquist. Rubio instantly turned Norquist’s press release into a bill. By yesterday, Obama had his spokesman join in the pandering, perhaps hoping that a bit of the game’s nationalistic enthusiasm would rub off of his presidential campaign.
What’s going on here? U.S. athletes who win their competitions get two forms of direct compensation. First, of course, is their medal—gold, silver, or bronze. The commodity value of the hardware is very modest, ranging from perhaps $700 for gold to about $5 for bronze. Second, the U.S. Olympic Committee (not the U.S. government) pays a cash bonus of $25,000 for gold, $15,000 for silver, and $10,000 for bronze. Those winnings are taxable just like any other income. The Rubio bill would make them tax-exempt. If you want to know more, PolitiFact has a nice, more detailed description.
I suspect much of the support for this silly idea is based on the mostly-outdated myth of the self-sacrificing amateur athlete who gives up all in the Olympic spirit. Chariots of Fire and all that.
But the dons who run the Olympics have let professionals compete for more than 40 years. As a result, many of those who would benefit from this tax cut are as far from amateurs as one could imagine. LeBron James, for instance, made $57 million last year in salary and endorsements. Kobe Bryant made $52 million. Michael Phelps made $10 million. Does BronBron really need an $8,700 tax cut? Seriously?
And even those winners who have not yet cashed in will do so soon enough. As Gabby Douglas is about to learn, a gold medal and a nice smile is worth untold bucks on Madison Ave.
Are there still U.S. athletes who compete for the love of their sport, and make great personal and financial sacrifices to participate in the Olympics? Absolutely. Many medal-quality athletes now have sponsors who pay most of their expenses but some, especially those in minor sports, must work temporary or part-time jobs to pay the rent while training.
The thing is, those self-sacrificing athletes won’t be helped very much by this new bill. A single person whose only income is her $25,000 cash award and who has no deductions would owe about $1,900 in federal income tax. But, of course, a world-class athlete would likely have many deductible expenses—for coaching, travel, equipment and the like. It is not unreasonable to suspect that in the real world, many of those low-income non-professional athletes already owe little or no tax on their Olympic cash bonus.
Let’s not kid ourselves, the Olympics is big business. Paying athletes performance bonuses for winning medals is no less commercial than anything else the Olympic bosses do. But why this extra cash should be tax-free escapes me. At least hedge fund operators have to pay capital gains taxes on their bonuses.
As my colleague Eric Toder reminds me, there once was a time when this sort of special tax treatment was slipped into revenue bills by high-paid lobbyists in the dark of night. Now, the code has been so corrupted that pols propose this junk without even being asked. For that, I suppose, they deserve the gold medal of stupid tax tricks.
This chart compares economist Robert Cherry's New Mothers Tax Relief Proposal to the tax credit currently in place – the EITC. Married parents in particular would benefit greatly from Cherry's plan. (Tax Policy Center (TPC))
New plan expands EITC benefits for families with children
The Earned Income Tax Credit (EITC) provides a significant income boost to low-income single-parent families, but can severely penalize those families if the parent marries. A new plan from Brooklyn College economist Robert Cherry could sharply reduce that problem while sharply increasing benefits for families with young children – particularly those with married parents.
Analysts consistently find that the EITC encourages work and reduces poverty. Recent evidence shows that EITC receipt is correlated with improved health outcomes for infants. But the credit is not all roses. A major problem is the marriage penalty embedded within the structure of the EITC. Taken to the extreme, if a single mom of three children earns $17,090, her EITC totals almost $6,000. If she marries a partner who earns more than $5,210, her EITC falls by just over 21 cents for every dollar his earnings exceed that threshold. If he earns $32,970 or more, she loses her EITC entirely.
Many analysts, including myself, have offered ideas for reducing or eliminating marriage penalties in the EITC, essentially by developing an individual worker credit and a child credit, rather than combining the two.
Cherry’s New Mothers Tax Relief (NMTR) proposal is more modest and would focus on marriage penalties that the EITC imposes on single parents. The proposal would be limited to parents with at least one pre-school aged child. While the NMTR does not increase the maximum EITC benefit, it does increase the income range over which the maximum benefit applies. For single-parent families, the NMTR (solid gray line in graphic) would start to phase out at a slightly higher income level than the current EITC ($18,000 rather than $16,690) and the phaseout rate would decline from the current 15.98 percent to 12 percent. Ultimately, this means that single-parent families would continue to receive a credit until earnings reached almost $44,000, rather than just over $36,000.
Benefits would rise much more for married couples. The proposal would increase the phaseout threshold for couples from not quite $22,000 to $40,000 and would reduce the phaseout rate from 15.98 percent to 6 percent to mitigate any remaining marriage penalties. Cherry contends that this would allow low-income parents to decide about marriage based on factors other than economic incentives in the tax code. At the extreme, the plan would allow a married couple to keep their entire EITC. For parents with 1 child, this is almost $3,100 – when under current law they would lose their EITC entirely.
Besides mitigating marriage penalties, the NMTR would also substantially increase the EITC for many parents with a young child – getting needed funds to lower middle class married families. If the proposal were limited to families with a child under age 3, Cherry estimates an annual cost of $8.5 billion. If the proposal were limited to families with a child under age 6, the annual cost of the proposal would be $15 billion. For reference, TPC estimates the total cost of the EITC in 2011 to be $57.5 billion.
This plan doesn’t go as far as others in separating out work and child incentives – and focuses on a very narrow population (families with a pre-school aged child), but it certainly provides for another way to improve the EITC for vulnerable low-income families by increasing benefits and reducing marriage penalties. The plan serves as a reminder that while the EITC continues to provide essential support to low-income families, there’s still room for improvement.
In this July 18, 2012 file photo, Republican presidential candidate, former Massachusetts Gov. Mitt Romney speaks in Bowling Green, Ohio. According to Gleckman, Romney's tax proposal is full of contradictions, even if it doesn't include the middle class tax hike the Obama camp claims. (Evan Vucci/AP/File)
Mitt Romney's tax plan doesn't add up
A new paper by Brookings Institution scholars and Tax Policy Center colleagues Bill Gale, Adam Looney, and Samuel Brown is generating lots of media buzz. Even Barack Obama has has put his spin on it with a campaign ad that says if you are middle class, Mitt Romney wants to raise your taxes by up to $2,000 even as he cuts taxes for rich people like himself.
That is a powerful political message, but it isn’t how I read the Gale-Looney-Brown paper. To me, the study highlights something else: The deep contradictions embedded in Romney’s tax platform. Like most candidates, the former Massachusetts governor has made many promises. And like most, he cannot keep them all.
In this case, Romney has promised at least five big things. They are:
- To start, he’d make all of the 2001 and 2003 tax cuts permanent but repeal the 2009 Obama tax cuts and the tax increases included in the 2010 health reform law.
- After that, he’d cut tax rates by 20 percent across the board and eliminate both the Alternative Minimum Tax and the estate tax.
- He’d eliminate taxes on investment income for couples making $200,000 or less (individuals making $100,000 or less) and keep current low rates for those with high incomes.
- He’d do this without increasing the budget deficit (beyond the cost of extending the 2001-2003 tax cuts) by curbing some tax preferences.
- He’d do it in a way that retains the progressivity of today’s tax system.
Romney’s problem is he cannot possibly achieve all of these goals. He is doomed by both political reality and simple mathematics.
Romney himself never says how he will make all this happen. Indeed, his tax platform includes a gaping hole. He says he’d finance these rate cuts by broadening the tax base–that is, by reducing some of the tax preferences that litter the Revenue Code. But he never says which of these deductions, credits, or exclusions he’d scale back—or how.
Thus, the real question is not whether Romney is proposing a huge middle-class tax increase (he isn’t). It is which of his ambitious campaign promises he will fail to keep.
That was the exercise that Brown, Gale and Looney engaged in. To show how hard it would be for Romney to achieve all of these goals, they assumed he’d keep his first four promises. If he did, they found it would be impossible for Romney to retain today’s levels of progressivity. Or, to say it another way, if Romney keeps the promises he has explicitly made, the middle class will pay higher taxes and the rich will pay lower taxes.
That’s because cutting rates this deeply without adding to the deficit or raising taxes on capital income would require massive cuts in those popular tax preferences that overwhelmingly benefit the middle- and upper middle-class. Brown, Gale, and Looney figure that tax breaks such as the deductions for mortgage interest and charitable giving or the exclusion for employer sponsored health insurance would have to be cut by as much as 65 percent for Romney’s plan to add up.
While their numbers are slightly different, their basic conclusion is the same as my TPC colleagues Eric Toder, Jim Nunns, Bob Williams, and Hang Nguyen reached in their own paper a couple of weeks ago: You just can’t cut rates this deeply without either adding to the deficit or making steep, exceedingly painful cuts in tax preferences.
Of course, Romney doesn’t have to raise taxes on the middle-class. He could fix this problem with less ambitious rate cuts on ordinary income, or by raising taxes on capital income. He could pay for his initiative outside of the individual income tax system by increasing corporate taxes—though he says he’d cut them. He could cut spending even more deeply than he’s already promised, though that would hurt low- and middle-income households too. Or he could just add to the deficit.
Thus, the right question to ask Romney is not whether he wants to raise taxes on the middle-class. The right question to ask is which of his campaign promises he will abandon.
This BEA chart shows the annual contribution of state and local spending t the Gross Domestic Product (GDP) since 2009. Since 2010, the lack of spending has negatively affected GDP. 2012 is on track to be a bigger drain than the previous three years. (Bureau of Economic Analysis (BEA))
State and local budget cuts hurt the recovery
On Friday, the Bureau of Economic Analysis released its first look at Gross Domestic Product and its components for the second quarter of the year plus revisions going back to 2009. Those data confirmed that weak government spending continues to hamper the economy. In the second quarter, government spending declines subtracted more than a quarter point from GDP growth, almost exclusively from the state and local government sector.
State and local spending cuts also dragged the economy down in 2010 and 2011. In 2011, the state and local sector contracted 3.4 percent, the largest decline since World War II.
On Friday, the Bureau of Economic Analysis released its first look at Gross Domestic Product and its components for the second quarter of the year plus revisions going back to 2009. Those data confirmed that weak government spending continues to hamper the economy. In the second quarter, government spending declines subtracted more than a quarter point from GDP growth, almost exclusively from the state and local government sector.
State and local spending cuts also dragged the economy down in 2010 and 2011. In 2011, the state and local sector contracted 3.4 percent, the largest decline since World War II.
The level of state and local spending in 2010 was revised up by a similar amount, so the rate of decline from 2009 to 2010 remained the same at 1.8 percent. The pace of decline in 2011, however, increased by over one percentage point. Instead of state and local government spending contracting by 2.2 percent it turns out the contraction was 3.4 percent. By late 2010 and 2011, the ARRA money was mostly spent, revenues were still well below the peak and states began cutting expenditures in earnest. Many of the cuts in spending were not done as part of the normal budget process. The National Association of State Budget Officers reported in its Spring 2012 Fiscal Survey of States that in fiscal year 2010, 39 states made mid-year budget cuts and 19 made mid-year cuts in FY 2011. Given the urgent nature of the changes required over the last four years, it is likely that the accounting for the crisis is not yet complete.
Beverly Voss, of Yukon, Okla., searches for a gift for a child as a volunteer in the Salvation Army Angel Tree program, at a warehouse in Oklahoma City,in this December 2011 file photo. The program serves 2,000 families with Christmas items and food for the holiday season. Gleckman argues that the tax-exempt status of large public charities like the Salvation Army deserves a second look. (Sue Ogrocki/AP/File)
Should charities still be tax-exempt?
Here’s a word association game: I say tax-exempt public charity. You say house of worship, soup kitchen, or university. You probably don’t think about secret back-room political operations or multi-billion dollar businesses. But you should.
Increasingly, these organizations are straying from the charitable work that drove Congress to grant them tax-exempt status in the first place. Instead, they are using the law to avoid tax on business profits or mask the identities of big-bucks campaign donors who finance increasingly nasty, but entirely anonymous, political ads.
Yesterday, while most tax wonks were focused on the Senate’s largely symbolic votes on the fate of the 2001-2010 tax cuts, the House Ways & Means Oversight subcommittee was holding an important hearing on the arcana of tax-exempt public charities. And the panel heard, in great, sad detail, how charities are abusing the spirit, if not the letter, of the law.
Let’s take two examples:
The first is the growing commercial activity of charities. As University of Illinois Law Professor John D. Colombo told the subcommittee, such business is booming. “It is increasingly common,” Colombo said, “to find charities engaged in a variety of economic activities through for-profit subsidiaries, joint-venture partnerships, and contractual arrangements.”
In theory, charities are required to pay tax, called the unrelated business income tax, on this revenue. They can even lose their tax-exemption for such aggressive business activities. But they almost never lose their exemption and they rarely pay the tax.
Once, this issue applied to income from college bookstores. Now, it is big business. Colombo described one non-profit Pennsylvania health system that controlled eight tax-exempt entities and three for-profit corporations. Then, there are non-profits such as the National Football League and the U.S. Olympic Committee that arguably exist only as commercial enterprises.
Colombo argued that this trend raises many important concerns, including unfair competition between non-profits and for-profits, the erosion of the corporate tax base, and the loss of focus by charity management.
The second issue, and one that is getting lots of attention in this heated election season, is the aggressive use of the public charity law by political operatives. Through a chain of immensely complex arrangements, these groups have been able to organize themselves in a way that allows their funders to make unlimited, entirely anonymous contributions to political campaigns.
The thread is mind-numbing. But Ohio State University Law Professor Donald B. Tobin walked the committee through the maze. First, keep in mind that the tax laws prohibit public charities from engaging in political advocacy. However, the IRS does allow tax-exempt social welfare organizations—organized under a different section of the Tax Code–to lobby or advocate for issues. Unlike charities, donors can’t deduct their contributions to these groups. However the organizations themselves do not have to pay tax on their income.
These social welfare groups can even create separate funds to engage in political activities. However, they must disclose the names of their contributors—exactly what the political operatives want to avoid. So, smart lawyers figured out a way to keep contributors’ names secret by laundering funds directly through the social welfare organizations themselves. This requires them to claim they are engaged in issue advocacy and not politics, and assertion that would surprise anyone who watches the ads they fund.
Tax-exempt organizations won’t be immune from the debate over tax reform, and their special treatment may be jeopardized as Congress looks for ways to broaden the tax base. The more public charities use their tax-exemption to avoid tax on regular business income or mask political operations, the more they will put that special treatment at risk.
President Barack Obama greets students after he called on Congress to stop interest rates on student loans from doubling next month during a news conference in the East Room of the White House in Washington,in this June 2012 file photo. Rueben argues that though college education should be a top priority, the government isn't paying for it in the most efficient way. (Susan Walsh/AP/File)
Do higher education tax credits make sense?
Higher education is a good investment, even though some new grads currently struggling to get jobs don’t think so. But does it make sense for the federal government to subsidize college with both tax incentives and direct grants? And if it doesn’t, which program should it dump?
There is a strong case that the government should keep and enhance the Pell Grant program, which is the main form of direct assistance for low-income kids. At the same time, it may be time to eliminate or at least consolidate some of the confusing collection of education tax credits.
That, at least was the consensus among witnesses at a recent hearing at the Senate Finance Committee. Experts ranging from Sue Dynarski of the University of Michigan, Scott Hodge of the Tax Foundation and James White of the Government Accountability Office all argued that the credits needed to be reformed.
There are currently 14 tax benefits available for college students and their parents. These include three broad classes – tax benefits for tuition and related expenses , tax benefits for student loans, and tax benefits for education savings plans. Basically benefits for before, during and after college attendance. JCT estimates the cost to the federal government of these tax benefits to be $95.3 billion between 2010 and 2014.
The size of these programs and direct federal grants have rapidly expanded in the last few years. Spending on Pell Grants has doubled – from $18.3 billion in 2008 to $36.5 billion in 2010, reflecting more generous programs and expanded enrollment during the recent recession. Likewise, spending on education tax credits doubled from $9 billion in 2008 to $18 billion in 2009.
Increasing enrollment and encouraging students to complete college, especially for students from low-income families, is one of the best ways to address growing income inequality. According to Dynarski, college attendance rates vary dramatically by income group, with only 9% of children born in the lowest income quartile earning a BA compared to 54% of children born in the top quartile. This gap has increased in the last 20 years.
Does the current panoply of programs, including grants and tax incentives, further the goal of increasing college attendance? While there is some evidence that Pell Grants help, there is little evidence that tax credits do.
The current programs and options are too complicated and families regularly select the wrong tax credit or program or fail to apply at all. The other problem is timing: A student may not see see the benefit of the tax break for up to 18 months after she must pay her tuition. While Dynarski thinks the solution is to simplify the credits and change the timing of delivery, I agree with Hodge that we would be better served by eliminating the tax credits. We could use some of the savings to protect the recent expansion of Pell grants. While we’re at it, we should simplify the Pell application process too.
Unfortunately, we are flying blind in our efforts to reform these subsidies. There are limited data to help evaluate the effects of these programs, including recent expansions. We know little about what the grants and credits mean for students over time. A key question is whether either or both programs result in higher tuition.
One big step forward: The IRS and Department of Education could coordinate their data so we could better understand how these programs work. More importantly, coordination could result in simpler forms for students and their families.
Helping low-income kids get to—and finish–college should be a top priority. But Congress needs to find the most cost-effective way to do that. And the belt-and suspenders approach of grants and tax subsidies may fail the efficiency test.
Vice President Joe Biden joins the Senate's Democratic leadership after passing their version of a yearlong tax cut extension, at the Capitol in Washington, Wednesday, July 25, 2012. According to the Congressional Budget Office, the Democrats' tax proposal would mean a tax increase for the wealthiest Americans, while a competing plan from the GOP would mean a lower tax bill for the richest households. (J. Scott Applewhite/AP)
Dueling tax bills: What each Senate proposal means for you
As early as today, the Senate is likely to vote on the first of two competing efforts to temporarily extend tax cuts passed between 2001 and 2010. Neither the Democratic nor Republican measures will pass in the hyper-partisan Senate, but it is instructive to see how the measures stack up.
The short summary: The Democrats would increase the deficit by $250 billion, while the GOP would add about $405 billion, compared to what would happen if all of the tax cuts expire on schedule at the end of 2012. Under either plan, nearly all taxpayers would pay less than if the tax cuts are allowed to expire. However, the highest-income households would, on average, pay about $340,000 less under the GOP plan than with the Democrats’ version.
But the story is more complicated. In their still-evolving bill, the Democrats left out two changes they have long supported–continuing to protect millions of middle- and upper-middle income families from the Alternative Minimum Tax and preventing the estate tax from returning to its pre-2001 level. If you include both, the Senate Democrats would cut taxes by $368 billion compared with today’s rules.
To help sort it out, my colleagues at the Tax Policy Center have put together a nice cheat sheet that summarizes the two bills. In addition, TPC has looked at how the measures would affect households in various income groups and, using Joint Committee on Taxation estimates, how much each plan would cost the Treasury in lost revenue.
Both plans extend most of the last decade’s tax cuts for another year (and in some cases two). But there are some big differences.
Senate Republicans would allow nearly all of the 2001/2003/2010 tax cuts to continue through at least 2013. As promised, they’d keep low rates on both ordinary and investment income. They would retain an estate tax but only on bequests in excess of $5 million, and at a 35 percent rate. It also appears as if they’d allow a package of low-income tax cuts enacted in 2009, including expansions of the Earned Income Tax Credit and the Child Tax Credit, to expire.
As a result, an average household would pay about $2,000 less than if Congress allowed all the tax cuts to expire. Middle income households would pay about $1,100 less. However, the highest-income 0.1 percent (those making more than $2.8 million) would be on average $391,000 better off than under current law.
For their part, Senate Democrats would extend all the tax cuts for those making $200,000 (couples making $250,000) or less. However, they’d let most tax cuts expire for high-income taxpayers.
In the Democrats’ plan, the top two rates would revert to 36 and 39.6 percent. Capital gains and dividends would be tax-free for those in the bottom two tax brackets, taxed at 15 percent for those in the 25, 28, and 33 percent brackets, and taxed at 20 percent for those in the top two brackets. The Democrats would extend the AMT patch for 2012 only (the AMT fix technically expired at the beginning of this year).
However, TPC also estimated the impact of extending AMT fix for both 2012 and 2013 and extending the 2009 estate tax levels (a $3.5 million exemption and a 45 percent rate).
If the Democrats did both, their overall plan would cut taxes by an average of about $1,700, a bit less than the $2,000 break under the GOP plan. Middle-income households would pay about $1,200 less, slightly more than if the Rs had their way. However, the highest-income 0.1 percent would pay about $54,000 more on average than under current law but almost $340,000 more than they would under the GOP plan.
Of course, if you assume that most of today’s tax rules are still in place, which the GOP will, the Democrats’ plan looks like a tax increase for top earners. Low- and middle-income households would pay the same. But about 1.4 percent of taxpayers, all with high incomes, would pay more. Those at the very top would pay about $340,000 more in 2013 than under today’s system.
If you think of these bills as political markers, the messages are quite clear. And they will give both parties plenty of ammunition for the coming campaign. And that, after all, is the point of the exercise.
Senate Majority Leader Harry Reid (D) of Nevada talks to reporters following a political strategy session at the Capitol in Washington last week. Senate Democrats are poised to keep taxes low on dividends, despite mixed evidence that it low rates have helped the economy. (J. Scott Applewhite/AP/File)
Even Senate Democrats may keep dividend taxes low
Senate Democrats, who will vote this week to allow most of the 2001/2003 tax cuts to expire for high-income households, are likely to make an exception for capital gains and dividends.
Under their proposal even top bracket taxpayers would pay a maximum rate on this investment income of 20 percent in 2013 (plus an additional 3.8 percent under the tax provisions of the 2010 health law). That would be far below the rate on ordinary income, which Democrats would restore to 39.6 percent.
Their choice is interesting, especially since the evidence is mixed at best on whether the big tax cuts on investment income in 2003 did much to help the economy. Indeed, economists still don’t agree on how much the 2003 dividend tax cut boosted payouts to shareholders, and whether it was good for economic growth or not.
Some of the nation’s best tax economists have been peering at the data for a decade and the most they agree on is that firms did increase dividends after the tax cut passed. But did the tax cut cause the change? That, it seems, is the matter of more than a little debate. University of Illinois economist Dhammika Dharmapala has a nice summary of the research in the book “Tax Policy Lessons from the 2000s” edited by Alan Viard (AEI Press, 2009)
To understand what’s going on, keep a couple of things in mind. First, remember that companies can choose what to do with their profits. They can distribute them directly to shareholders through a dividend, or indirectly by buying back their own stock( which makes remaining shares more valuable).
They also can retain earnings, eventually reinvesting them in new equipment, hiring new workers, or buying other companies. In that event, those returns might eventually be distributed to shareholders as future dividends or capital gains.
Thus, one key question is whether the cut in dividend taxes increased the total amount companies distributed to their shareholders or just changed the way they did it by, for instance, increasing dividends but reducing share repurchases.
In addition, about half of all corporate dividends are paid to investors that don’t pay tax—pensions, non-profits, foreign entities, and the like. Changes in the dividend tax rate don’t affect their tax bills. However, they still might care if higher dividend payouts boost the share prices of their investments.
Sorting it out isn’t easy, especially since there was so much else going on in the early and mid-2000s. For instance, the post dot-bomb corporate governance scandals drove many firms to pay dividends regardless of the tax rate. Rising stock prices from 2003 to 2007 may have discouraged share repurchases.
The weight of the evidence seems to be that companies did boost dividends after the 2003 tax cuts and those increases were concentrated in firms where managers owned a lot of stock. Make of that what you will.
(ADDENDUM: A new paper by Federal Reserve Board economist Jesse Edgerton throws more cold water on the claim that the dividend tax cut generated more payouts. Among other things, he finds that the increase in dividends corresponded to a comparable rise in corporate profits).
But what did this mean for the overall cost of capital, which is the real question? On that, even 10 years after the 2003 tax cut, we simply don’t know. As Dharmapala notes, research shows that while the value of firms with high dividend yields rose, the value of non-dividend paying firms rose even more.
Given all that uncertainty, Senate Democrats are making a curious choice. They seem to want to continue a dividend tax cut, despite the lack of evidence that it did much to help the economy over the past decade.
In this May 2011 file photo, Senate Finance Committee Chairman Sen. Max Baucus, D-Mont., left, and Republican Sen. Orrin G. Hatch, R-Utah, right, open a hearing on Capitol Hill. In testimony to the committee last week, Gene Steuerle of the Tax Policy Center estimated that of the nearly $750 billion in mobility-enhancing tax and spending programs in 2006, $540 billion went to higher income households. (J. Scott Applewhite/AP)
How the government hinders the American Dream of upward mobility
Upward mobility has been a foundation of America’s self-image since the 18th century. If you work hard enough, nothing can stop you from getting ahead. That, at least in the minds of many Americans, is what distinguishes us from much of the rest of the world.
Yet, according to my always-provocative Tax Policy Center colleague Gene Steuerle, our tax and spending priorities not only fail to promote mobility for those who are starting at the bottom, but they often actively discourage the hard work and savings that help us climb the socio-economic ladder.
Oh, the federal budget is loaded with subsidies that encourage work and savings. But they are almost always aimed at improving the lot of middle- and upper-income households, not those who most need a leg up.
In testimony last week to the Senate Finance Committee, Gene estimated that of the nearly $750 billion in mobility-enhancing tax and spending programs in 2006, $540 billion–or nearly three-quarters– went to higher income households. Those with low-incomes received only about 2 percent of the benefit of subsidies for home ownership and almost none of the benefit of employer-related work subsidies or incentives for savings and investment.
Some of these programs not only fail to help poor and lower middle-class households, they actively hurt them. For instance, if home ownership is a key to upward mobility (an arguable proposition, but one many believe), we need to acknowledge that subsidies such as the mortgage interest deduction inflate home prices and make it harder, not easier, for poor families to buy.
Worse than that, Gene argues, once low-income households reach poverty level, government policy discourages work. True, social welfare programs provide a valuable safety net for the very poor. For instance, the Earned Income Tax Credit and the Child Tax Credit are important income supports for low-income families.
But because these safety net programs phase out as incomes rise, some people face marginal tax rates as high as 80 percent for getting a better job or even a raise. A new Urban Institute calculator shows how this works.
With a budget that encourages consumption rather than work and savings, the gap between the American Dream of unfettered mobility and the reality will only widen, Gene fears. His solution: Rethink those tax subsidies and spending programs that too often hinder mobility, paradoxically in the name of enhancing it.
This debate over mobility is a key subtext in the presidential race between Mitt Romney and President Obama. Each happily talks about the importance of the American Dream and upward mobility. Yet, neither seems willing to tackle the issues that Gene is raising.
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