Closing up shop
It’s tough saying goodbye to policy work. But someday I knew I’d have to get out of D.C. and get a real job.
Anyhow, since I’m not writing anymore this is probably the last post I’ll make on this public blog.
If you’ve got questions about my old research, email me at editor@the-idea-shop.com. Otherwise, thanks for reading along and drop a line if you’re ever in the Seattle area.
Posted by Andrew on Thursday August 16, 2007 | Feedback?
New report on tax burdens and government spending by age groups
Released a new report today exploring the distribution of tax burdens and government expenditures by age group in 2004. It’s a spin-off project from the fiscal incidence model we built back in March. Here are some key findings:
• As the Baby Boom generation prepares to retire, lawmakers should be aware of the distribution of taxes and government spending across age groups.
• America’s youngest households aged 25 and under received $2.32 in government spending for each dollar of taxes paid in 2004. Middle-aged households aged 45 to 54 received $0.73 per tax dollar, and America’s oldest households aged 75 and over received $4.93 per dollar of taxes paid;
• As a group, households aged 35 to 64 pay more in taxes than they receive in government spending, while households under age 35 and over age 64 receive more government spending than they pay in taxes. Overall between $376 billion and $872 billion per year is fiscally transferred from middle-aged groups to the youngest and oldest Americans each year through government taxes and spending;
• Over a lifetime, government spending follows a U-shaped pattern, with large education and welfare spending in youth and large Social Security and Medicare payments in old age. But even within each age group, there are large differences in taxes and government spending across households at different income levels.
Posted by Andrew on Monday June 4, 2007 | Feedback?
New York Sun on fiscal incidence study
Our fiscal incidence study got a nice write up in this morning’s New York Sun. The author compares our findings to an influential new study of tax progressivity from Profs. Thomas Piketty and Emmanuel Saez:
Messrs. Chamberlain and Prante took an entirely different approach [from Piketty and Saez]. Rather than focusing solely on federal individual taxes, they analyzed the distribution of all taxes paid — federal, state, and local. They looked at fifths of the population and didn’t produce data for fractions of the top percent. They analyzed the period between 1991 and 2004, thereby avoiding the pitfalls of comparing incomes before and after 1988.
And they added another dimension to the analysis. They analyzed government spending and which income groups it benefits — all government spending for goods and services, and also transfer payments to individuals, such as unemployment benefits and Social Security.
Households in the two lowest quintiles — a quintile is one-fifth of the whole — received 51% of all government spending because they received more transfer payments. Messrs. Chamberlain and Prante concluded that “both taxes and spending appear to have large distributional effects on households,” and that our tax system is very progressive. The share of total taxes paid by the top quintile rose to 49% in 2004 from 46% in 1991, after peaking at 51% in 2000.
Households in the lowest fifth of incomes received about $8 in federal, state, and local spending for every tax dollar they paid, whereas households in the top fifth of earners received only 41 cents. This shows a tax system with substantial progressiveness.
Looking at the burden of taxes paid in light of benefits received makes far more sense than looking at these taxes in isolation, so Messrs. Chamberlain and Prante are more persuasive.
Posted by Andrew on Friday April 20, 2007 | Feedback?
director's law in tennessee
I’ve got a new analysis of a proposal in Tennessee to fund a package of education, smoking cessasion and farm program spending with a 40-cent increase in the state’s cigarette tax. Unfortunately there’s an unanticipated side effect:
While the Governor’s plan to boost education spending may be well intended, funding the Schools First initiative through tobacco taxes rather than general sales taxes will make low-income households in Tennessee much worse off that they could otherwise be. Because the plan relies almost entirely on cigarette tax revenue, at least three components of the plan have the perverse effect of redistributing millions of dollars from low-income Tennesseans to the highest-income households in the state.
Sounds like a case of Director’s Law if you ask me. Read the full piece here.
P.S.—Bonus points for locating the Tax Foundation reference in the famous Stigler piece above.
Posted by Andrew on Wednesday April 18, 2007 | Feedback?
Podcast interview on fiscal incidence study
I’ve got a new podcast interview out today. The subject: our recent study of combined U.S. tax and spending distributions. As always, there’s a transcript.
Posted by Andrew on Tuesday April 17, 2007 | Feedback?
New survey on U.S. tax opinions
Released a new report this week on our 2007 Annual Survey of U.S. Attitudes on Taxes and Wealth. This is the third year we’ve done the survey, so we’ve got a decent time series going on some of the questions. Here’s the executive summary:
Executive Summary
While foreign policy continues to dominate politics in Washington, the 2007 Annual Survey of U.S. Attitudes on Taxes and Wealth shows that the domestic issues of tax complexity, fairness and burdens continue to weigh heavily on the minds of the American people. For the third consecutive year, we find that a majority of U.S. adults say the federal income taxes they pay are “too high,” that the federal tax code is complex, and that the U.S. tax system is in need of major changes or a complete overhaul.
This report summarizes the findings of our third annual survey of U.S. opinions on taxes. All results are based on a Harris Interactive® survey conducted on behalf of the Tax Foundation between March 5 and 12, 2007. The survey covers a nationwide cross section of 2,012 U.S. adults aged 18 or older. All data from this and previous years’ surveys are available for download free of charge at www.taxfoundation.org under “Public Opinion Surveys on Taxes.”
Posted by Andrew on Thursday April 12, 2007 | Feedback?
New fiscal incidence working paper
Finally released a new working paper today on something economists call “fiscal incidence”—the combined distribution of tax burdens and government spending across income groups in the U.S. Here’s the abstract:
Abstract
While the U.S. tax system is progressive, the distribution of government spending makes the overall fiscal system more progressive than is apparent from tax distributions alone. Using a microdata model we estimate the distribution of federal, state and local taxes and spending between 1991 and 2004. We find households in the lowest quintile of income received roughly $8.21 in federal, state and local government spending for every dollar of taxes paid in 2004, while households in the middle quintile received $1.30, and households in the top quintile received $0.41. Overall, tax payments exceeded government spending received for the top two quintiles of income, resulting in a net fiscal transfer of between $1.031 trillion and $1.527 trillion between quintiles. Both taxes and spending appear to have large distributional effects on households, and these effects have grown since 1991. The results suggest tax distributions alone are an inadequate measure of progressivity, and policymakers should examine both tax and spending distributions when judging the overall fairness of policy toward income groups.
Full study is here. Here’s the original Tax Foundation study on the subject from 1967.
Posted by Andrew on Thursday March 22, 2007 | Feedback?
New paper on federal taxes by city, county and U.S. congressional district
I’ve got a new paper out today that’s a fun stroll through the geographic landscape of federal tax burdens throughout the nation. Here’s the summary:
Executive Summary
In 2004 the federal government in Washington spent $2.18 trillion, roughly one-fifth of the U.S. economy. To finance that spending, it collected $1.91 trillion from taxpayers across the United States. However, the burden of those federal taxes did not fall equally on the cities, counties and states that comprise the diverse geographic landscape of the United States.
Some areas of the nation bear a heavy tax burden, while others pay comparatively little. Many previous Tax Foundation studies have estimated federal tax burdens at the state level, but none has provided detailed estimates down to the narrow geographic areas that taxpayers most closely identify themselves with, such as counties, cities and congressional voting districts.
This report presents the Tax Foundation’s most detailed portrait of the geographic spread of the federal tax burden to date. It provides estimates of all federal taxes—individual income taxes, corporate income taxes, payroll taxes, estate taxes and all federal excise taxes—by major city area, county, congressional district and state, illustrating the striking diversity of impact that federal tax policies established by Congress have on communities across the United States.
Full paper is here. For those who want the technical methodology behind the numbers, the working paper is here.
Posted by Andrew on Thursday March 22, 2007 | Feedback?
Working paper on modeling federal tax burdens by narrow geographic areas
Got a new technical working paper out today that grew out of this post. Here’s the abstract:
Abstract
The burden of federal taxes does not fall equally on the cities, counties and congressional districts that comprise the geographic landscape of the United States. Because tax collections figures provide little information about the true economic burden of taxes, researchers must employ various statistical methods to estimate the economic incidence of federal taxes across geographic areas. We outline a detailed methodology for modeling the burden of each federal tax—individual income, corporate income, payroll, estate and gift, and all excises—by narrow geographic areas. Using this model, we provide estimates of federal tax burdens by three geographic areas for Calendar Year 2004: major city area, county and U.S. congressional district.
Posted by Andrew on Thursday March 22, 2007 | Feedback?
problems with illinois' gross receipts tax plan
Got a few mentions today in a story exploring the questionable economics behind Illinois Gov. Rod Blagojevich’s plan to enact a Depression-era gross receipts tax in Illinois:
The gross receipts tax targets every transaction or sale that comes in the door and would replace the current corporate income tax that targets profits and allows for deductions.
The states that resurrected the tax in recent years had one major problem — pyramiding. Every transaction that takes place to transform raw material into a final product had been taxed at different amounts as different industries became involved in the process, said Andrew Chamberlain, an economist with the Tax Foundation in Washington, D.C.
“Even something as simple as a loaf of bread shows pyramiding,” Chamberlain said.
The mill has to buy the grains to make flour, so that transaction is taxed. Then that flour is sold to a bakery, and that is taxed. The bakery makes the flour into bread and sells it to a distributor, and that’s taxed. Finally, that bread is sold to the consumer and it’s taxed again, he said.
“With the auto industry, it’s even more complex and has more layers of pyramiding,” Chamberlain said…
Because different tax programs will hurt some businesses and help others, it’s difficult to say what impact a gross receipts tax would have on Illinois businesses and the economy, said Chamberlain. He was one of the sources of research as Illinois leaders were shaping their tax plan.
“I talked with them (Illinois officials) extensively and told them the problems with a gross receipts tax, and to be fair told them some of the advantages,” he said. “The next thing I heard was Illinois was considering the tax. It’s such a mistake.”
Posted by Andrew on Wednesday March 7, 2007 | Feedback?
An idea for estimating payroll taxes by narrow geographic areas
(Note: The post below later became this working paper on estimating federal taxes by geography, and this report summarizing the results.)
Let’s say we want to know how much payroll taxes are paid by residents of some U.S. county. Seems easy. Just go to the Bureau of Economic Analysis (BEA) website, and look it up the Regional Economic Accounts, right?
Unfortunately, that won’t do. BEA accounts give total payroll taxes remitted by employers in each county, and that counts both residents and nonresidents who commute in from other areas. Turns out official figures for counties are hard to come by. Same for cities, congressional districts or ZIP codes.
So that’s our problem. Here’s a rough-and-ready solution another economist and I worked out recently. It uses a simple fact about the U.S. income distribution—that it approximately follows what statisticians call an exponential distribution—to generate decent estimates of payroll taxes for counties, cities and other narrow geographic areas.
Some Basic Facts
Here’s how payroll taxes work. Earnings are subject to 15.3 percent payroll taxes. Of that, 2.9 percent is for Medicare, and 12.4 percent is for Social Security. But the Social Security portion applies only to about the first $90,000 of income—$87,900 in 2004.
This "capped" structure becomes a huge pain in the neck when estimating payroll taxes by geography. Some areas are richer than others, which means they have more earners above the cap. So to estimate payroll taxes by area, you’ve got to have knowledge of the full income distribution for each area. And that’s not easy to find.
So here’s what we do. First, go to the BEA’s website and gather two pieces of data for each county you want to examine: county population, and the earnings of county residents. Note that to find resident earnings, you’ll have to manually sum "earnings by place of work" and "adjustment for residence" from published BEA tables.
Take those earnings and divide by population. That’s the average earnings for the county. Let’s call this 
.
Some Math You’ll Need
Most U.S. incomes can be approximately described by what’s called an exponential probability density function. Here’s what it looks like:
(1) 
.
In equation (1), is the number for mean county earnings we calculated above. The next step is to turn equation (1) into a cumulative probability distribution that lets us plug in values for some income level, and find the percentage of people earning less than that amount.
Let’s call this new function F(x). Here’s what it looks like:
(2) 
.
Equations (1) and (2) look complex, but there’s an elegant feature of them. They’ve got just one parameter: . And we already know that from above. That means we can use them to estimate the income distributions of counties by knowing only one fact about each one—mean county income.
Here’s how it works.
Step One: How Many People Earn Above and Below the Payroll Cap?
Using equation (2), we calculate the percentage of residents earning above and below the payroll tax cap. The 2004 cap was $87,900. Plug this in for x in equation (2), with 
equal to average county income. That gives us the percentage of people earning below the cap. Then subtract that figure from one. That’s the percentage of people who earn above the cap. Multiplying each of these by county population, and set the results aside. We’ll need those in a minute.
Step Two: How Much Was Earned Above the Cap?
Taxable earnings for those above the cap are simple to calculate. Take the number of people earning above the cap from step one, and multiply by the 2004 cap of $87,900. That’s the total taxable income of folks earning above the cap. Sit that number aside until the end.
Step Three: How Much Was Earned Below the Cap?
Finding taxable earnings for people below the cap is harder. Every penny of earnings of that group are subject to payroll taxes. That means we have to derive the full earnings of folks below the cap analytically from the exponential distribution above.
The simplest way to do that is to calculate the probability-weighted average earnings of everybody below the cap. Then we’ll just multiply that by the number of people below the cap.
To do this, we put on our math hat and write the following integral for the probability-weighted average earnings of people below the cap,
(3) 
,
where k is the 2004 payroll cap of $87,900. Think of equation (3) like this. If we take every possible earnings level from zero to k, and multiply each by the probability that somebody will earn that amount, we’ll end up with a probability-weighted average wage for everybody together. That’s what equation (3) gives you.
So let’s solve it. Thinking hard back to high-school calculus, we integrate this by parts. Here’s what we get:
(4) 
.
With a little more algebra, this monster simplifies to,
(5) 
,
where W is the probability-weighted average earnings of folks below the cap. That’s the number we need.
Step Four: Put It All Together
Now we’re home free. All that’s left is to take the W we calculated in equation (5), and multiply it by the population earning below the payroll tax cap, which we calculated back in step one. That gives us the total income earned by everybody below the cap. Then we add that to the taxable income of everybody above the payroll cap, which we found in step two.
Putting those two together and multiplying by the 12.4 percent payroll tax rate, we’ve got total Social Security payroll taxes for the area. And we’re done.
Table 2 shows some estimates using this method for the five sample counties from earlier. These estimates can then be used to allocate nationwide payroll tax aggregates to those counties.
Table 2. Here's what some results of this method look like for a few sample counties in 2004.
County | State | Population | Mean Resident Earnings | Percentage Residents Below Cap | Probability-Weighted Mean Earnings Below Cap | Social Security Payroll Tax Per Capita | Medicare Payroll Tax Per Capita | Effective Payroll Tax Rate |
Los Angeles | California | 9,917,331 | $26,224 | 96.5% | $22,228 | $3,041 | $761 | 14.5% |
King (Seattle) | Washington | 1,777,746 | $39,818 | 89.0% | $25,773 | $4,043 | $1,155 | 13.1% |
St. Louis | Missouri | 1,007,723 | $33,334 | 92.8% | $24,656 | $3,619 | $967 | 13.8% |
Denver | Colorado | 555,991 | $38,571 | 89.8% | $25,621 | $3,968 | $1,119 | 13.2% |
Washington | D.C. | 554,239 | $48,065 | 83.9% | $26,228 | $4,480 | $1,394 | 12.2% |
As far as I can tell, the above works as a rough estimate for cities and counties. But be careful drilling down to really small areas. The math probably falls apart if you plug in Hyannis, Nebraska, population 287. Otherwise, enjoy.
Further Reading
Banerjeea, Anand et al. 2006. "A Study of the Personal Income Distribution in Australia." Physica A 370: 54–9.
Borges, Ernesto P. 2003. "Empirical Nonextensive Laws for the County Distribution of Total Personal Income and Gross Domestic Product." Physica A 334: 255-66.
Bureau of Economic Analysis. 2005. "Local Area Personal Income." (Available at http://bea.gov/regional/pdf/overview/Regional_LAPI.pdf.) Washington, D.C.: U.S. Commerce Department.
Dragulescu, A. and V.M. Yakovenko. 2000. "Evidence for the Exponential Distribution of Income in the U.S.A." The European Physical Journal B 20: 585-9.
National Institute of Standards and Technology. 2007. Engineering Statistics Handbook. (Available at http://www.itl.nist.gov/div898/handbook/). Washington, D.C.: U.S. Commerce Department, Chapter 1.3.6.6.7.
Silva, A. C., and V. M. Yakovenko. 2005. "Temporal Evolution of the ‘Thermal’ and ‘Superthermal’ Income Classes in the U.S.A. During 1983-2001." Europhysics Letters 69: 304-10.
Posted by Andrew on Monday February 12, 2007 | Feedback?
Michigan Public Radio on tax credits for film production crews
Landed a quote in a story by Michigan’s NPR affiliate on the use of tax credits to lure Hollywood production crews to local areas:
But not everyone agrees film incentives are healthy in the long term. Andrew Chamberlain is an economist with the Tax Foundation in Washington D.C. He’s researched the impact of state and local film incentives.
“There’s surprisingly little evidence that film tax incentives create the kind of long term stable family types of jobs that most people have in mind,” said Chamberlain.
Chambelain says on top of that, there’s been a rapid increase in competition between states to lure the film industry.
“And so when everyone’s doing it, everyone can’t win, because film credits are really a beggar-thy-neighbor tax policy. Not everyone can benefit at the same time,” said Chamberlain. (Full piece here.)
There’s some audio here also.
Posted by Andrew on Thursday January 11, 2007 | Feedback?
Piece on the alternative minimum tax by congressional district
I’ve got a new short piece estimating the impact of the alternative minimum tax (AMT) by all 435 congressional districts and the District of Columbia for 2004. Here’s the intro:
As the 110th Congress convenes this month a key issue facing lawmakers is whether to reform—or possibly repeal—the Alternative Minimum Tax (AMT). Although the growing AMT has caused anxiety throughout Congress, not all lawmakers’ congressional districts are equally affected. An analysis of recently released IRS data reveals that some congressional districts are much more heavily affected by AMT expansion than others—suggesting some federal lawmakers have a much stronger incentive to reform the AMT than others. (Full piece here.)
FYI, we also ran the numbers by state, by county, and by MSA. And we’ve also got it by ZIP code if anybody wants to email me for it.
Posted by Andrew on Tuesday January 9, 2007 | Feedback?
Paper on the economics of gross receipts taxes
I’ve got a new paper out today on a growing trend in state and local taxation: the return of Depression-era gross receipts taxes. Here’s the executive summary:
Executive Summary
State governments have traditionally raised revenue from business by taxing corporate income. But in recent years the growing difficulty of administering state corporate income taxes has prompted a search for alternative ways of taxing companies. This search for new business taxes has ironically sparked a resurgence in one of the world’s oldest broad-based tax structures: the gross receipts tax, also known as the “turnover tax.”
Gross receipts taxes have a simple structure, taxing all business sales with few or no deductions. Because they tax transactions, they are often compared to retail sales taxes. However, they differ in a critical way. While well designed sales taxes apply only to final sales to consumers, gross receipts taxes tax all transactions, including intermediate business-to-business purchases of supplies, raw materials and equipment. As a result, gross receipts taxes create an extra layer of taxation at each stage of production that sales and other taxes do not—something economists call “tax pyramiding.”
Advocates of gross receipts taxes generally defend them on two grounds. First, it is argued that their simple structure makes them easy for states to administer and for companies to comply with, in contrast to notoriously complex state corporate income taxes. Second, because they tax an expansive base of all transactions in the economy, they are able to raise a given amount of revenue at lower rates than any other tax, making them politically attractive to lawmakers.
But while gross receipts taxes appear to be a simple alternative to complex corporate income taxes, this simplicity comes at a great cost. Gross receipts taxes suffer from severe flaws that are well documented in the economic literature, and rank among the most economically harmful tax structures available to lawmakers. The economic problems with gross receipts taxes are not the result of poor implementation by lawmakers. The flaws are inherent in their design. State lawmakers searching for alternatives to complex state corporate income taxes should be wary of gross receipts taxes, and should instead seek more economically neutral ways of taxing business.
Posted by Andrew on Monday December 4, 2006 | Feedback?
Op-ed on cigarette tax regressivity and social costs of smoking
I’ve got an op-ed in this morning’s Los Angeles Times on California’s Prop 86, which may lead to unintended consequences worse than the public health problem of smoking itself:
The Proposition 86 Poor Tax
In California, a state famous for its progressive politics, a proposition on the Nov. 7 ballot includes a shockingly regressive tax on the state’s poorest residents. Unfortunately, that’s the reality behind Proposition 86—an initiative that aims to cut smoking through a dramatic hike in the state’s cigarette tax, from 87 cents to $3.47 a pack, the nation’s highest rate.
It’s nice to pretend that cigarette taxes come out of the hides of Big Tobacco. But it’s mostly low-income groups who take it on the chin when cigarette taxes rise.
Low-income Californians are much more likely to be smokers, and as a group they spend a lot more on cigarettes than the wealthy as a percentage of their income. One recent analysis of U.S. Census data found that tobacco taxes take a 50-times-larger share of income from those earning less than $20,000 than those earning more than $200,000. That makes cigarette taxes the most regressive way of funding state government programs.
The general sales tax is routinely derided as unfairly regressive, but it’s like a millionaire’s tax compared with the tax on cigarettes.
Most people who support progressive taxes—that is, taxes that fall most heavily on the wealthy—would consider such a regressive tax outrageously unfair. So if Californians plan to raise taxes on smokers, who are disproportionately also among the state’s poorest, they’d better have a good reason.
What might be a good reason? One would be if smokers imposed costly damages on nonsmokers in society. Do smokers impose “spillover” burdens on society, justifying a special tax on them?
It turns out they don’t. Over the last 15 years, evidence has accumulated showing smokers hardly cost society more than anyone else. Dozens of peer-reviewed studies throughout the 1990s from economists such as Harvard’s Kip Viscusi and Willard Manning Jr. from the University of Chicago demonstrate conclusively that nearly all the costs of smoking — healthcare, higher insurance premiums, lower productivity at work—are borne by smokers themselves.
Over their lifetimes, smokers cost taxpayers only trivially more than nonsmokers—about 32 cents a pack, according to most studies. That’s far below the current tax of 87 cents a pack and a fraction of the $3.47-a-pack tax supplied by Proposition 86.
Once we realize smokers are mostly hurting themselves and not others in society, we’re left with an ugly reality: The only justification for a $3.47 cigarette tax is straightforward paternalism. The rich have always turned up their noses at uncouth behaviors of the poor. Proposition 86 just burnishes that condescension into state law, raising some revenue in the process.
But the worst aspect of such condescension? It doesn’t work very well. Punitive approaches such as higher cigarette taxes don’t make smokers quit. They cause smokers to buy tax-free cigarettes on military bases, Indian reservations and over the Internet. Even with today’s 87-cent tax, the California Board of Equalization says about 300 million untaxed packs of cigarettes are sold in the state each year—a figure that will boom if Proposition 86 passes.
The programs funded by Proposition 86 have broad public appeal. Health insurance for low-income children, funding for emergency hospital services and public education about the health risks of tobacco are supported by most Californians. So why not fund them with broad-based taxes on everyone?
Raising cigarette taxes isn’t just bad for the poor. It’s bad for lawmakers’ credibility. Who really believes California politicians are “anti-smoking” when they’re hooked on tobacco-tax cash themselves?
Andrew Chamberlain and Patrick Fleenor are economists at the Tax Foundation in Washington.
Posted by Andrew on Saturday October 28, 2006 | Feedback?
Tax exporting and rental car taxes
Another few quotes on problems with funding local government with rental car taxes on outsiders, from Business Travel Executive magazine:
“Funding programs by taxing outsiders from other states or cities is what economists call ‘tax exporting.’ This type of taxation makes lawmakers less accountable to their constituencies and encourages overspending on projects that may or may not make economic sense,” states Andrew Chamberlain, staff economist for the Tax Foundation, a non-partisan educational organization in Washington, DC. “If a specific project is really needed, economists believe it should be funded through broad-based taxes spread fairly and evenly among those who will benefit from the project.” He says that economists believe that overall, car rental excise taxes are unreliable, regressive and retaliatory. (Full piece.)
Also, there’s another article in Auto Rental News with a bunch of quotes from me here.
Posted by Andrew on Wednesday September 27, 2006 | Feedback?
Minneapolis Fed on tax incentives for film companies
I landed a few quotes in a story on the practice of state and local lawmakers handing out tax incentives to lure filmmakers in the September issue of fedgazette, from the Federal Reserve Bank of Minneapolis. Some clips from the piece:
...[J]ust how much film incentives cost and how much is gained remain a mystery in most programs. The Tax Foundation’s Chamberlain noted that there are no studies by economists that determine the financial benefits or costs of film incentives because very few governments track their costs and tax benefits.
It may be a compelling argument from state and local officials about getting more than you had before, Chamberlain said. “But it’s really a wash or loss.” He added, however, that “you’ll never convince [politicians] that it’s not a good idea—the payoff is too big.” Chamberlain said he once heard another economist describe the incentive issue this way: Incentives were not designed to create jobs but to create job announcements. This may be a little harsh, but “the literature speaks with one voice,” Chamberlain said. “At the national level, this does nothing to spur more activity.”
From an economist’s viewpoint, these are terrible policies, Chamberlain said. In the long run, incentives will erode the tax base because they favor certain (often new) businesses over others, and the tax burden falls disproportionately on existing businesses. The notion of incentives as an investment leaves something to be desired as well. To be considered an investment, incentives should return the original capital plus some profit—in other words, after all the adding and subtracting, incentives should lead to higher total tax revenue…
Chamberlain, from the Tax Foundation, acknowledged that states face a classic prisoner’s dilemma. Here, two crime suspects interviewed separately are offered reduced sentences if each rats the other out; if both stay mum, they’ll go free. But because they are separated, neither trusts the other to keep quiet—so each rats on the other in order to secure a lesser sentence, and ultimately both are worse off.
Incentives work the same way, Chamberlain said. If all states eliminated incentives, they would all be better off; films would still get made, and they would go to the most optimal locations, while states could focus scarce tax dollars on traditional public goods rather than on film incentives. But they’re unable to do so because they can’t trust other states to do the same, and doing nothing is even worse, because states lose economic activity to others offering incentives.
Michigan’s Lockwood believes the incentive game has gotten out of hand, with each state upping the ante a little more. Chamberlain and others suggest that federal legislation may offer the only resolution, essentially legislating a cease-fire to the incentive arms race.
Posted by Andrew on Sunday September 10, 2006 | Feedback?
USA Today on property taxes
Got a couple hits in a USA Today cover story today on rising property taxes around the country. Here’s the one with a pull-quote from me about why polls show people always and everywhere seem to despise local property taxes—despite the fact that many economists consider them among the least economically harmful taxes. And here’s one that mentions our annual tax policy opinion survey I’ve been doing for a couple years.
Posted by Andrew on Friday August 25, 2006 | Feedback?
Doing the math on gross receipts taxes
(Note: The post below later became background paper on the economics of gross receipts taxes. The math’s in the appendix at the end.)
Lots of lawmakers like gross receipts taxes (GRTs). The reason is simple: they raise a ton of money with low rates. And while that’s usually a good thing, a quirk in the way GRTs are structured makes them an inherently lousy way to raise revenue.
Here’s how they work. GRTs tax everything sold by businesses. They tax final goods, intermediate goods, raw materials, everything. That means things with lots of production stages get taxed over and over—something economists call “tax pyramiding”—while things with short production chains don’t.
It’s easy to see the problem. Products end up with totally different effective tax rates. High-tax industries vertically integrate to cut tax burdens. And this tax-induced madness distorts investment patterns toward tax-favored industries, magnifying their economic harm over time.
Makes sense, right? I’ve seen this argument dozens of times, as far back as U.S. Treasury studies on “turnover” taxes from the ‘30s.
But what I never see is anybody who does the math. It’s pretty simple, so why not?
So for the two people still reading at this point, here’s my version of the math, courtesy of my office whiteboard last week:
I. Effects on Firm Structure in a Two-Firm Industry
Consider an industry with two firms that produce a final product in two stages: manufacturing and retail. The manufacturing company ("upstream" firm) assembles the product, and the retail company ("downstream" firm) sells it to retail consumers. To keep things simple, assume the upstream firm sells all its output to the downstream firm, and both companies are competitive price takers (think contestable markets).
If the companies operate independently, the profit of upstream firm is given by:
,where R is the upstream company’s revenue, t is the gross receipts tax rate, and C is the upstream company’s total cost of production. Similarly, the profit of the downstream firm is given by:
,where R, t and C are defined as above. Because the costs of the downstream firm consist of both purchases from the upstream firm and its internal costs of production for labor and capital, 
can be decomposed into the sum of 
, where
is the cost of purchases of intermediate goods from the upstream firm and K equals the downstream firm’s internal production costs. In this case, the total tax burden faced by the two unmerged firms is equal to
.Under these conditions, when does it make sense for the two companies to vertically integrate?
Note that in the absence of taxes, companies will organize in the best possible way. If taxes cause them to organize differently, they will generally be less efficient firms. That is, if companies merge for tax reasons they will have a higher total cost of production than they’d otherwise have.
Imagine the two firms in the above example vertically integrated into a single company. The profit of the merged firm is given by
,where e is the increased total cost of production due to the merged firm being organized inefficiently. In practice, this inefficiency probably varies with output, but to keep things simple it’s assumed to be a fixed production cost. The tax burden of the merged firm is then
,which is less than the total tax burden of the unmerged firms by an amount equal to 
. As a result, the total profit of the merged and unmerged firms will differ by an amount equal to
.That means under a gross receipts tax, industries will vertically integrate only if the tax benefits of doing so—that is, 
—outweigh the efficiency losses from merging companies that are better left separate. More formally
if e >
, firms remain unmerged;
if e <
, firms will merge;
if e =
, firms are indifferent between merging and remaining separate.
II. Effects on Effective Tax Rates Across Industries
In addition to encouraging inefficient vertical integration, gross receipts taxes also lead to disparate effective tax rates across industries, distorting investment patterns in the economy over time.
To see why, imagine two industries: one where it is highly inefficient to vertically integrate, and one where the efficiency costs of integration are small. That is, imagine an industry that won’t integrate A such that e > 
, and another industry that will integrate B such that e = 0. Under a gross receipts tax, industry A will remain unmerged, while industry B will vertically integrate for tax reasons.
In this case, the effective tax rate faced by industry A is given by
.By comparison, the effective tax rate faced by industry B is given by
The effective tax rates faced by industries A and B differ by only one term in both the numerator an denominator: 
. Because it’s assumed that 0 < 
< 1, the addition of a constant equal to 
to both the numerator and denominator increases the value of 
. As a result, > 
, which means industries A and B face different effective tax rates, for no good reason other than a poorly designed tax.
That’s a bad thing, because it means gross receipts taxes will distort investment patterns in the economy over time, away from industry A and toward B. And that makes everybody poorer, making them an inherently lousy tax.
I leave it as an exercise for the reader to empirically test the impact of GRTs on vertical integration using value added data from the Survey of Manufacturers. Let me know if it works.
Posted by Andrew on Wednesday August 16, 2006 | Feedback?
free to choose
If it weren’t for a few little books by economist Milton Friedman, today I’d be building houses in Washington State rather than writing economics in Washington, D.C.
Some might say the world’s worse off because of that. But hey—my own life’s been made enormously better, both materially and intellectually, because of the power and clarity of the ideas in two little books I stumbled upon in a university library a decade ago: Capitalism and Freedom and Free to Choose.
Now, thanks to the folks at the Palmer R. Chitester Fund, the ten volumes of the original “Free to Choose” PBS television series that later became the book are now available free on Google Video. They’ve also made the five volumes of the 1990 follow-up series available.
At the end of the day, all the important things in life are ideas—not the junk we spend our days trying to accumulate. These videos have got plenty of good ones. Do your kid’s generation a favor, and pass it on:
Original 1980 Series (10 Volumes):
Volume 1: Power of the Market
Volume 2: The Tyranny of Control
Volume 3: Anatomy of a Crisis
Volume 4: From Cradle to Grave
Volume 5: Created Equal
Volume 6: What’s Wrong With Our Schools?
Volume 7: Who Protects the Consumer?
Volume 8: Who Protects the Worker?
Volume 9: How to Cure Inflation
Volume 10: How to Stay Free
Updated 1990 Series (5 Volumes):
Introduction by Arnold Swarzenegger
Volume 1: The Power of the Market
Volume 2: The Tyranny of Control
Volume 3: The Failure of Socialism
Volume 4: What’s Wrong With Our Schools?
Volume 5: Created Equal
Update: Unfortunately, the “Free to Choose” videos appear to have been removed from Google Video. Not sure why…
Update 2:The videos have been deleted from Google video. Short clips of the videos are available via You Tube at http://youtube.com/results?search_query=free+to+choose&search=Search
Update 3:I just received notice via email that high-quality versions of the “Free to Choose” videos are now available here: http://btjunkie.org/search?q=free+to+choose. These are clearly pirated—download at your own risk.
Update 4: The full “Free to Choose” series has now been made available at http://ideachannel.tv/. Enjoy.
Posted by Andrew on Thursday August 10, 2006 | Feedback?
