Economics, Pethokoukis, U.S. Economy

So you think you know how to reform the US tax code? Really?

Image Credit:

Image Credit:

How should policymakers reform the US tax code so that it is fairer, growthier, more efficient, and less cronyist — and raises enough dough to pay the bills, both today and tomorrow? Flat tax, FairTax, X tax? Lower tax rates for companies, increase tax credits for parents? The Camp plan, Ryan plan, Obama plan?

Before you answer, consider the following:

1.) US real GDP growth averaged 1.8% annually in the 2001-2013  period vs. 3.7% in the 1950-2000 period.

2.) During two recent extended periods of strong average annual real GDP growth — 4.4% in 1983-1989, 4.3% in 1996-2000 — the average top marginal tax rate on labor income averaged 41%, capital gains income 23%.

3.) From 1974 through 2013, the federal government spent an average of 20.5% of GDP and took in revenue that averaged 17.4% of GDP. In 2013, spending was 20.8%, revenue 16.8%.

4.) The US has the highest corporate tax rate – including loopholes and all — among advanced economies. (And the burden of the corporate income tax falls on human beings — investors and workers.)

5.) Forty-three percent of households paid no income tax in 2013, but two-thirds of those households did pay payroll taxes.

6.) April 2014 median household income was 7.0% lower than the median of $56,941 in January 2000.

7.) Post-tax, post-transfer, household-size adjusted (but not counting health benefits) median income rose just 1.0% from 2000 to 2007 vs. 14.4% in the 1990s and 12.0% in the 1980s.

8.) In 2013, the CBO says, more than half of the combined benefits of the 10 largest tax expenditures — worth nearly $1 trillion — went to households with income in the highest quintile of the population, with 17% going to households in the top 1% of the population.

9.) Although parents would prefer to have, on average, 2.6 kids, the US fertility rate has fallen to 1.9. And in the long run, low rates of fertility are associated with diminished economic growth, according to an NBER study.

10.) US productivity growth averaged 2.3% annually for most of the 20th century. But it slowed from 1973 through 1994 to 1.4%, bounced back to 2.4% from 1996 through 2004, and has slowed again to 1.2%.

11.) The federal debt (held by the public) as a share of GDP was 25% in 1981, or $789 billion. In 2007, those numbers were 35% of GDP, and $5 trillion. In 2013, 72% and $12 trillion.

12.) Under its alternative fiscal scenario, the CBO projects the federal (publicly-held) debt to GDP ratio will rise to 190% by 2038.

13.) Over the next 25 years, 60% of the rise of health-related entitlement spending will come from aging, and only 40% from rising medical costs. 

14.) There have been jobless recoveries after each of the past three downturns, with each leading to a depressed share of middle-class jobs

15.) The average labor force participation rate of prime-aged men in 1980 was 94.3% vs. 88% last month. Only 83 prime-aged men out of every 100 have a job today.

16.) The overall US employment rate is 58.9% vs. 62.9% pre-Great Recession.

So what’s the best tax reform for America?

Follow James Pethokoukis on Twitter at @JimPethokoukisand AEIdeas at @AEIdeas.

Economics, Pethokoukis, U.S. Economy

Michael Strain on the biggest problems facing the US economy right now

Priorities, priorities, priorities. My colleague Michael Strain offers three problems facing America that he sees as more important right now than tax reform:

1.) The long-term unemployed are workers who have been out of work and looking for a job for six months or longer. … I would employ a suite of policies to help get the long-term unemployed back to work before reforming the tax code. Long-term unemployment is a national emergency that belongs at the front of the line — addressing it is good economics, and the right thing to do.

2.) Men of prime working age — too old to be in school and too young to be retired — are in flight from the labor force. … Public policy can help. It must start with conservative solutions to reform our schools. We should also increase the generosity of the earned income tax credit (EITC) for childless workers as a way to increase labor force participation by increasing the financial rewards from work and to ensure that no one who works full time and heads a household lives in poverty

3.) Our health-care system is in need of serious reforms. The Affordable Care Act is an ugly package filled with unintended consequences. One of those consequences is a significantly smaller labor force. It should be repealed and replaced with a conservative alternative. And health-care costs are projected to put Medicare and Medicaid spending on an unsustainable and destructive path, and are putting downward pressure on wages and salaries.

And what about taxes? Strain, again:

To be clear, we should reform our tax code along the lines these conservatives suggest. (Much better would be to replace the current system with a progressive consumption tax, as my AEI colleague Alan Viard has suggested.) In particular, we should broaden the tax base by phasing out the tax exclusion for employer-provided healthcare, the mortgage interest deduction, and the state and local tax deduction. But conservatives must prioritize their policy goals, and the rather modest economic gains from tax reform do not merit it being addressed before (at least) the three issues I discussed above.


Follow James Pethokoukis on Twitter at @JimPethokoukisand AEIdeas at @AEIdeas.


No, New Yorker magazine didn’t just disprove Clayton Christensen’s ‘disruptive innovation’ theory

Quick recap: Harvard history prof Jill Lepore wrote a long New Yorker piece attacking Harvard business prof Clayton Christensen, best known as the author of “disruptive innovation” theory. As I wrote the other day, the critique seem less about the details and proper application of Christensen’s analysis of how innovation transforms business and more about how online education will disrupt the status quo life of a Harvard academic. Oh, and then you have Paul Krugman tossing in his two cents since reformers often refer to “disruptive innovation” in their approach to fixing the public sector through increased competition driving innovation. Krugman doesn’t much like that, apparently, and really thinks Lepore nailed it.

In her critique, Lepore goes after the case studies that form the original foundation of the theory. Over at the Winterspeak blog, a business prof comes to Christensen’s defense with an illuminating analysis:

 I think this article is totally fair to Silicon Valley and totally unfair to Clay and the concept of “disruptive innovation” as used in academia. (I do not research the topic anymore, so I have no particular dog in this fight)

Yes, “disruptive innovation” is based on case studies, but Leporte is completely off base when she says that “The handpicked case study, which is Christensen’s method, is a notoriously weak foundation on which to build a theory.” In fact, handpicked case studies are a terrific way to build initial theory. In fact, one of the most cited articles is recent social science discusses exactly this point. Case studies are terrible at proving theory, but they serve as a great way to think through a problem.

The reason they are bad at proving theory is exactly the issues that Leporte raises: establishing clear historical facts is hard, and sometimes slippery. I think she has some valid points on the history, but does miss the fact that there is a difference between firms and individuals, and that fact that Shugart had to start multiple firms to compete in hard discs was the point – the organizations couldn’t always deal with technological change.

However, she makes it seem like academics (and Clay) basically stopped working on the topic in 1999. One need only look at the Google Scholar cites to see that this is wrong. Since Clay’s initial book, a huge amount of empirical evidence has been amassed on this topic, and discussion has become a lot more nuanced. We talk about modular, sustaining, incremental, and discontinuous innovation, and about how to manage the issues that cause firms to fail to innovate: absorptive capacity, ambidexterity, and problemistic search on rugged landscapes. I throw out this jargon not to be overwhelming, but because these are, by and large, ideas that have followed on the work of Clay (and other scholars working on the topic at the same time). It is incredibly unfair to point at one concept, as introduced in one book, by an academic with a long career and yell “the emperor has no clothes!”


Follow James Pethokoukis on Twitter at @JimPethokoukisand AEIdeas at @AEIdeas.


I have seen the future of reform conservatism – and it looks pretty Reaganesque

Image Credit: Shutterstock

Image Credit: Shutterstock

The embryonic-but-harsh critique of reform conservatism pretty much ignores what reform conservatives have to say about healthcare reform, education reform, regulatory reform, welfare reform — and focuses almost entirely on the tax piece.

Actually just a piece of the tax piece. A slice of a slice. Some on the center-right argue that sharply expanding the child tax credit – a proposal featured in the (free-and-downloadable) new book “Room to Grow” — amounts to a betrayal of a supply-side/Reaganesque/pro-growth approach to tax reform.

But is that all there is to reform conservatism and taxes? For a broader perspective, check out the Mike Lee tax plan that the Utah senator announced last September here at AEI:

The “Family Fairness and Opportunity Tax Reform Act” would establish two individual income tax rates: 15% on all income up to $87,850 – and twice that amount for married couples – and 35% on all income above that.

It would eliminate most existing deductions and credits not related to children, and create in their place the following:

– a $2,000 personal credit to replace the personal exemption and standard deduction;

– a new charitable deduction that would be available to all taxpayers;

– a new mortgage interest deduction, also available to all home-owners, but capped at $300,000 worth of principal, focusing the deduction on the families and communities who need it the most.

– And the centerpiece of the plan is an additional $2,500-per child tax credit, available to all parents of younger children. Coupled with existing child tax provisions, this new credit will begin to equalize the tax code’s treatment of parents and children.

So the Lee plan would reduce and cut marginal rates – to the same level as the much-ballyhooed Dave Camp plan — and cut taxes for the middle class, the latter even for those folks for whom the payroll tax is the real tax burden. Now Lee doesn’t mention business tax reform, but I know that is coming. And plenty of reform conservatives have mentioned business tax reform. Now the Lee plan isn’t revenue neutral – as scored by Washington — but it can be tweaked into revenue neutrality without disturbing its basic structure.

But let’s say that the top rate can only be brought down to 38% in order to achieve revenue neutrality. Would a plan that still lowers the top marginal rate, does major business tax reform, and provides major tax relief for beleaguered American middle-class families really be out of step with pro-growth/Reaganesque/supply-side tax reform? Maybe so  – if anything other than a 17% flat tax is simply beyond the pale. But as President Reagan once said, “Somebody who agrees with me 80 percent of the time is a friend and ally, not a 20 percent traitor.”

Follow James Pethokoukis on Twitter at @JimPethokoukisand AEIdeas at @AEIdeas.


Wage growth remains pitiful, but is it about to get a lot better?

The New York Times

The New York Times

The NYT’s Neil Irwin:

Average hourly earnings for private sector American workers rose about 49 cents an hour over the last year, to $24.38 in May. But that wasn’t enough to cover inflation over the year, so in real or inflation-adjusted terms, hourly worker pay fell 0.1 percent over the last 12 months. Weekly pay shows the same story, also falling 0.1 percent in the year ended in May.

But some optimism from Deutsche Bank:

Our preliminary employment forecast for June is 225k on nonfarm payrolls and a further one-tenth decline in the unemployment rate to 6.2%. However, as we have previously highlighted, jobless claims are also useful in terms of forecasting other facets of the economy—including GDP growth and wage trends.

Solid income growth has been one of the key reasons why we remain constructive on current quarter activity. As of the May employment report, aggregate hours worked were up 3.8% (annualized) compared to Q1.

Unless there is a big collapse in productivity in the current quarter, which is unlikely, the rise in aggregate hours tells us that GDP growth should be in the vicinity of 4%, as well. (Our forecast is 4.2%.) A modest increase in average hourly earnings (1.7%) implies an even stronger rise in aggregate income (5.6% May vs. Q1 annualized); which at the current pace is on track to post the third strongest quarterly increase since the end of the recession. …

The level of claims has historically shown a significant correlation (86%) with the pace of wage and salary gains. The current level on claims implies a multi-point acceleration from the 4.2% private wage gain reported in April. In fact, based on the past 20 years, if claims cross 300k, wage growth should exceed 7% something which has not occurred on a sustained basis since early 2006. The trend in household income will undoubtedly make or break economic forecasts for the remainder of 2014—in the meantime, jobless claims will provide important clues.


Have Reagan-style tax cuts lost their political power?


America has an anti-growth tax code that penalizes investment, innovation, and family formation, and encourages cronyism and rent seeking. Smart tax reform would boost economic growth and worker incomes. Passing such reform should be a high priority with Washington policymakers.

Yet three decades of radical-though-imperfect reform has still left the code in better shape than in 1981 when high marginal income tax rates discouraged productive investment and coupled with inflation to raise the cost of capital and nudge taxpayers into higher and higher tax brackets.

Today, by contrast, the top rate is 40% not 70%, tax brackets are annually adjusted for inflation, and 43% of Americans pay no federal income tax (although two-thirds of those folks pay payroll taxes.) Even The New York Times has conceded the impact of a generation of supply-side tax reform (though not the generational economic boom it caused):

Most Americans in 2010 paid far less in total taxes — federal, state and local — than they would have paid 30 years ago. According to an analysis by The New York Times, the combination of all income taxes, sales taxes and property taxes took a smaller share of their income than it took from households with the same inflation-adjusted income in 1980.

Given all that, it shouldn’t be surprising that the tax issue doesn’t have the old oomph that it used to with voters. So here’s the problem — an economic one for America, a political one for Republicans who fondly recall the 1980s: cutting marginal rates, lowering business taxes, and tax simplification just doesn’t look like much of an election winner anymore. Take a look at these poll results:

1.) In the early 1980s, close to 70% of Americans thought their taxes were too high. Today, that number is 50%.



2.) Middle-class Americans, by 53% to 42%, think they’re paying their fair share in taxes.


3.) Americans rank taxes low on their list of concerns — even below climate change (via Bloomberg):


4.) In the age of online tax preparation, Americans don’t think their tax returns are hard to fill out:


5.) Americans think raising the minimum wage and business deregulation are better ways to boost economic growth than cutting tax rates on the business and the wealthy:


One more thing: perhaps these polls also reflect America’s recent history with tax cuts. George W. Bush cut taxes, yet the economy didn’t seem to respond as it did in the 1980s and his term ended in economic collapse (though I am not suggesting as a result of the tax cuts). And then you have the Obama tax cuts. A third of the $800 billion, 2009 stimulus came in the form of various tax incentives. Not only has the recovery been sluggish, but people barely noticed the Making Work Pay tax credit as it was parceled out in dribs and drabs.

Follow James Pethokoukis on Twitter at @JimPethokoukisand AEIdeas at @AEIdeas.


3 charts that show why, yes, American families need a tax cut

Image Credit: shutterstock

Image Credit: shutterstock

You can’t have a healthy, prosperous America if American families aren’t flourishing. And right now — actually, for some time — American families have been under severe financial stress. A few examples:

1.) Incomes have been going nowhere:

Sentier Research

Sentier Research

And if you prefer words over pictures: “The April 2014 median was 7.0 percent lower than the median of $56,941 in January 2000.”

(By the way, this data from Sentier Research includes the counts the following as income: wages and salary; nonfarm self-employment income; farm self-employment income; Social Security and Supplemental Security Income; interest, dividends; net rental income, and royalties; cash public assistance (federal and state); unemployment compensation and workers’ compensation; retirement income from pensions, annuities, other retirement plans; veterans’ pensions and compensation; child support and alimony; other cash income excluding capital gains or lump sum, one-time amounts.)

And it’s not just the Great Recession and Not-So-Great Recovery. Note particularly, the prerecession period. The work of economist Richard Burkhauser and his team of researchers at Cornell University has found that post-tax, post-transfer, household-size adjusted (but not counting health benefits) median income rose just 1.0% from 2000 to 2007 vs. 14.4% in the 1990s and 12.0% in the 1980s.

2.) Higher education, the path to upward mobility, is an increasingly heavy burden:


As AEI’s Andrew Kelly writes in “Room to Grow: Conservative reforms for a limited government and a thriving middle class“: “Figure 2 displays the net price of tuition, after accounting for grants and scholarships, as a percentage of family income for middle-income respondents in 2004, 2008, and 2012. Data are for four-year colleges only, and are disaggregated by private and public colleges. The figure shows a clear upward trend since 2004, with middle-income families now paying 25 to 40% of their annual incomes to attend college. Remember, this is after accounting for any grants and scholarships that students receive.”

3.) And to quote the 1992 Bill Clinton presidential campaign: “Don’t forget about healthcare”: 


James Capretta, also from “Room to Grow”: “Rising health costs have contributed directly to the stagnation of cash compensation as employers have kept pay raises low in response to the rising costs of employee health benefit plans.”

Bottom line: In “Room to Grow,” conservative policy reformers outline a number of ideas, including sweeping health care and education reform, to help American families. On the tax side of things*, coauthor Robert Stein advocates expanding the child tax credit (including letting it apply to both income and payroll taxes since nearly half of Americans pay no federal income taxes). A married couple with two children earning $70,000 would get a tax cut of roughly $5,000 per year vs. current law. Stein:

For some families, the extra money could be just the boost they need to be able to send their kids to a better school. Coming at a time in life when many parents and potential parents are considering whether they can afford an additional child, the extra credit would directly make carrying the burden (and generating the future social benefits) of a growing family somewhat easier. In addition, because the size of the credit would temporarily wipe out tax liabilities for some middle-class parents it would also reduce their marginal tax rate on additional work to zero.

And from Stein’s National Affairs essay on the topic:

The new child credit would accomplish several significant policy goals. First, it would offset the anti-parenting bias created by Social Security and Medicare. Second, the credit would help simplify the tax code by getting rid of other exemptions and credits that apply to ­children. Third, and very important for many families, it would end the bias against families with a stay-at-home parent now caused by the child-care credit (which applies only if both parents are working for pay). And finally, it would reduce effective marginal tax rates for many middle-class families.

In other words, time for American families to get a tax cut.

* Nothing in the book — which isn’t mean to be a soup-to-nuts policy agenda — precludes comprehensive tax reform. Stein himself has written on the need for pro-growth, pro-investment, corporate tax reform, which would raise worker incomes. Other authors, including myself, have advocated replacing the current tax code with a pro-investment, progressive consumption tax.  I alone have written some 55 (!) AEI blog posts advocating for corporate tax reform. Apparently, however, some have failed to take notice.

Follow James Pethokoukis on Twitter at @JimPethokoukisand AEIdeas at @AEIdeas.

Economics, Pethokoukis

America in the slow lane: How unions and lobbying groups are ruining US transportation infrastructure

Debate around improving US infrastructure are typically funding discussions. Where will the money come from to (a) build more airports/bridges/roads and (b) repair or improve existing airports/bridges/roads? Then again, poor infrastructure and financial woes are about what one would expect when government fails to apply basic economic principles. As Clifford Winston writes in a new Mercatus study:

Prices are not aligned with users’ contributions to congestion and delays, investments are not based on benefit-cost analyses, and regulation inflates operating costs.

Those problems persist because of the limitations of government agencies and regulatory constraints, as well as political forces. Among the latter, the American Trucking Association has long opposed axle-weight charges for the pavement damage caused by trucks, and labor unions have blocked the repeal of Davis-Bacon rules that raise the costs of road building and repair by requiring federal construction projects to pay “prevailing” (i.e., union-level) wages.

The public sector should be adopting technologies to bring economic rationality to transportation, the kinds of technology a privatized system would likely already be employing. Among the options highlighted by Winston:

– GPS devices, Bluetooth signals, and mobile software applications could provide motorists with real-time information about traffic speeds and volumes and conditions on alternate routes, allowing drivers to adjust their route choices.

– Weigh-in-motion capabilities, which provide real-time information about truck weight and axle configurations, could be employed to set pavement-wear charges. Those charges could encourage truckers to shift to vehicles with more axles that do less damage to road pavements.

– Governments also could apply adjustable lane technologies and variable speed limits, which are better aligned for driving conditions than fixed limits, to adapt to traffic flows and to set tolls. Such measures could encourage drivers to use less-traveled routes or lanes.

– Efficiency in air travel could be enhanced through technologies such as heated runways, which would reduce delays caused by time-consuming manual snowplowing; advanced screening technologies, such as full-body scanners and biometrics, to speed security measures; and the adoption of a next-generation satellite-based air traffic control system known as NextGen.

Follow James Pethokoukis on Twitter at @JimPethokoukisand AEIdeas at @AEIdeas.


St. Louis Fed: Stimulus-funded jobs were heavily tilted toward government

From the St. Louis Fed:

Over one-half of the fiscal spending component of the American Recovery and Reinvestment Act (ARRA; i.e., the Recovery Act) was allocated via grants, loans, and contracts. Businesses, nonprofits, and nonfederal government agencies that received this type of stimulus funding were required to report the number of jobs directly created and saved as a result of their funding. …

It is estimated that at the one-year mark following the start of the stimulus, 166,000 of the 682,000 jobs directly created/ saved were in the private sector. Examples of private sector stimulus jobs include social workers hired by nonprofit groups to assist families, mechanics to repair buses for public transportation, and construction workers to repave highways.

Examples of government stimulus jobs include public school teachers, civil servants employed at state agencies, and police officers. While fewer than one of four stimulus jobs were in the private sector, more than seven of nine jobs in the U.S. economy overall reside in the private sector. Thus, stimulus-funded jobs were heavily tilted toward government.

Follow James Pethokoukis on Twitter at @JimPethokoukisand AEIdeas at @AEIdeas.