Wednesday, February 3, 2016

Fred Thompson: Tax Mavens Talk About Disappearing State Corporate-Income-Tax Revenues; Oregon Did Something About It

 Fred Thompson checks in with the second of his two-part post.  The first one appeared last week.


In 2010, under Measure 67, Oregon adopted a minimum-tax scheme whereby C-corporations are taxed on profits (income) or on turnover (gross revenue), whichever tax liability is greater.

Measure 67 set the alternative minimum turnover tax rate at approximately .1 percent (to a maximum of $100 thousand). Measure 67 also increased Oregon’s marginal corporate-tax rate on Oregon taxable income (profits earned in Oregon) over $10 million from 6.6 percent to 7.6 percent and increased the minimum tax on pass-through businesses to $150.
Economists don’t like turnover taxes. The Diamond-Mirrlees production-efficiency theorem is hostile to taxes on intermediate inputs, a predisposition I appreciate and generally embrace. However, Diamond-Mirrlees presumes the absence of widespread tax avoidance/evasion, an assumption that is clearly violated so far as state corporate income taxes are concerned. In contrast, turnover taxes are hard to avoid and relatively cheap to enforce, much more so on both counts than state corporate-income taxes. Consequently, I found it fairly easy to support Measure 67’s alternative minimum turnover tax, as an effective complement to the corporate income tax, and would not rule out further incremental increases in the turnover tax rate. Massive SCIT avoidance/evasion provides ample justification for alternative minimum turnover taxes.

But there’s more: Oregonians pay high taxes, partly because we face fairly high tax rates, but a lot of the taxes that we pay are actually paid to other states (and to jurisdictions in other states). On a per-capita basis, Oregon is one of the nation’s leading net tax exporters. Consequently, Oregon’s per capita state and local tax collections are actually below the average of the US as a whole. It’s only when one adds in fees paid to state and local governments that Oregon’s collections come up to the US average. One of the neat things about supplementary turnover taxes is that they implicitly raise the cost of jurisdiction shopping, by making it cheaper for multi-state businesses to pay the higher Oregon CIT than for them to pay turnover taxes in Oregon and pay CITs in other states, even where those CIT rates are lower. Minimum alternative turnover taxes tend, thereby, to reduce tax exports.

Moreover, it looks the minimum turnover taxes work the way they are supposed to: under Measure 67, business tax revenues (the sum of alternative minimum turnover tax and CIT revenues) increased from 1.9 percent of total state cash inflows in the decade prior to its passage to 2.3 percent today. Interestingly, most Oregonians, even those who pay attention to state fiscal policy matters, are unaware of the apparent success of this experiment.

Nevertheless, there are a variety of proposals to increase or extend Oregon’s turnover tax. The group, A Better Oregon, is seeking to put an initiative on the ballot that would leave its structure pretty much unchanged, but increase the marginal tax rate on the Oregon sales of C-corps in excess of $25 million from .1 percent to 2.5 percent, or 25 times (2500 percent!).  That’s a huge increase, so much so that, if enacted, the turnover tax might no longer represent a supplement to the corporate income tax, but would very likely behave more like a sales tax (averaging about 4 percent on roughly half of all goods and services sold in Oregon) than an income tax (i.e., a higher portion of it would be shifted to final consumers rather than stick with shareholders).  It would also probably have the effect of shifting even more business activities from C-corps to pass-through entities, encourage vertical integration, and advantage high mark-up businesses relative to their high-turnover counterparts – in other words, do all the bad things Diamond-Mirrlees warned us against. It is hard to say how much damage to Oregon’s economy these things would do. It could be a lot; it could just as easily be minimal. But whether the damage would be a lot or only a little, I seriously doubt that it would strengthen Oregon’s economy. Personally, I’d prefer it if experiments like this were performed in some other laboratory of democracy.

The Oregon Legislative Revenue Office recently assessed the consequences of adopting a comprehensive turnover tax (called a commercial activity tax or CAT) that would apply to nearly all business transactions and not just to the sales of large C-corps, as under the status quo. Its analysis considered an array of rates from .4 percent to .65 percent of sales and various uses of CAT revenue, most notably, repealing Oregon’s corporate income tax, increasing the standard deduction on Oregon’s personal income taxes, and creating a property-tax exemption for owner-occupied, primary residences. The revenue office assumed that the CAT would behave pretty much like a consumption tax (albeit on gross rather than final output). If so, relative to repeal of the corporate income tax, it should reduce the progressivity of Oregon’s state and local tax system and, thereby, reduce its short-term volatility somewhat, as well as its long-term growth rate; relative to increasing the standard deduction or creating a homestead exemption, its effects should pretty much be a wash. Seems like a lot of back and forth for not much practical payoff, which is an extremely informative insight (although oddly, it’s not the finding that has gotten the most attention).

Me? I’d like to increase the PIT standard exemption, but otherwise my tastes run to the incremental: increasing the alternative minimum turnover tax rate (to .4 or .5 percent) and, maybe, since I am a fan of tax harmonization, finding a way to extend it to all businesses, partnerships included, with revenues exceeding $500 thousand (as in the proposals assessed by the LRO, but retaining the offset provision for C-corps and creating one for other businesses) and, perhaps, not so incrementally, to all non-governmental corporations and some special-service districts as well (which is consistent with the logic of tax harmonization).


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Friday, January 29, 2016

Fred Thompson: Why Are State Corporate Income Taxes Disappearing?

Fred Thompson checks in with the first of a two-part post.  I'll post the second one next week.

They are.

But why? The easiest explanation to discard is that, in a race to the bottom, states have reduced corporate income-tax (SCIT) rates. They haven’t. Marginal SCIT rates have been more or less constant for more than 30 years.

Me? I attribute the decline in SCIT to increased tax avoidance/evasion. Tax avoidance/evasion isn’t a new enterprise, but its direction and focus changed dramatically after 1980 and it has been growing in size and sophistication ever since. The simple fact is that it is ridiculously easy for multi-state businesses to shelter profits from SCITs, reporting them where state corporate income-tax rates are low (in states like Nevada or Washington) and avoiding them in high-tax states (like Pennsylvania or Iowa). These days, this can be done with a couple of mouse clicks (and some accounting and legal legerdemain). Unfortunately, it’s hard to fix tax avoidance/evasion mechanisms or even say which ones matter most at the state level. Multi-state businesses are not required to publicly report the income taxes they pay in each state, just the total.

Many of our colleagues deny that the massive decline in the weight of state SCIT revenue (which is itself unquestioned) is due to increased tax avoidance/evasion. They note that enactment of the pass-through provision in 1986 and its subsequent expansions have fundamentally transformed the business landscape in America, leading to a decline in C-corporations relative to pass-through businesses.

Under the U.S. tax code the profits (income) of publically held or C-corps are taxed twice, first through corporate income taxes and then again through personal income taxes on dividends and capital gains. Other businesses – individually, family, or employee owned – are all eligible for pass-through status, meaning that their income passes directly to their owners’ personal income tax returns, as are most partnerships (these businesses are not necessarily small; there are nearly 1,000 of them in Oregon with over 100 employees).  As a result, the owners (shareholders) of C corps tend to pay higher tax rates on their businesses’ profits than do the owners of other businesses. That is generally also true at the state level. It is almost certainly the case in Oregon.

Consequently, pass-through businesses now account for more than 50 percent of all business income in the U.S., triple what it was in 1986. In fact, there are only about 3,500 large publicly traded companies in the U.S., down from more than 5,000 in the mid-80s. This goes a long way to explaining the relative decline in the importance of the federal corporate income tax vis รก vis personal income tax receipts.



However, if that were the whole story, the decline in the relative importance of state corporate income-tax revenues would have been proportionate to the relative decline in the federal corporate income tax. Instead, it has fallen nearly twice as fast. Or, perhaps, more clearly, since 1990 total federal corporate tax revenues have grown about as fast as C-corp profits; total state corporate tax revenues have grown only half as fast. As a consequence, state corporate income-taxes now account for less than 2 percent of annual state revenues nationwide, down from 2.7 percent in the decade of the 1990s and 3.5 percent in the 1980s. In Oregon, the proportional decline has been less dramatic, from 1.8 percent of total state revenue, to 1.9 percent, and now 1.4 percent, according to Governing Magazine.

The decline in the relative contribution of Oregon’s CIT is proportionally less than in most states, especially places like Connecticut, Louisiana, Michigan or Ohio, where real corporate income revenues actually declined by more than 50 percent after 1990, but it still looks to be significant (although, in reality, probably not, since GM evidently excluded revenue from turnover taxes from its figure – see my next post).

Others of our colleagues are more conspiratorially minded. They tend to hold to an older view of corporate income taxes, which posits that the incidence of the tax is entirely shifted to other, less mobile, factors of production (labor and real property). Consequently, it follows that states should not tax corporate income, that, to avoid adverse effects on investment, output, and employment, it would be better to tax labor/land directly. While this view cannot be entirely ruled out as a theoretical matter, it’s wholly inconsistent with the best empirical evidence. For that reason, most tax economists now reject it.

Nevertheless, it might be noted, that, under this view, state elected officials choose to tax corporate income only because they are forced to by popular sentiment ("I pay taxes, but big companies get away Scot free?"). Bizarrely, some of those who hold this view assume a level of rationality on the part of state tax authorities that beggars all belief: they adopt high statutory tax rates to appease the public, but consciously mitigate their effects through special tax breaks. Hence, one observes persistent high state corporate income tax rates along with diminished collections.

However, as the Governing Magazine. article clearly shows, the scale of SCIT tax breaks is nowhere close to accounting for the relative decline in SCIT revenues. If nothing else, that should put paid to this particular conspiracy theory.


If I am right, tax avoidance/evasion is at the heart of the problem of the mystery of declining SCIT revenue, what can be done about it? I offer one answer in my next post.

Thursday, January 21, 2016

Blog

No, I don't know why the blog's background has suddenly turned to light gray and, no, I do not know how to fix it.  Maybe it is a sign that it is time for an overhaul...


Update!  Okay, so now there is the Earth.  Upgrade complete.  Like a whole new site...

Wednesday, January 20, 2016

The Tricky Problem of Child Labor

On NPR this morning there was a report on an Amnesty International report on the child cobalt miners of DR Congo.  Families can dig their own mines in mineral-rich DRC.  Often, apparently, all or many members of the families take part in this household production, including children.  The report suggests that this is a bad thing, that children should not be involved in mining and should instead be in school.

On the face of it, this all makes sense.  Children are not old enough to make these decisions for themselves and society must protect them.  Mining is a difficult and dirty task, not suitable for small children.  School is where they should be.

But this ignores the fact that most parents in the world want what is best for their children and would prefer that they do not work.  But if it comes to the stark choice of having the child work or not feed the family, families are forced send their children to work.

Ironically, by calling on Apple, Samsung and Sony to ensure no children are used in the mining of the cobalt used in their products might be condemning these families to a worse fate - making these kids worse off not better.

This was the point of a seminal paper by Basu and Van in 1999, only if, by banning child labor does the overall supply of labor decrease so much that adult wages rise enough to compensate, does a ban actually improve the welfare of the children.  And if the local schools are poor - as they often are in rural parts of low-income countries - there maybe little benefit to sending children to them.

Much of my work over the last decade and a half studies the consequences of children working so I am acutely aware of the problem.  Enough to know that calls to ban child labor, though well-meaning, are often misguided.  I prefer focusing on investments in education and social safety nets to create a situation where families have enough consumption to survive and where sending kids to school is a good long-term investment.   Besides, bans are often essentially toothless without  real enforcement, something that low-income countries do not have the resources to do.  Better to focus on the incentives that cause children to work in the first place.

Friday, January 8, 2016

Fred Thompson: Kickers Redux



Fred Thompson once again keeps the blog alive with another insightful piece.

Patrick Emerson and I have written about the Kicker and its folly often here at the Oregon Economics Blog. In what is otherwise an arguably exemplary state and local tax system, Oregon’s kicker is an embarrassment, or, more correctly, the legislature’s unwillingness to deal with it is simply shameful.



As it happens the kicker isn’t entirely unique to Oregon. At least six other states – Colorado, Massachusetts, Missouri, New Hampshire, North Carolina and Oklahoma – have “triggers” that automatically impose tax cuts (i.e., give refunds, credits or a reduction in rates to taxpayers or businesses) whenever cash inflows (real or expected) exceed planned outflows. Moreover, Michigan’s Governor, Rick Snyder, recently signed a bill that will automatically roll back personal income-tax rates whenever state revenue exceeds 1.425 times the rate of inflation, although not until 2023.

All of these measures have a similar justification: the widespread belief that governments are myopically imprudent, that when times are flush they will spend like drunken sailors, thereby creating irresistible pressures to raise taxes when times are tight to maintain otherwise unsustainable current service levels. Moreover, automatic cuts are apparently politically appealing. They promise tax cuts for voters, but grant them only when there is enough cash to pay for the cut.



From this standpoint, Oregon’s kicker could be worse. It goes into effect retrospectively, when actual cash inflows exceed the budget forecast. In Oklahoma, the kicker is prospective, based on the revenue forecast itself. This year Oklahomans, like Oregonians, will get a big refund. Unfortunately, forecasts are not reality. Oklahoma’s actual revenues are insufficient to cover both its budget and the automatic tax cut. Moreover, Oklahoma has a very strict balanced-budget law. It must bring its cash outflows into line with inflows during the current year and it is prohibited from borrowing (even from itself) to do so. In this instance, the automatic trigger caused precisely the problem it was supposed to fix.

Economies are cyclical; revenues are too. That’s not necessarily a bug. The problem is stabilizing spending, but, as the Legislative Task Force on Restructuring Revenue and Governor Ted Kulongoski’s reset team recognized, the solution is straightforward: avoid myopic imprudence, i.e., grow spending at a sustainable rate, using saving and, when necessary, borrowing, to smooth out spending. Were the legislature less pusillanimous, repeal of the kicker law would allow this solution to be put into effect without a foreseeable need for borrowing (actually, given my druthers, I would base the revenue estimate on a sustainable, long-term growth rate, use the kicker – revenues in excess of the estimate – to automatically pay down state debt/build a sinking fund, and rely on borrowing whenever actual revenues dropped below the revenue estimate, but that is a slightly different story).




It might be noted that other states have found the political cojones to repeal automatic triggers. According to Governing Magazine, the trigger trend began in California, but was laid to rest during the Schwarzenegger administration. More recently, thanks to their Governor Brown, California voted Proposition 2 into law. Proposition 2 amends the California Constitution to require that the Governor make mid-term spending and revenue targets part of the state budget process, requires the state to set aside revenues each year – for 15 years – to pay down specified state liabilities, and substantially revises the rules governing the state’s rainy day fund. In other words, California’s legislature did pretty much what Oregon’s has consistently refused to do. They referred a measure aimed at making state and local spending sustainable to the citizenry. On November 4, 2014, 70 percent of the electorate voted in its favor. It is downright shocking when California exhibits greater fiscal responsibility than Oregon.

Monday, November 16, 2015

Fred Thompson: Raising Oregon’s Minimum Wage to $15?

Fred Thompson checks in again with this piece (I should really start calling this the "Fred Thompson Economics Blog). Thanks Fred for keeping this blog alive!



Recently Chuck Sheketoff of the Oregon Center for Public Policy addressed a barrage of questions to the opponents of raising the Oregon minimum wage to $13.50 and, then, $15. Like a good attorney he asked only questions he knew and liked the answers to. Some of the questions he didn’t ask are:

1. Who do minimum wages hurt? Someone pays. Who are the net losers, and by how much?
2. How much do they increase the earnings of lower-wage (<$20 per hour) workers and for how long?
3. Do employers reduce employer benefits or the quality of working conditions when minimums are increased?
4. Do higher minimum wages enhance productivity and, if so, why and how much?
5. Do they attract more qualified/more productive workers into the low-wage labor pool, permitting employers to be more selective and, if so, who gets displaced?

One thing that we know for certain is that the effects of moderate minimum-wage boosts on total low-wage employment, when and where the economy is healthy, are trivially small, maybe non-existent. What happens in the macro-economy, boom or bust, swamps the direct effects of minimum-wage increases. Consequently, Chuck’s claim that “a substantial minimum wage increase can go hand-in-hand with solid economic growth” is undoubtedly true.

Moreover, even the direct employment effects that we have observed from minimum-wage hikes are vanishingly small. Statutory wage minimums work like taxes on low-wage labor, with their proceeds paid directly to low-wage workers and most of their costs shifted forward to consumers in the form of higher prices. This might have two kind of effects on the demand for low-wage labor: an income effect, since consumers wouldn’t be able to afford to buy as many goods and services as before (more or less fully offset in the aggregate by the wage increases), and a substitution effect, as consumers shift away from goods and services whose relative prices have increased as a result.



Consequently, moderate increases in the minimum wage should raises the price of some things, e.g., services produced by the hospitality industry, although, in the case of a 30% increase in the minimum wage, probably by less than 3%, and also perhaps cause folks to substitute away from sit-down restaurants, and toward fast-food restaurants. Nevertheless, so far as the food preparation and service industry is concerned, about 80,000 workers, it would be really surprising if the net, one-time reduction in jobs caused by Oregon’s current minimum wage were 1,000, statewide, This is the case primarily because labor costs represent less than 40% of the total cost of sit-down hospitality services and 25% of take-out food service. Moreover, while Oregon’s minimum wage is 27 percent above the national rate, its median wage for food preparation and service occupations is only 5.5 percent higher ($9.60 compared to $9.10 nationwide in 2014). More broadly, the scale of this effect is undoubtedly far higher for food preparation and service occupations than in most other Oregon industries that hire large numbers of minimum wage workers, e.g., retail, where the low-wage, labor-added component is typically ≥ 10%.

There is one industry, however, where one might see an effect, if one is to be found: child-care. The minimum wage is the median hourly wage in the child-care industry in most states. Moreover, wages and salaries account for more than 60% of the cost of service in this industry. Not surprisingly, Oregon, with one of the nation’s highest minimum wages, also has the highest child-care cost in the nation. Oregon has about 15K child-care workers. If Oregon’s current minimum wage has a discernable effect anywhere, it should have one here.

This also points to another consideration often omitted in these discussions: the effects of an increase in the minimum wage, both for good and for ill, depends less on the existing minimum wage than on median wages in low-wage occupations. Oregon’s minimum wage has raised median-wages in food preparation and service occupations about 6% compared to the rest of the country; in child-care, the effect is more like 25%. This is relevant to the chuck’s claim that Oregon has previously made big jumps in our minimum wage previously (42% in 1989 vs. a 43% proposed increase today) without harming the economy. The last time Oregon did so, its state minimum wage was the same as the national minimum; it is now 27% higher.



From this standpoint, an increase to $13.50, let alone $15, would at this time be entirely unprecedented. We might end up in a very good place, but we have no real basis for drawing such a conclusion.

Moreover, contrary to Chuck’s claim, the fact is that, over the next couple of years following the 1989 minimum wage boost, Oregon unemployment increased substantially (just as it did in the rest of the US). Eventually, the economy picked up, but ever since, Oregon’s unemployment level has exceeded that of the US, despite faster GDP growth overall. Of course, the 1990-92 recession, not the increase in the minimum wage, caused the fall in employment. But there is some evidence of a possible link between Oregon’s 1989 minimum-wage hike and the persistence of higher levels of unemployment after the recession, i.e., evidence that the timing of minimum wage hikes matters, not just their size.

Some might argue, therefore, that, before taking a leap into the dark, it might be better to see how things work out in Seattle, Los Angeles, and Chicago. But such caution mostly applies to giant leaps. A minimum-wage boost to $13.50 is not really a giant leap: we are talking about a >$2 billion shift in a >$150 billion economy (with the net gain to below-median-income households of $200-$600 million).

Of course, from a welfare standpoint, it is too bad that the attention given to boosting minimum wages isn’t focused on policies that are better targeted at low-income families and the working poor: the preservation and expansion of the social safety net, especially foodstamps, aid to needy families, and unemployment benefits. There is clear, unambiguous evidence that these policies materially improve the welfare of low-income households. Moreover, states that pursue these policies have lower rates of infant mortality, less crime, higher earnings, and better education outcomes. There is even some evidence that these policies are associated with greater social mobility, which is evidently not the case for minimum wage policies.

It’s also too bad that those who are primarily concerned with the working poor don’t concentrate on the expansion of Oregon’s earned income-tax credits (EITC) or on increasing participation of Oregonians in the federal EITC. Unlike minimum wages, these programs target their benefits exclusively to the working poor and are implicitly financed by personal income taxes, which are progressive at both the federal and state level, rather than consumption, which is not. Indeed, the net-gain to low-income Oregonians from boosting participation in EITC to 100% (i.e., if all of those eligible to participate did so) might be as much as half the gain to low-income households from the proposed minimum-wage boost.

Because the most important reason for under-participation in the EITC is the failure to file a tax return, which, as a result of withholding, leads to over collections from low-income taxpayers of up to $200 million per year in Oregon and probably a comparable amount in federal income taxes, we could be talking about net gains to low-income households from fixing EITC participation that are actually larger than those of a minimum-wage boost.


The policies are not inherently rivals (indeed, a good case can be made that they are complements). We could do both; but we probably won’t. In this case the not-so-bad looks like the enemy of the pretty-good. I’m not against increasing the minimum wage, but we could do better.