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Chart 1a
Inflation, 1965 - 1988
12
P e r c e n t
GNP Price Deflator *
10
10.8
10.0
(Percent Change from Year Earlier)
8
5.7
6
5.7
3.7
4
4.1
3.6
3.0
2
2.1
0
1965
1970
1975
* Quarterly data from 1965-I to 1988-IV.
1980
1985
Chart 1b
Unemployment Rate, 1965 - 1988
12
10.8
P e r c e n t
Civilian Unemployment Rate **
10
9.0
8
5.7
6
4.6
4
5.3
3.4
2
0
1965
1970
1975
** Monthly data from Jan. 1965 to Dec. 1988.
1980
1985
Chart 1c
Interest Rate, 1965 - 1988
18
P e r c e n t
16
3-Month Treasury Bill Rate **
15.5
16.3
14
12
10.5
10
8.8
7.9
8
8.1
6
7.0
4
7.1
5.2
4.4
3.5
2
0
1965
3.2
1970
1975
** Monthly data from Jan. 1965 to Dec. 1988.
1980
1985
Keynesian Demand Management
Price
Chart 2
Aggregate
Supply
P1
E1
P0
E0
Aggregate
Demand
Y0
Y1
GDP
Rebates Did Not Boost Consumption
Billions of Dollars
11,000
10,500
Disposable
Personal
Income
10,000
9,500
Personal
Consumption
Expenditures
9,000
J F M A M J J A S O N D J F M A M J J A S O
2007
2008
Data Source: U.S. Bureau of Economic Analysis <http://www.bea.gov>. Based on John B. Taylor, "Why
Permanent Tax Cuts Are the Best Stimulus,' Wall Street Journal, Nov. 25, 2008.
Chart 3a Neoclassical Monetary Policy
One-Time Jump In Money Supply
Causes Higher Price Level
Price
Level
Short Run
Aggregate
Supply
Long Run
Aggregate
Supply
P2
E2
E1
P0
E0
Aggregate
Demand
Full Employment
(Capacity)
GDP
Chart 3b Neoclassical Monetary Policy
Permanent Shift In Money Growth Rate
Causes Inflation
Inflation
Rate
Short Run
Aggregate
Supply
Long Run
Aggregate
Supply
Infl2
E2
E1
Infl0
E0
Aggregate
Demand
Full Employment
(Capacity)
GDP
Imposition Of A Tax
Price
Chart 4
Supply
(With Tax)
Supply
(No Tax)
Reduction in Value of
Economic Output =
E1
Pc
Loss to Consumer
Tax
E0
+
P0
Loss to Producer
Pp
Resources
Redirected
to other
Activities
Q1
Q0
Demand
Quantity
Higher Tax Rates Raise, Then
Lower Revenues
Price
Chart 5a
Tax Revenues at
3 Different Tax
Rates
t3
t2
Supply
Deadweight
Loss
t1
t1
t2
Demand
t3
Q3
Q2
Q1
Q0
Quantity
Chart 5b
Laffer Curve
Government revenue maximized,
but tax rate too high because it's
hurting growth.
Tax Revenue
B
Optimum tax
rate: value of
government
services equals
revenue and
growth costs
that taxes
impose on
society.
0%
A
Normal
Range
C
Prohibitive
Range
Tax Rate
Tax rate much
too high. It's
hurting growth
and lowering
government
revenue.
100%
Chart 5c Tax Increases Reduce Economic
Activity Long Before They Reduce Tax Revenues
A
Dollars
Economic
Output
B
Optimal Tax
Rate
0%
Revenue
Maximizing
Tax Rate
Govt
Revenues
Tax Rate
100%
Because of deadweight loss and
distortions, it costs the country
more than a dollar to buy an
added dollar of government
goods and services
(about $2.50 - $3.00 total
on average, with some taxes
costing much more).
Cost =
direct budget outlay +
economic damage of tax +
and other distortions.
(All at the margin.)
Chart 6a
Effect of Tax On Labor
Wage
Labor
Supply
Gross Wage
Marginal
Product of Labor
(Demand)
Tax
Net Wage
Drop
in
Labor
L1
MPL would
rise if labor
had more
capital to work
with, and fall if
capital
formation
lagged.
L0
Hours Worked
Chart 6b Effect of Tax On Desired Capital
Stock
Return to Capital
Gross Return
Tax
Required Return
to Capital (Supply)
Net Return
Drop in
Capital
Marginal Product of
Capital (Demand)
K1
K0
Desired Amount of Capital
Wage
Chart 6c A Smaller Stock Of Capital Reduces Wages
Labor Supply
W0
MPL (K0)
W1
MPL (K1)
N1
N0
Employment
Chart 7a
Expanding Capacity By Reducing Taxes At The Margin
Price
(Constant Money Supply)
Long Run
Aggregate Supply
P0
Short Run
Aggregate
Supply
E0
P1
E1
Aggregate
Demand
Y0
Y1
Full Employment
(Capacity)
Real GDP
Chart 7b
Expanding Capacity By Reducing Taxes At The Margin
Price
(If Money Supply Is Adjusted To Keep Price Level Constant)
Long Run
Aggregate Supply
Short Run
Aggregate
Supply
P
E0
E1
Aggregate
Demand
Y0
Y1
Full Employment
(Capacity)
Real GDP
Chart 8
Average And Marginal Tax Rate Illustration
Illustrative Tax Schedule
Income
Tax
$0 to $10,000
0% (exempt amount)
$10,000 to $30,000
Over $30,000
20% of amount over $10,000
$4,000 plus 40% of amount over $30,000
Income, Tax, and Rates of Two Taxpayers
Taxpayer A
Taxpayer B
Income
$20,000
$50,000
Tax
$2,000
$12,000
Average Rate
10% (2,000/20,000)
24% (12,000/50,000)
Marginal Rate
20%
40%
Chart 9a
Individual Income Tax’s Rate Schedules
2009 Tax Rate Schedules
Single — Schedule X
If taxable income is:
Over— But not
over —
$0
8,350
33,950
82,250
171,550
372,950
$ 8,350
33,950
82,250
171,550
372,950
----------
Head of Household — Schedule Z
The tax is:
------------$835.00
4,675.00
16,750.00
41,754.00
108,216.00
of the
amount
over —
+
+
+
+
+
10%
15%
25%
28%
33%
35%
$0
8,350
33,950
82,250
171,550
372,950
Married filing jointly — Schedule Y-1
If taxable income is:
Over— But not
over —
$0
16,700
67,900
137,050
208,850
372,950
$16,700
67,900
137,050
208,850
372,950
----------
The tax is:
------------$1,670.00 +
9,350.00 +
26,637.50 +
46,741.50 +
100,601.00 +
$0
11,950
45,500
117,450
190,200
372,950
$11,950
45,500
117,450
190,200
372,950
----------
The tax is:
------------$1,195.00 +
6,227.50 +
24,215.00 +
44,585.00 +
104,892.50 +
of the
amount
over —
10%
15%
25%
28%
33%
35%
$0
11,950
45,500
117,450
190,200
372,950
Married filing separately — Schedule Y-2
of the
amount
over —
10%
15%
25%
28%
33%
35%
If taxable income is:
Over— But not
over —
$0
16,700
67,900
137,050
208,850
372,950
If taxable income is:
Over— But not
over —
$0
8,350
33,950
68,525
104,425
186,475
$8,350
33,950
68,525
104,425
186,475
----------
The tax is:
------------10%
$835.00 + 15%
4,675.00 + 25%
13,318.75 + 28%
23,370.75 + 33%
50,447.25 + 35%
of the
amount
over —
$0
8,350
33,950
68,525
104,425
186,475
Chart 13
The Kennedy and Reagan Tax Cuts
The Kennedy rate cuts were roughly the same percentage rate reductions
across the board, but rewards rose most where rates were highest:
Top tax rate cut from 91% to 70%.
After-tax reward rose from 9% to 30%, up 230%.
Bottom tax rate cut from 20% to 14%.
After-tax reward rose from 80% to 86%, up 7.5%.
Similarly for the Reagan Tax cuts:
Top tax rate cut from 70% to 50%.
After-tax reward rose from 30% to 50%, up 67%.
Bottom tax rate cut from 14% to 11%.
After-tax reward rose from 86% to 89%, up 3.5%.
In both cases, a greater response by upper-income taxpayers raised the
total share of taxes they paid.
Chart 9b
Marginal Individual Income Tax Rates Under Old
Law and 2001 / 2003 Tax Acts
1986 Tax
Reform Act*
If Congress
1990 Tax Act
1993 Tax Act
2001 / 2003 Tax Acts
Lets Tax
Cuts Sunset
1988 - 1990
1991 - 1992
1993 - 2000
2001
2002
2003 - 2010‡
2011 -
---
---
---
10%†
10%
10%
---
15%
15%
15%
15%
15%
15%
15%
28%
28%
28%
27.5%
27%
25%
28%
33%**
31%
31%
30.5%
30%
28%
31%
28%
---
36%
35.5%
35%
33%
36%
---
---
39.6%
39.1%
38.6%
35%
39.6%
* 1986 Tax Reform Act had transition rate for 1987, fully effective in 1988.
** The 5% surtax recaptured the "benefit" of the initial 15% rate, creating the 33% "bubble"; marginal rate returned to 28% after
taxpayer had lost all "benefit" from the 15% rate.
† Rebate in 2001 equivalent to 10% rate.
‡ 2001 / 2003 Tax Acts sunset at end of 2010. Old rates return in 2011 in the absence of further legislation.
CHART 12
Taxes And The Need For Indexing
No Tax Indexing
Initial tax schedule:
$0-$10,000: 0% (exempt amount)
$10,000-$30,000: 20% of
amount over $10,000
$30,000-plus: $4,000 plus 40% of
amount over $30,000
Tax Indexing
Initial tax schedule (above) for year 1;
Indexed tax schedule for year 2:
$0-$20,000: 0% (exempt amount)
$20,000-$60,000: 20% of
amount over $20,000
$60,000-plus: $8,000 plus 40% of
amount over $60,000
Year 1, P=100
Income year 1:
Tax year 1:
Average rate:
Marginal rate:
$20,000
$2,000
10%
20%
Year 1, P=100
Income year 1:
Tax year 1:
Average rate:
Marginal rate:
$20,000
$2,000
10%
20%
Year 2, P=200,
income doubles with
inflation,
no tax indexing
Income year 2:
Tax year 2:
Average rate:
Marginal rate:
$40,000
$8,000
20%
40%
Year 2, P=200,
income doubles with
inflation,
with tax indexing
Income year 2:
Tax year 2:
Average rate:
Marginal rate:
$40,000
$4,000
10%
20%
Year 2 in year 1 real
dollars,
no indexing
Income year 2: $20,000
Tax year 2: $4,000
Average rate: 20%
Marginal rate: 40%
Year 2 in year 1
real dollars,
with indexing
Income year 2:
Tax year 2:
Average rate:
Marginal rate:
$20,000
$2,000
10%
20%
Weighted Marginal Individual Income Tax Rate
34%
33.2%
32.0%
32%
30.5%
30.1%
30%
29.5%
28.5%
28.5%
Percent
28.1%
28%
27.6%
27.7%27.8%
26.8%
26.5%
26.1%
26.1%
26%
25.3%
25.6%
25.4%
25.1%
25.2%
24.7%
24.2%24.3%
24%
23.3%23.4%23.3%
23.2%23.2%
25.6%
24.7%
23.2%
22.9%
22.3%
22%
20%
72 73 74 75 76 77 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05
Year
Data Source: Internal Revenue Service, Statistics of Income, Individual Income Tax Returns, various issues; Internal Revenue
Service, Statistics of Income Bulletin, various issues. (Data not published for 1978)
Chart 13
The Kennedy and Reagan Tax Cuts
The Kennedy rate cuts were roughly the same percentage rate reductions
across the board, but rewards rose most where rates were highest:
Top tax rate cut from 91% to 70%.
After-tax reward rose from 9% to 30%, up 230%.
Bottom tax rate cut from 20% to 14%.
After-tax reward rose from 80% to 86%, up 7.5%.
Similarly for the Reagan Tax cuts:
Top tax rate cut from 70% to 50%.
After-tax reward rose from 30% to 50%, up 67%.
Bottom tax rate cut from 14% to 11%.
After-tax reward rose from 86% to 89%, up 3.5%.
In both cases, a greater response by upper-income taxpayers raised the
total share of taxes they paid.
Tax Rate and Tax Base interact; Both Matter!
True Versus Statutory Marginal Tax Rates
True
Marginal
Tax Rate
=
Statutory
Marginal
Tax Rate
Incremental
Tax Base
x
Actual
Incremental
Income
If the tax system hits the same income more than once, or if tax
rules overstate actual income, then the effective marginal tax rate
may be much higher than the apparent statutory marginal tax rate.
Example: Suppose the Statutory Marginal Tax Rate is 25%, but each extra
$1.00 of income is overcounted as $1.50. Then the True Marginal Tax
Rate is 37.5% (37.5% = 25% x 1.5).
Chart 17 Cumulative Marginal Tax Rate For A Single
Taxpayer Earning $12,000 to $40,000 With 2 Children
50%
46.71%
Marginal Tax Rate
40%
30%
41.71%
Cumulative
Marginal Tax Rate
16.71%
EITC Phase-Out
(21.06%)
26.71%
25.65%
20%
Federal Income Tax
(10%, 15%)
10%
0%
Child Tax
Credit (-15%)
-4.35%
-10%
Payroll Tax (7.65%)
State Income Tax (3%)
-20%
12,000
16,000
20,000
24,000
28,000
Earned Income
32,000
36,000
40,000
Chart 18
Effective Federal* Marginal Tax Rates for Social Security Recipients
Marginal tax rates as Social Security benefits become taxable, in tier 1 (50% phasein range) or tier 2 (85% phase-in range)
Income from savings, pensions **
Statutory Income
Tax Rate
Tier 1 (150% of statutory income tax rate)
Tier 2 (185% of statutory income tax rate)
10% (Current Law)
15%
NA
15%
22.5%
27.8%
25% (Current Law)
NA
46.3%
28% (Pre-2001 Law)
NA
51.8%
Wage Income ***
If not subject to earnings test
Subject to earnings test if between ages 62
and “normal retirement age”
Statutory Income
Tax Rate
Tier 1
Tier 2
Tier 1
Tier 2
10% (Current Law)
28.1%
NA
74.3%
NA
15%
35.0%
39.9%
79.4%
83.0%
25% (Current Law)
NA
57.1%
NA
95.5%
28% (Pre-2001 Law)
NA
62.3%
NA
99.3%
* Add 4 to 8 percentage points for typical state income tax rates for states that follow federal taxation of benefits.
** Tax-exempt bond income is included in determining whether income is over the threshold for taxing benefits. An additional dollar adds $0.50 or $0.85 to
taxable income, producing effective tax rates of 50% or 85% of the statutory rate on the supposedly exempt income.
*** Assumes self-employed payroll tax, and allows for deduction of "employer's" half of payroll tax from AGI and effect of deduction on modified adjusted gross
income used to determine amount of Social Security benefits subject to income taxation. Figures would be very similar for employee beneficiaries after adding
the employee and employer payroll tax rate adjusted for income tax deduction of employer's half at employer's income tax rate.
Chart 19
Multiple Taxation of Saving
One Tax on Consumption, Four Taxes on Saving
Layer 1– Tax on Earnings
Income is taxed when earned. If it is used for consumption, there is
usually no further federal tax.
Layer 2 – Personal Income Tax on Returns
If the income is saved, the returns are taxed as interest, dividends, capital
gains, or non-corporate business profits.
Layer 3 – Corporate Income Tax
If the saving is in corporate stock, the corporate tax hits the income before
it is either paid out to shareholders or reinvested to boost future earnings.
Layer 4 – Transfer (Estate and Gift) Tax
Another tax on already taxed assets.
(Similar taxes at the state and local levels increase the multiple taxation.)
Chart 20a
Income Tax Bias Against Saving and Two Cures
Pre-tax income needed to have either (a) $100 for consumption after taxes or
(b) a $100 bond paying $4 in interest after taxes.
Ordinary Income Tax Treatment, IRA-type Treatment, or Tax Exempt Bond Treatment.
Pre-tax
income
Tax
After-tax
income
Interest
on
saving
Tax on
interest
Aftertax
interest
% increase
in cost of
activity
due to tax
Income
consumed
$100
$0
$100
--
--
--
--
Income
saved
$100
$0
$100
$4
$0
$4
--
Income
consumed
$125
$25
$100
--
--
--
25%
Income
saved
$156.25
$31.25
$125
$5
$1
$4
56.25%
IRA-type treatment: amounts
saved tax deductible, returns
on saving taxed
$125
$0
$125
$5
$1
$4
25%
Tax-exempt bond treatment:
no deduction of saving,
returns not taxed
$125
$25
$100
$4
$0
$4
25%
No income tax
exists
Ordinary
income tax
levied at 20%
rate
The 20% income tax, by taxing income when first earned and taxing the return on saving, raises the cost of consumption by 25%
and the cost of obtaining additional future income by 56.25%, more than twice the increase in the cost of consumption.
Under IRA or tax exempt bond treatment, the tax raises the cost of obtaining additional future income by 25%, the same penalty as
on consumption.
Chart 20b Equivalence Of Saving Deferred And Returns
Exempt Tax On Saving; Contrast With Ordinary Income Tax
(Illustration assumes 7.2% pre-tax interest rate,
20% tax rate, and 10-year investment)
Tax Treatment
Pretax earnings to be
saved
Saving Deferred Returns Exempt
Ordinary Income
Tax
$100
$100
$100
Tax on saving
0
20
20
Amount saved
100
80
80
No, 7.2% reinvested
No, 7.2% reinvested
Yes, 5.76% reinvested
Account after 10 years
200
160
140
Tax due on withdrawal
40
0
0
After-tax spendable
balance
160
160
140
---
---
20 (= 160 – 140)
(a third of the interest)
Is interest on inside
build-up taxed?
Cost to saver of
ordinary tax treatment
Chart 21 Advantage Of Tax Deferred Saving
Over Ordinary (Biased) Tax Treatment:
Build-up Of $1,000 Saved per Year
$450
$400
Assets (thousands of $)
$350
Tax
Deferred
$300
$250
$200
$150
$100
$50
Ordinary
(Biased)
Tax Treatment
$0
20 25 30 35 40 45 50 55 60 65 70
Age
Saving from age 20 onward, under tax-deferred system and ordinary "double taxation"
(7.2% interest rate, 20% tax rate).
Chart 22
Multiple Taxation of Corporate Income
(a) Retained
Earnings,
Pre-2003 Act
(b) Dividend
Payout,
Pre-2001 Act
(c) Retained
Earnings and
Dividends,
2003 Act
1) Corporate Income
$1.00
$1.00
$1.00
2) Corporate tax at top rate
$0.35
$0.35
$0.35
3) After-tax corporate income:
Either retained, raising stock price
(columns (a), (c)), or paid as dividend (col.
(b), (c))
$0.65
$0.65
$0.65
$0.13
(tax rate 20%)
$0.2574
(tax rate 39.6%)
$0.0975
(tax rate 15%)
5) Total tax
$0.48
$0.6074
$0.4475
6) Total tax rate
48%
60.74%
44.75%
7) Income left to shareholder
$0.52
$0.3926
$0.5525
4) Individual income tax at top rate
(dividends as ordinary income, retained
earnings as capital gain)*
* Top corporate rate excludes corporate surtaxes, and top individual rate ignores phase-outs of exemptions and deductions and taxation of
Social Security, which may push effective top tax rates higher than statutory rates. Retained earnings are assumed to trigger a long-term
capital gain with a maximum rate of 20% or 15%. Short-term gains are taxed at ordinary tax rates.
CORPORATE TAX INTEGRATION
DIVIDEND PAID DEDUCTION FOR
CORPORATIONS (PARTIAL INTEGRATION)
SHAREHOLDER TAX CREDIT FOR
CORPORATE TAX PAID ON DIVIDENDS
(GROSS-UP METHOD, PARTIAL INT.)
PARTNERSHIP METHOD
(PASS-THROUGH OF CORPORATE INCOME
TO SHAREHOLDER FOR TAX PURPOSES,
WITH WITHOLDING PAID BY CORP.)
Chart 23
Present Value of Current Law Capital Consumption Allowances per
Dollar of Investment Compared to Expensing (First-Year Write-Off)
3
Yrs
Asset lives:
5
yrs
7
yrs
10
yrs
15
yrs
20
yrs
27.5
yrs
39
yrs
Present value of firstyear write-off of $1 of $1.00 $1.00 $1.00 $1.00 $1.00 $1.00 $1.00 $1.00
investment:
Present value
of current law
write-off of $1 if
inflation rate
is:
0%
$0.96 $0.94 $0.91 $0.88 $0.80 $0.74 $0.65 $0.55
3%
$0.94 $0.89 $0.85 $0.79 $0.67 $0.59 $0.47 $0.37
5%
$0.92 $0.86 $0.81 $0.74 $0.60 $0.52 $0.39 $0.30
Assumes a 3.5 percent real discount rate, 3-20 year assets placed in service in first quarter of the year, 27.5 - 39
year assets placed in service in January.
Chart 24
Expensing Versus Depreciation: Depreciation Overstates Taxable
Income and Depresses Return on Capital
Expensing (Full Cost Recovery)
Depreciation
Revenues from
machine, present value
$115
Revenues from machine,
present value
$115
Full cost of machine
$100
Full cost of machine
$100
Full cost write-off
for tax purposes
(expensing)
$100
Allowable depreciation
write-off, present value
$85
Real profit =
Taxable profit
$15
Taxable “profit” (exceeds
real profit)
$30
Tax
$5
Tax
$10
After-tax income
$10
After-tax income
$5
Rate of return
10%
Rate of return
5%
Marginal Tax Rates On Estates And Income
Contributed To Estates, 35% Estate Tax Rate
100%
90%
78%
Marginal Tax Rate
80%
73%
GST
70%
GST
60%
58%
50%
GST
40%
Estate Tax
35% *
Estate Tax
Payroll Tax
State Income Tax
State Income Tax
Federal
Income
Tax
Tax on a Dollar
of Wages (self-employed)
Left in an Estate
30%
20%
Estate Tax
Estate Tax
Federal
Income
Tax
Estate Tax
Estate Tax and
Generation
Skipping Trust
Tax on a Dollar
of Interest
Left in an Estate
10%
0%
* A 35% Estate Tax Rate, with a $5 million exclusion, became effective in 2011 through 2012.
It will revert to 55% in 2013, with a $1 million exclusion, without further legislation.
Assumes married couple in 33% tax bracket, who are self-employed, with a 6% state income tax
22
Chart 26 Marginal Tax Rates On Estates And
Income Contributed To Estates, 2009
90%
81%
80%
GST
70%
Marginal Tax Rate
70%
60%
50%
85%
GST
GST
Estate Tax
Estate Tax
45%*
Payroll Tax
40%
State Income Tax
State Income Tax
Federal
Income
Tax
30%
20%
Estate Tax
Estate Tax
Federal
Income
Tax
Estate Tax
Estate Tax and
Generation
Skipping Trust
Tax on a Dollar
of Interest
Left in an Estate
10%
0%
* 45% Estate Tax Rate became effective in 2007.
Assumes married couple in 33% tax bracket, who are self-employed, with a 6% state income tax.
Computed prior to Estate Tax Repeal, which is now scheduled for 2010.
Tax on a Dollar
of Wages (self-employed)
Left in an Estate
Chart 19
Multiple Taxation of Saving
One Tax on Consumption, Four Taxes on Saving
Layer 1– Tax on Earnings
Income is taxed when earned. If it is used for consumption, there is
usually no further federal tax.
Layer 2 – Personal Income Tax on Returns
If the income is saved, the returns are taxed as interest, dividends, capital
gains, or non-corporate business profits.
Layer 3 – Corporate Income Tax
If the saving is in corporate stock, the corporate tax hits the income before
it is either paid out to shareholders or reinvested to boost future earnings.
Layer 4 – Transfer (Estate and Gift) Tax
Another tax on already taxed assets.
(Similar taxes at the state and local levels increase the multiple taxation.)
STEPS TOWARD NEUTRALITY:
ALL SAVING GETS DEFERRAL
OR RETURNS EXEMPT EQUIVALENT;
EXPENSING OF INVESTMENT;
NO DOUBLE TAX OF CORPORATE
INCOME;
NO ESTATE AND GIFT TAX.
TAX BASES OF FOUR NEUTRAL TAXES &
POINTS OF COLLECTION
NRST -- INCOME LESS SAVING =
CONSUMPTION (NOT IMPOSED ON INVESTMENT GOODS). POINT
OF SALE.
VAT -- INCOME LESS SAVING =
CONSUMPTION (INVESTMENT EXPENSED).
AT BUSINESSES, IN STAGES.
CASH FLOW TAX -- INCOME LESS SAVING = CONSUMPTION.
(INVESTMENT EXPENSED)
INDIVIDUAL TAX FORM.
FLAT TAX -- INCOME LESS INVESTMENT = CONSUMPTION.
CAPITAL INCOME ON BUSINESS OR PROPRIETOR FORM
(INVESTMENT EXPENSED); WAGES ON INDIVIDUAL FORM.
Elements of Neutral Taxes
 All treat saving neutrally vs. consumption.
 All employ expensing instead of depreciation.
 All are territorial.
 All have the same basic tax base.
 Differ mainly as to point of collection.
29
Chart 27
Inflow Outflow Tax
Form 1040: Individual Tax Form, Inflow Outflow Tax
1. Sum of: Labor compensation, Pension receipts, Taxable Social
security, Transfer payments (from W-2 forms).
2. Net saving (+) or net withdrawals (-) (from Schedule B)
$33,000
$ 3,000
3. If line 2 is net saving (+), subtract dollar amount from line 1; if net
withdrawal (-), add the dollar amount to line 1.
$30,000
4. Other itemized deductions from Schedule A
$10,000
5. Subtract line 4 from line 3.
$20,000
6. Personal allowance times number of taxpayers and dependents:
$5,000 x 2 =
$10,000
7. Subtract line 6 from line 5. This is your taxable income.
$10,000
8. Tax from table (or, line 7 times 20%).
$ 2,000
9. Withholding, from W-2, plus estimated tax payments.
$ 2,100
10. Amount due (+) or amount overpaid (-) (line 8 less line 9). If
amount is due, pay Internal Revenue Service.
11. If overpaid, fill in: Amount to be refunded $100 ; or
Amount to be applied to estimated tax
.
-$ 100
Chart 27, cont.
Inflow Outflow Tax
Inflow Outflow Tax:Schedule A, Itemized Deductions
1. Sum of individual payroll tax (from W-2), state and local
income tax withheld (from W-2) and estimated state and
local tax less refunds from previous year, and local property
taxes.
$ 5,000
2. Gifts, contributions.
$ 1,000
3. Qualified tuition, training expenses.
$ 4,000
4. Total. Enter on Form 1040, line 4.
$10,000
Inflow Outflow Tax:Schedule B, Saving
List net saving (+) or withdrawals (-) from financial
institutions reported on 1099 forms:
First National Bank
-$1,000
Merrill Paine Schwab
+$4,000
Total (if greater than zero, this is net saving; if less than zero,
a net withdrawal). Enter on Form 1040, line 2.
$3,000
Why it Matters
History tells us that:
 When we have moved toward a neutral tax with
lower rates, the economy has boomed.
 When we have increased tax biases the
economy has faltered.
 When we have wasted tax cuts on non-growthrelated rebates, nothing good has happened.
25
1,100
340
1,050
320
1,000
950
2002 Tax
Cut
2003 Tax
Cut
2001
Tax
Cut
300
Equipment
and Software
<-- Left Axis
280
260
900
240
Nonresdidential
Structures
Right Axis -->
850
800
2000
220
200
2001
2002
2003
2004
2005
Quarter
Data Source: BEA, National Income and Product Accounts, Table 5.3.6, accessed via www.bea.gov.
Billions of Dollars (2000 $)
Billions of Dollars (2000 $)
Real Private Investment
And 2001, 2002, and 2003 Tax Cuts
45
8
Top Tax Rate on
Long-Term Gains
40
35
7
6
30
5
25
4
20
3
15
2
10
Realized Gains as
Percent of GDP
5
0
1975
1
Realized Gains as Percent of GDP
Maximum Tax Rate on Long-Term Gains
Capital Gains Realizations Rise When The Maximum
Tax Rate on Long-Term Gains Falls, 1976 - 2007
0
1980
Data from U.S. Treasury
1985
1990
1995
2000
2005
Year
27
Chart 1
Change in GDP Due To Tax Law Changes
During Presidential Administrations
12%
10.2%
10%
8.0%
7.7%
8%
6%
4%
2.8%
1.2%
1.0% 1.0%
2%
0%
-0.9% -0.5%
-2%
-2.1%
-4%
-3.2%
-3.4%
Source: Calculations by author
G
H
W
B
us
C
h
lin
to
n
(I )
C
lin
to
n
(I I
G
)
W
B
us
h
O
ba
m
a
)
(II
an
ea
g
R
ga
n
(I)
er
R
ea
C
ar
t
d
Fo
r
N
ix
on
n
so
hn
Jo
K
en
ne
dy
-6%
Objective: Growth
Neutral taxation is best for growth. It can yield:
 More saving, investment, and growth. Potentially:
o Trillions of dollars of added capital.
o Millions of added jobs and higher wages.
o Thousands of dollars in added family income.
U.S. would become a jobs and investment magnet.
30
Objective: Simplicity
Neutral taxes are much simpler, even if collected on
individual tax forms:
 No double taxation.
 No limits on savings plans. One universal plan, not
dozens.
 No separate taxation of capital gains.
 No depreciation schedules.
 No foreign tax and tax credit.
 No phase-outs of exemptions, credits, deductions.
31
Objective: Fairness
 Consumption is a fairer tax base than income; it
respects the effort of people who work and
save.
 Neutral taxes can be made progressive to shelter
the poor.
 There is no need to tax saving and investment
more harshly than consumption to achieve
progressivity.
 The simpler, clearer neutral tax would be seen to
be fair.
32
Objective: Visibility
 Only people pay taxes.
 Businesses and things don't pay tax.
 Taxes are best levied on individuals.
 Voters need to see what government costs.
 Everyone who can do so should pay something
toward the cost of government.
 Simplicity is no excuse for dropping tens of millions
of people from the tax rolls.
33
Recap
Tax reform is about:
 Getting the tax base right.
 Setting rates that cover the amount of government
that people want to have.
 Raising revenue with less damage to the economy.
 Informing voters of the price they pay for government so that they can make informed decisions
about how much government activity to support.
34
Chart 28 Government And Private Saving
Often Move In Opposite Directions
Gross Saving
20%
Percent of GDP
15%
Business Saving
10%
Personal Saving
5%
Government Saving
0%
-5%
1960
1965
1970
1975
1980
1985
1990
1995
2000
Quarterly Data, 1960:Q1 to 2008:Q4
Sources NIPA data from Bureau of Economic Analysis (accessed at www.bea.doc.gov);
Chart based on Gary Robbins and Aldona Robbins, "Robbing Peter to Pay … Uncle Sam,"
Economic Scorecard, 2nd Quarter, 1999, Institute for Policy Innovation, accessed at www.ipi.org.
2005 2008
The Circular Flow Diagram
BASIC MACRO EQUATION
INCOME (= WHAT
WE PRODUCE)
EQUALS
HOW WE USE
THE INCOME
C + I + G + (X - M)
=
C+S+T
Where:
C = consumption, I = investment, G = government,
X = exports, M = imports, S = saving, T = taxes
IN AN ISOLATED PRIVATE ECONOMY
WITH NO GOVERNMENT,
SAVING = INVESTMENT
C+I
=
C+S
I
=
S
IN AN OPEN PRIVATE ECONOMY
(WITH NO GOVERNMENT)
DOMESTIC AND FOREIGN SAVING CAN COVER INVESTMENT
OR EXCESS SAVING LENT ABROAD FUNDS A TRADE SURPLUS
C + I + (X - M)
=
C+S
I
I + (X – M)
=
=
S + (M - X)
S
IN AN ISOLATED ECONOMY WITH GOVERNMENT
SAVING MUST COVER INVESTMENT AND BUDGET DEFICIT
C+I+G
=
C+S+T
I+G
G-T
I + (G - T).
=
=
=
S+T
S-I
S
IN AN OPEN ECONOMY WITH GOVERNMENT,
DOMESTIC AND FOREIGN SAVING MUST COVER
INVESTMENT AND BUDGET DEFICIT
C + I + G + (X - M)
=
C+S+T
I + (G - T)
=
S + (M - X)
BASIC GDP EQUATION RECAP
•
•
•
•
•
•
•
•
Domestic
Y = C+I+G = C+S+T
S = I+(G-T) or (S-I) = (G-T)
Saving covers investment and the gov’t deficit.
With rest of world
Y = C+I+G+(X-M) = C+S+T
S = I+(G-T)+(X-M) or (S-I) = (G-T)+(X-M)
If saving > investment and govt. def., we have a balance of
payments surplus.
Current and Capital Accounts
What we sell:
=
Exports of goods &
services +
=
U.S. financial
instruments & real
property
What we buy:
Imports of goods &
services +
Foreign financial
instruments & real
property
Current and Capital Accounts, Cont’d.
Exports – Imports of
goods & services
or
Current acct. surplus =
U.S. lending abroad Foreign loans to
U.S.
or
Capital account deficit
or
Net capital outflow
Trade: Absolute Advantage
cloth (yds/hr)
peanuts (lbs/hr)
relative price
workers
cloth (yds/hr)
25
peanuts (lbs/hr)
25
United States
100
1000
10/1
output
2500
25000
Mali
5
100
20/1
workers
25
25
output
125
2500
total
2625
27500
Shift workers to the relatively advantaged work
workers
output
workers
cloth (yds/hr)
27
2700
0
peanuts (lbs/hr)
23
23000
50
output
0
5000
total
2700
28000
Trade: Comparative Advantage
cars (#/mnyr)
wheat (tons/mnyr)
relative price
workers
cars (#/mnyr)
25
wheat (tons/mnyr)
25
United States
50
1000
20/1
output
250
5000
Germany
75
600
4/1
workers
25
25
Shift workers to the relatively advantaged work
workers
output
workers
cars (#/mnyr)
20
1000
30
wheat (tons/mnyr)
30
30000
20
output
1875
15000
2125
20000
output
2250
12000
total
3250
42000
GLOBAL VERSUS TERRITORIAL TAXATION
GLOBAL:
U.S. taxes firms on their domestic income and the
earnings of their foreign subsidiaries, then gives a tax
credit for foreign taxes paid. But the foreign tax is
deferred until the parent repatriates the earnings
(deferral of foreign source income).
TERRITORIAL:
Almost all other countries tax business activity within
their borders, and not the earnings of their
businesses’ foreign subsidiaries. This gives foreign
firms a competitive advantage vs. U.S. firms trying to
operate internationally.
GLOBAL TAXATION AND CAPITAL FLIGHT
• Does deferral encourage U.S. firms to send
capital and production abroad?
• Or does the global tax itself trap U.S. capital
abroad?
• Without deferral, U.S. firms would have to
cede business to competitors, not bring
production home.
• Global taxation makes it hard for firms to use
cash earned abroad to fund U.S. investment.
Chart 6b Effect of Tax On Desired Capital
Stock
Return to Capital
Gross Return
Tax
Required Return
to Capital (Supply)
Net Return
Drop in
Capital
Marginal Product of
Capital (Demand)
K1
K0
Desired Amount of Capital
Wage
Chart 6c A Smaller Stock Of Capital Reduces Wages
Labor Supply
W0
MPL (K0)
W1
MPL (K1)
N1
N0
Employment
BOTTOM LINE ON GLOBAL TAXATION
• Investment in each country is mainly set by its
own tax and regulatory climate.
• Taxes on capital are largely shifted to labor.
• If U.S. taxes on capital force capital abroad,
U.S. workers suffer, foreign workers gain.
• More likely, U.S. taxes on capital merely
reduce capital here; we lose, no one gains.
38
Please consider:
Economics is not the dismal
science -if you have a morbid sense of humor -and a large tru$t fund.
39
On the other hand --(Sorry, I’m an economist, it’s our
mantra) ----
40
Political science (sic)
is rather depressing, -and actual politics is surely the
Great Dismal swamp!!!
40
40