Ebook review Tax Policy and the Economy, Volume 20 by James M. Poterba
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Introduction
Tax Policy and the Economy, Volume 20″ by James M. Poterba is a comprehensive analysis book that mainly seeks to establish the relationship or effects of taxation on varied aspects of the economy such as entrepreneurship and saving among others. It incorporates papers presented at the 2005 Tax Policy and the Economy conference. This conference held every year communicates the current findings of economic research in the areas of government spending and taxation to policy analysts both in the private sector and the government. These papers address issues that have immediate bearing on questions of long-term effects, as well as current policy debates. In the book, the author examines the varied effects of different forms of tax on different aspects of the economy including savings, entrepreneurship, and innovation among others. In addition, it examines the effects of varied tax provisions on individuals in different income brackets including low-income, middle-income and high-income earners. For example, flat tax rates would encourage entrepreneurial activity among low-income and middle-income earners while having a negative effect on high-income earners’ entrepreneurial activity.
As to how tax policies would encourage savings, the book examines how tax refunds may be used to encourage saving. It suggests that the temptation to spend the money prior to saving may be eliminated in varied ways including splitting tax refunds, and then directing part of the split amount to a certain savings account.
As much as the author was simply presenting information that would be useful in shaping tax policies, he was essentially aiming at calling for reforms in the various aspects of the tax system. These reforms would allow for increased innovation and entrepreneurship while encouraging saving among all groups of taxpayers.
Alan J. Auerbach, Who bears the burden of corporate tax? A review of what we know
There has been intense debate among public finance economists as to the corporate income tax incidence or rather who bears the corporate tax burden. In examining this, Auerbach examines Arnold Harbeger’s model of tax analysis. It is noteworthy that, despite numerous years of study, there is yet to be any consensus as to individuals who bear corporate tax burden. While tax accounts for a minute proportion of federal revenues, alteration of the corporate income tax and the associated revenues have usually been a considerable part of the revenue legislation. In addition, since corporate tax incidence is usually perceived to be borne by the affluent, the assignment of the burden may have a considerable effect on the tax system’s assessed progressivity. The difficulty in assigning the burden of corporate tax is most evident in the fact that, unlike many other types of taxes, there exists no guidance offered by statutory incidence (Auerbach 2).
The oldest theory explaining corporate tax incidence has stated that the corporate shareholders bear the burden in line with their ownership proportion. This theory is likely to be understood by individuals who see corporate tax as extremely progressive. However, this theory may not be so simply applied for several reasons. First, corporations may incorporate common and preferred shares, as well as varied classes of common shares with each class conferring varied rights to the income of the corporations. This theory is not clear on how a reduction in aftertax income would be borne by the varied classes of shareholders (Auerbach 5). In addition, even in cases where there is clarity as to the assignment of income, the shareholders may be corporate entities and not just individuals.
Harberger showed that owners of capital bore the corporate income tax in the entire economy. This shows that the entire tax is borne by capital and not shifted to consumers or labor. In addition, tax is borne by the entire capital and not the corporate capital only (Auerbach 9). Harberger also indicated that corporate tax is less progressive than under the assumption of shareholder incidence since shareholders are more affluent than the owners of capital ((Auerbach 9). However, aggregate capital ownership has a higher concentration among high-income individuals than labor income or consumption, in which case corporate income tax may be seen as encouraging tax progressivity. Harberger also shows that corporate income tax disfigured capital allocation between noncorporate and corporate uses in ways that overall capital income would not (Auerbach 9).
The complexity of analyzing taxation and its effects is increased by the tax treatment of cross-border flows. Unlike the domestic context, a distinction exists as to where the income has been earned and the residence of the owner. The residence concept is applied to both individuals and corporations (Auerbach 29). It is noteworthy that countries may tax corporate income on a residence basis or source basis or a blend of the two. When corporate capital income is taxed on a residence basis, it leaves less shifting scope than source-based taxation. In the residence basis taxation of corporate income, the United States tax rate would be applicable irrespective of the place the capital moved in which case it would be difficult to avoid. Residence, however, is not unchallengeable especially for corporations. In essence, residence-based corporate income tax may decrease the possibility of shifting capital and induce shifting of residence (Auerbach 30). It is noteworthy that, as much as the United States corporate income tax is said to be residence-based it incorporates numerous features that make it similar to source-based tax. First, foreign subsidiaries income is only taxed when it is repatriated to the country. Second, foreign income taxes are allowed tax credits, in which case little extra tax is collected on foreign-source income.
Cullen, Julie Berry and Gordon, Roger. “Tax reform and entrepreneurial activity.”
This paper’s authors sought to examine varied provisions pertaining to the payroll tax, corporate income tax and personal income tax that may impact on a person’s choice between working as a self-employed entrepreneur or salaried employee. It is noteworthy that many scholars agree that entrepreneurial activities are crucial determinants of economic growth and development in the long-run. However, there is little consensus as to how activities are impacted on by government policy.
While tax reform has many likely objectives, this paper focuses on the unleashing of the innovative energies in the economy by enhancing the attractiveness of the entrepreneurial activities. The most palpable element of tax law that possibly affects creative activities is the tax credit on research and development. This credit has been quite effective in enhancing the level of research and development in the United States. However, the credit comes with a restriction as to its nonrefundable nature, meaning that it does not benefit start-up firms since they may not currently have profits or even make them for quite a number of years. This means that these taxes would not be reduced through the credit (Cullen and Gordon, 43).
For individuals who are risk neutral, it is noteworthy that their choice of entrepreneurial risk to take would be entirely distorted by the taxes to such an extent that their expected tax payments as entrepreneurs would be different from the tax they pay as employees (Cullen and Gordon, 45). However, in cases where the income as entrepreneurs is similar to income as employees, the tax payment would remain virtually unaffected. In general, tax structures that incorporate marginal tax rates that are different over a range of income may affect a risk-neutral individual’s career choice (Cullen and Gordon, 45). In cases where the income from the entrepreneurial activity is lower than the income from employment, risk-neutral individuals may not find the project sufficiently attractive as to justify becoming entrepreneurs. However, it is noteworthy that the current personal income tax incorporates numerous provisions other than the fundamental rate structure that lessen or exacerbate the tax distortion. These include payroll tax, Earned Income Tax Credit, as well as the options that firms have to incorporate instead of remaining as noncorporate firms (Cullen and Gordon 47). Corporate firms are subjected to 15% corporate tax on their profits, not to mention other taxes when profits are taken out as realized capital gains or dividends.
In the case of risk-averse entrepreneurs, tax laws may potentially encourage entrepreneurial activities as the government would be sharing in the risk (Cullen and Gordon 53). If a flat rate of tax is imposed on all income without any deduction or exception, the entrepreneurs’ behavior would not change. In the case of progressive tax structure, its effect would depend on the weighted sum of the variation of tax payment across the income realization. Risk-averse individuals would be encouraged to take entrepreneurial risk under progressive tax by the high weight on the tax savings compared to the tax surcharges (Cullen and Gordon, 56).
Empirical research shows that changing to flat rate income tax structure encourages entrepreneurial activity among low-income earners and has a converse effect on high-income earners (Cullen and Gordon, 65). This is because the marginal tax rates would increase in the case of low income earners, providing increased sharing of the business losses with the government.
Eissa, Nada and Hoynes, Hilary W., “Behavioral Responses to Taxes: Lessons from the EITC and Labor Supply.”
This paper comes up with new evidence pertaining to how EITC affects labor supply. It is noteworthy that, EITC is United States’ largest cash antipoverty program, costing about $40 billion every year and affecting close to 20 million households. EITC is administered via the tax system and may substantially modify the marginal rate of tax that applies to the labor income of a household. There has been an increase in reliance on the system of tax in the recent times as a way of offering cash assistance to low-income families that have children. EITC has been successful in lowering poverty in the country, with research showing that it has lifted more children from poverty than other government programs.
For a taxpayer to be considered eligible for EITC, he or she must incorporate positive-earned income, as well as an adjusted-earned income and gross income lower than a specified amount (Eissa and Hoynes, 78). In addition, the taxpayer seeking EITC must have a child who qualifies as one. The child may be aged below 19 or 24 if he or she is a full time student. The credit amount to which the taxpayer is entitled depends on his earned income, the number of children eligible for EITC in the household, as well as the adjusted gross income (Eissa and Hoynes, 78). The credit schedule incorporates three regions including the initial-phase-in region, the flat region and the phaseout region. In the initial phase-in region, an amount equal to the subsidy rate multiplied by the earnings is transferred. In the flat-region, there is a set maximum region that the family would receive (Eissa and Hoynes, 78). In the phaseout region, a phaseout rate would be used to phaseout the credit.
The authors outline the fact that the EITC is expected to encourage the participation of single parents in the labor force (Eissa and Hoynes, 87). However, the effects of EITC on the number of hours that single working taxpayers are subject to the region where the taxpayer is in before the introduction or expansion of the credit. EITC has an ambiguous effect on the hours worked by single parents in the phase-in region, thanks to the positive distribution effect and the negative income effect. For single parents in the flat region, EITC has a negative income effect, which produces an ambiguous reduction in the number of hours worked. The EITC has a negative substitution effect and a negative income effect for single workers in the flat region (Eissa and Hoynes, 87).
In the case of married taxpayers, there are expectations that the EITC would reduce the hours worked, as well as the participation. This is because family incomes and earnings are used as the basis for the credit (Eissa and Hoynes, 91).
The authors identify three reasons as to why EITC does not affect or impact on the hours that the workers put in their workplaces. First, the workers may not have the capacity to select continuous work hours thanks to institutional norms or restrictions (Eissa and Hoynes, 103). In addition, there may be errors in the hours that the survey data has reported. Finally, it is noteworthy that taxpayers may not have full awareness as to the EITC schedule structure. This is because a large proportion of the taxpayers receive their EITC credits as lumpsum payments with the yearly tax returns, in which case their chances of learning the credit’s features are limited (Eissa and Hoynes, 103).
Sondra Beverly, Daniel Schneider, and Peter Tufano. “Splitting Tax Refunds and Building Savings: An Empirical Test.”
A large number of conventional policy debates pertaining to saving and tax incentives concentrate on the behavior of high-income and middle-income households, who might modify the proportion of their income that they dedicate to saving when responding to tax incentives. The authors examine the possible effects of these modifications of how tax refunds are treated administratively on the low-income households’ saving behavior.
It is always imperative for a saver to defer the gratification that he or she would have received today for an enhanced quality of life today (Beverly et, al 111). In essence, most would-be savers direct their money to saving prior to being tempted to spend it on other things. In this case, quite a large number of savings programs have been devised all in an effort to encourage saving. These programs have one common characteristic; they exploit the potential sources of saving before the saver has the chance to spend the money. In the case of low-income and middle-income families, state and federal tax refunds form a crucial source of savable funds (Beverly et al, 112).
It is noteworthy, however, that the current, saving system encourages savings through lowering tax payments that the well-to-do make (Beverly et al, 116). The taxpayer-based incentives have proven to be ineffective for low, as well as middle-income families who remit small amount of tax. However, the federal tax refund system has proved to be a possible, powerful way of facilitating asset-building amongst the low and middle-income families (Beverly et al, 116). Most low and middle-income families receive enormous refunds thanks to two federal tax credits, which are the partially refundable child tax credit (CTC) and the refundable Earned Income Tax Credit. This tax system not only facilitates savings but also distributes considerable funds. Evidence pertaining to the use of tax refunds in encouraging saving has triggered for-profit, as well as volunteer tax preparers to support recipients in their efforts to save these refunds (Beverly et al, 116).
While behavioral economists argue that individuals usually make irrational financial decisions mainly due to spending temptations, it is possible for constraints and incentives to be deliberately modified so as to overcome or avoid temptations (Beverly et al, 120). Empirical and theoretical evidence argue that assisting individuals to implement self-discipline via pre-committing their money to savings would be extremely effective. Since people undersave simply because they are unable to resist the temptation to spend, refund splitting where funds meant for saving are separated physically from the money for spending would be an effective tool for encouraging saving (Beverly et al, 120). Today, the IRS sends refunds to a single account in which case the would-be saver receives the whole refund. Programs that deposit the entire refunds in a single place require the recipients to set-aside some money, thereby leaving them open to temptations (Beverly et al, 121). If only the refunds could be split then sent to varied destination when the recipient is filling tax returns, then the family would physically and mentally separate the funds, thereby making saving automatic. In essence, the mental energy that is required to save would be reduced (Beverly et al, 121). This is reinforced by the direction of the savings portion to financial products that are savings oriented, especially products that restrict the withdrawal of the funds to some degree.
Jeffrey R. Brown and James M. Poterba. “Household Ownership of Variable Annuities.”
This chapter examines how variable annuities are treated as far as tax is concerned. It also outlines how aftertax returns on variable annuities compare to returns accruing from other financial instruments. The paper also explains how these are affected by minor tax rates on capital gains, ordinary income and dividends. It is noteworthy that these financial were some of the fastest-growing by the end of the 20th century. They offer buyers with numerous investment options, as well as a chance to defer tax on income from their investment. This is done via the inside buildup that these investment products incorporate. Variable annuities are deemed as insurance products, in which case any returns to the investment would not be taxed until the buyers withdraw cash from the variable annuity accounts. There are several reasons why people buy variable annuities. First, the buyers may desire to amass wealth at favorable rates of aftertax on returns. This is because income accruing from the investment is not taxed. Second, variable annuities come with an insurance component. It is noteworthy that, most variable annuities specify that in case of the death of a policyholder before retirement his heirs would be entitles to at least the policy contributions’ nominal value (Brown and Poterba 165). Third, variable options incorporate the option to change the contract to a life annuity in the future, thereby offering an annuitized stream of income where payouts are indexed to the diversified investment portfolio’s performance. There are varied ways in which distributions from variable annuities may be received, all of which are subject to varied tax rules. First, the buyer may go for lumpsum distribution where the variable annuity value during distribution less the annuity premium would be subjected to ordinary income tax rate of the policyholder (Brown and Poterba 170). Second, the buyer could go for periodic withdrawals from the account of variable annuities (Brown and Poterba 171). These withdrawals would be taxed in line with the earnings first, principal last rule. It is noteworthy, however, that withdrawal that have a value lower than the purchase price would be treated as returns on principal, therefore, they would not be considered a part of the taxable income. Third, the buyer may select a stream of different payouts to be released for a prespecified period (Brown and Poterba 171). Lastly, the buyer could go for life contingent annuity, in which case the number of payments is unknown, as well as the payout size. In this case, the IRS states the inclusion ratio that establishes the proportion of income in every period that would be incorporated in the taxable income of the recipient (Brown and Poterba 172).
As for ownership of variable annuities, research shows that older households have a relatively high likelihood of owning variable annuities. In addition, the ownership of variable annuities is highly concentrated in high-net-worth and high-income groups (Brown and Poterba 177). However, since the current income of many retired households may not reflect their position as far as lifetime earning is concerned, using the current income to rank them may come with an incomplete indicator as to the concentration of the variable annuity holdings (Brown and Poterba 179). It is noteworthy that households with low tolerance to risk have few chances of holding onto variable annuities than households with high risk tolerance. This underlines the high willingness that such households have as far as investing in assets held in variable annuities is concerned, rather than demanding the variable annuities insurance component (Brown and Poterba 189).
Jagadeesh Gokhale and Kent Smetters’s analysis of “Fiscal and Generational Imbalances: An Update.”
In this chapter, Jagadeesh and Kent provide new evidence pertaining to the federal government’s fiscal position in the long run. Their calculations are based on population growth, economic growth, healthcare outlays growth rate, as well as the evolution and development of the age structure of the population. These are compared to the outlays of other elements of the GDP. In this chapter, the authors note that the United States’ fiscal imbalance has increased since fiscal year-end 2002 from approximately $44 trillion to around $63 trillion. They mainly attribute this to the implementation of the prescription drug bill in the recent times known as Medicare Part D. A fiscal Imbalance measure is equal to the discounted value of federal noninterest in the future plus the current level of the public debt pertaining to past overspending minus the future federal receipts discounted to their present value. This means that the Fiscal imbalance indicates the level of unsustainability of the current United States Federal fiscal policy. When it is sustainable, the FI is Zero meaning that the outstanding public debt plus future spending commitments have been balanced with the discounted value of future receipts. The authors state that the imbalance increases by over $1.5 trillion every year when appropriate measures are not taken to lower it. Fiscal balance would be attained through massive cuts in the government expenditure. The incorporation of the Generational imbalance is supported by the deficiency of fiscal imbalance in reflecting policy bias. Generational imbalance calculates the input of the current and past generations to Fiscal imbalance, or rather, the level by which current and past generations have overspent under the current law. In essence, generational imbalance is a measure of the level by which the benefits to current and past generations exceed the amount of tax they have paid.
The GI measure shows that the current and past generations have overspent funds amounting to $33.6 trillion in Social Security and Medicare programs. While fiscal balance would only be attained through enormous reduction in government outlay, and an enormous increase in tax, the authors opine that such a thing would halt the economy and pass a worse economy to the future generations than the current generation inherited. Reduction in social security would also entail considerable hardships for retirees especially if the reduction is not sufficiently progressive. Tax increase alone would be insufficient to bring fiscal balance, especially having in mind that the extent of reductions is restricted by the need to get revenue from the tax base of state balancing. This underlines the importance of incorporating reductions in federal spending.
Since the current social security FI is lower than its GI, future generations will have a need to pay more in terms of present value of payroll taxes than the present value of the benefits they derive from Social Security. This underlines the importance of carrying out these reforms (Gokhale and Smetters, 206). As much as a speedy growth in real wage leads to an increase in tax revenue before the benefit levels increase, the cumulative extra growth in the level of wages ultimately leads to an increase in the comparatively enormous projected cost pertaining to the Old Age, Survivors and Disability Insurance program than in the minute projected tax revenues. In essence, a speedy increase in real wage leads to an increase in the OASDI program unfunded obligation.
Summary
In the book tax policy and the economy, James M Porteba examines the various aspects of tax policies, as well as their impacts on varied economical aspects. These include investment in variable annuities, investment, investments and saving among others. The authors produce convincing arguments as to the effects of tax on entrepreneurship, as well as the differences in fiscal imbalance and generational imbalance.
One of the book’s greatest strengths is its presentation of issues in a comprehensive manner. The comprehensive presentation allows for enhanced clarity of the issues presented, in which case it would be relatively easy to utilize the book when coming up with policies. On the same note, it is noteworthy that the various authors present their issues using both empirical and theoretical evidence. This underlines the comprehensive nature of research that has been done when compiling the information.
Like any other excellent book, however, this book comes with a number of failings. As much as the issues presented by the various authors incorporate comprehensive research, it is noteworthy that the findings are built on numerous assumptions. This means that if the conditions do not hold, then the findings would not be applicable. Unfortunately, not many economies would conform to the assumptions made to simplify to simplify the various theories. On the same note, it is noteworthy that the book used data from the last few decades or several years ago. This data may not be effective as far as making predictions or shaping future tax policies is concerned. This is because economies and policies do change alongside other aspects of the economies. This notwithstanding, the book would still be helpful in providing guidelines as to the various aspects of tax policies and their impact on the economy.
