Saturday, October 09, 2010

Chapter 3 of Toomey's Road to Prosperity

Partial review of The Road to Prosperity: How to Grow Our Economy and Revive the American Dream, by Patrick J. Toomey and Nachama Soloveichik. NY: Wiley, 2009.

A few years ago I wrote a lengthy multi-part review of Rick Santorum’s book. I’d like to do something similar for Toomey’s Road to Prosperity. Each post will discuss one or more chapters of the book with a post at the end with a linked list of all the entries and some final thoughts.

The third chapter, "Tax policy,"(51-75) provides an overview of his thoughts on our current policy and what he thinks would be a good replacement.

Toomey starts out with an example of supply-side economics, his father giving up “rest, leisure and other alternatives to work” (51) to earn overtime. He also references bonuses and the incentives this provides to stay late, work weekends or take work home. Unlike many who support supply side economics Toomey does not think that lower tax rates will encourage spending. He thinks it will increase production because people will be willing to work longer or more hours to earn more and bring home more money. It is the greater productivity that he sees as the real result.

However, he does not take into account the large number of jobs that are salaried and in companies or organizations that do not offer bonuses. Or that do not offer or encourage overtime. For those people his views on productivity do not apply.

His two primary tax recommendations are to lower marginal income tax rates and lower capital gains tax. This is especially true in the case of entrepreneurs, who he thinks are more likely to hire more workers if tax rates are low. Tax credits would not have the same effect.

In Toomey’s view, the ideal capital gains tax is zero. One sentence really stood out for me: “Share prices tend to rise when a company’s earnings increase” (57). As someone who has dabbled in the market and followed some stock, and read the Wall Street Journal faithfully for some year, I note that this is logical, and therefore has no real correlation in the stock market. Share prices should go up when earnings increase, but they often don’t. Bad press, an overall down market, and a host of other factors can affect a stock’s share price. Irrational exuberance and it’s opposite, irrational gloominess can have a drastic affect on market volatility regardless of how an individual company is doing. However, this is apparently an area where Toomey and I disagree.

Continuing with his train of thought he writes that people hold on to stocks they might want to see because they wish to avoid paying capital gains tax, and this restricts “the free flow of capital to is most productive uses” (57). I’m not sure I agree with that either. It might cut down on people trading stocks willy nilly but I’m not sure we need any more day traders. Another question I have of his argument is his statement that 50% of Americans are investors. I find this extremely high and think it includes people who own retirement funds. Checking the source Toomey uses for his statistic (which is on page 9 of that document), I found this explicitly stated a few pages later (p. 13) – defined contribution retirement plans account for much of the increase in stock ownership between 1989 and 2008. These are generally managed funds and so people are not individually paying capital gains tax. In this case I think people would be better off choosing a fund with a low or no load (management fees) that worrying about capital gains. Stable funds, especially index funds, do not buy and sell often.

By lowering the capital gains tax Toomey thinks workers would invest in goods that would make them more productive – more efficient tools, computerization or other technological innovations, and so forth, that increase their ability to work quickly and better.

In response to anticipated questions on how to replace the revenue lost when taxes are lowered, Toomey takes the line that increased productivity will make up for it. I have doubts about this in general and am not sure it would work the way he thinks it would.

Taking the opposite tact, Toomey thinks that increasing tax rates will not increase tax revenue because those with the option to do so will simply work less and start fewer businesses.

The book also compares American’s capital gains tax with that of other countries and finds our tax rate extravagant, although it falls in the middle range. Toomey theorizes that we lose international business as companies would gravitate to countries with lower tax rates.

The disparity in taxation within the population is taken up next. The book points out that while the overall tax rate for wealthier Americans has gone down, their share of the overall tax burden has gone up, and more Americans are paying no tax at all.

While admitting that the country’s income disparity has grown (the rich get richer and the poor get poorer), Toomey says that across the board incomes and standards of living have gone up. In addition, in a democratic society people can move from one income level to another. He cites statistics showing that people frequently move from one income level to another. One example given is that someone just starting a career would naturally have a low income level and that it will rise as the person moves up the career ladder. Personally I think that someone whose parents could afford to pay for college is always going to have a higher income that someone whose entire working life is spent in various positions within the fast food industry, regardless of how high on that occupational ladder they rise.

The next section of the chapter is on the tax code itself. It is Byzantine, obtuse, and convoluted. Toomey cites examples of tax credits written in such a way that only a few or even one person, benefits from it He also takes on the Alternate Minimum Tax. In Toomey’s view time spent preparing tax returns and studying tax codes could be better spent working. Two factors that aided the development of our tax code, and that prevent it from being reduced to simpler terms, are lobbyists and politicians. If a president truly committed to tax reform was supported by a House and Senate of the same party, Toomey thinks real reform would be possible.

The rest of the chapter compares two possible reforms, the flat tax and the fair tax. The flat tax is fairly simple. All earned income above a certain amount is taxed at one rate.. Toomey favors this plan and suggests a rate of 17%. He cites Steve Forbes and Dick Armey as supporters of this plan. Note that there would be no tax on “interest income, dividends, or capital gains. The death tax would be dead. An you could fill out your taxes on a 3 by 5 postcard.” In my view the tax on earned income only, and the exclusion of interest and dividends means that the wealthy, who are more likely to have interest and dividend income, would benefit from sources of untaxed income that are not likely to be found in poorer households. Toomey thinks this flat tax would stimulate new businesses and unemployment would decrease dramatically. I don’t necessarily agree with him on this.

The second tax reform option is the fair tax. is a national sales tax on goods and services; there would be no income tax. Toomey has reservations about this, one being that it would decouple Social Security taxes and benefits. The transition to a fair tax would fall disproportionately on those on a fixed income like seniors who paid income taxes while accumulating wealth or benefits and now have to pay a higher sales tax when spending their savings.

In his summation Toomey says that “Excessive taxes are morally offensive because they directly diminish our economic freedom, and economic freedom is a fundamental part of personal freedom. (74). He also invokes, once again, the greater unseen benefit that is lost compared to the visible benefit gained. With our current tax code we lose the businesses that would have been started and jobs that would have been created under a simpler, and lower, tax code.

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