Chart 1a Inflation, 1965 - 1988 * Quarterly data from 1965-I to 1988-IV.

Chart 1a Inflation, 1965 - 1988

* Quarterly data from 1965-I to 1988-IV.

0

2

4

6

8

10

12

Pe

rce

nt

1965 1970 1975 1980 1985

GNP Price Deflator *(Percent Change from Year Earlier)

3.0

5.7

4.1

10.8

5.7

10.0

3.6

2.1

3.7

Chart 1b Unemployment Rate, 1965 - 1988

** Monthly data from Jan. 1965 to Dec. 1988.

0

2

4

6

8

10

12

Pe

rce

nt

1965 1970 1975 1980 1985

Civilian Unemployment Rate **

3.4

4.6

9.0

5.7

10.8

5.3

Chart 1c Interest Rate, 1965 - 1988

** Monthly data from Jan. 1965 to Dec. 1988.

0

2

4

6

8

10

12

14

16

18

Pe

rce

nt

1965 1970 1975 1980 1985

3-Month Treasury Bill Rate **

3.5

7.9

3.2

8.8

4.4

15.5

7.0

16.3

7.1

10.5

5.2

8.1

GDP

Pri

ce

Chart 2 Keynesian Demand Management

Aggregate Supply

Aggregate Demand

Y0 Y1

P1

P0 E0

E1

9,000

9,500

10,000

10,500

11,000

J F M A M J J A S O N D J F M A M J J A S O

Bil

lio

ns

of

Do

llar

sRebates Did Not Boost Consumption

2007 2008

Disposable Personal Income

Personal Consumption Expenditures

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.

PriceLevel

Chart 3a Neoclassical Monetary PolicyOne-Time Jump In Money Supply

Causes Higher Price Level

GDP

P2

P0

Full Employment(Capacity)

Long RunAggregate

Supply

Short Run AggregateSupply

AggregateDemand

E1

E2

E0

InflationRate

Chart 3b Neoclassical Monetary PolicyPermanent Shift In Money Growth Rate

Causes Inflation

GDP

Infl2


Long RunAggregate

Supply

Short Run AggregateSupply

AggregateDemand

E1

E2

E0Infl0

Chart 4 Imposition Of A Tax

Quantity

Pri

ce

Supply(No Tax)

Demand

Tax

Q0

P0

Q1

Supply(With Tax)

Reduction in Value ofEconomic Output =

Loss to Consumer

+

Loss to Producer

Pp

Pc

Resources Redirected to other Activities

E1

E0

Quantity

Pri

ceChart 5a Higher Tax Rates Raise, Then

Lower Revenues

Supply

Demand

Deadweight Loss

t1

Q3 Q2 Q1 Q0

Tax Revenues at 3 Different Tax

Rates

t1

t2

t2

t3

t3

Chart 5b Laffer Curve

Tax Rate

Tax

Rev

enu

e

0% 100%

Government revenue maximized, but tax rate too high because it's

hurting growth.

Tax rate much too high. It's

hurting growth and lowering

government revenue.

Optimum tax rate: value of government services equals revenue and growth costs that taxes impose on society. Normal

Range ProhibitiveRange

A C

B

Tax Rate

Do

llars

Chart 5c Tax Increases Reduce Economic Activity Long Before They Reduce Tax Revenues

Economic Output

Govt Revenues

0% 100%

A

B

Optimal Tax Rate

Revenue Maximizing Tax Rate

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.)

Hours Worked

Wag

eChart 6a Effect of Tax On Labor

Labor Supply

Net Wage

Gross Wage Marginal Product of Labor

(Demand)Tax

Dropin

Labor

L1

MPL would rise if labor had more

capital to work with, and fall if

capital formation

lagged.L0

Desired Amount of Capital

Ret

urn

to

Cap

ital

Chart 6b Effect of Tax On Desired Capital Stock

Net Return

Gross Return

Required Return to Capital (Supply)

Tax

Drop in Capital

K1

Marginal Product of Capital (Demand)

K0

Employment

Wag

e

Labor Supply

MPL (K0)

W0

N1

MPL (K1)

W1

N0

Chart 6c A Smaller Stock Of Capital Reduces Wages

Real GDP

Pri

ce


Chart 7aExpanding Capacity By Reducing Taxes At The Margin

(Constant Money Supply)

Long RunAggregate Supply

Aggregate Demand

P0

P1

E0

E1

Y0 Y1

Short RunAggregate

Supply

Real GDP

Pri

ce


Chart 7bExpanding Capacity By Reducing Taxes At The Margin(If Money Supply Is Adjusted To Keep Price Level Constant)

Long RunAggregate Supply

Aggregate Demand

PE0 E1

Y0 Y1

Short RunAggregate

Supply

Chart 8Average And Marginal Tax Rate Illustration

Illustrative Tax Schedule

Income Tax

$0 to $10,000 0% (exempt amount)

$10,000 to $30,000 20% of amount over $10,000

Over $30,000 $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 9aIndividual Income Tax’s Rate Schedules

2009 Tax Rate Schedules

Single — Schedule XIf taxable income is: The tax is: of the

Over— But not amount

over — over —

Head of Household — Schedule ZIf taxable income is: The tax is: of the


over — over —

$0

8,350

33,950

82,250

171,550

372,950

$ 8,350

33,950

82,250

171,550

372,950

----------

------------- 10%

$835.00 + 15%

4,675.00 + 25%

16,750.00 + 28%

41,754.00 + 33%

108,216.00 + 35%

$0

8,350

33,950

82,250

171,550

372,950

$0

11,950

45,500

117,450

190,200

372,950

$11,950

45,500

117,450

190,200

372,950

----------

------------- 10%

$1,195.00 + 15%

6,227.50 + 25%

24,215.00 + 28%

44,585.00 + 33%

104,892.50 + 35%

$0

11,950

45,500

117,450

190,200

372,950

Married filing jointly — Schedule Y-1If taxable income is: The tax is: of the


over — over —

Married filing separately — Schedule Y-2If taxable income is: The tax is: of the


over — over —

$0

16,700

67,900

137,050

208,850

372,950

$16,700

67,900

137,050

208,850

372,950

----------

------------- 10%

$1,670.00 + 15%

9,350.00 + 25%

26,637.50 + 28%

46,741.50 + 33%

100,601.00 + 35%

$0

16,700

67,900

137,050

208,850

372,950

$0

8,350

33,950

68,525

104,425

186,475

$8,350

33,950

68,525

104,425

186,475

----------

------------- 10%

$835.00 + 15%

4,675.00 + 25%

13,318.75 + 28%

23,370.75 + 33%

50,447.25 + 35%

$0

8,350

33,950

68,525

104,425

186,475

Chart 13The 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:





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*1990 Tax Act 1993 Tax Act 2001 / 2003 Tax Acts

If Congress

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.

* 1986 Tax Reform Act had transition rate for 1987, fully effective in 1988.

CHART 12Taxes And The Need For Indexing

No Tax Indexing Year 1, P=100Year 2, P=200,

income doubles withinflation,

no tax indexing

Year 2 in year 1 realdollars,

no 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

Income year 1: $20,000Tax year 1: $2,000Average rate: 10%Marginal rate: 20%



Tax Indexing Year 1, P=100Year 2, P=200,

income doubles withinflation,

with tax indexing

Year 2 in year 1real dollars,

with 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




Weighted Marginal Individual Income Tax Rate

25.3%

26.1%

26.8%

27.6%

28.5%

29.5%

30.5%

32.0%

33.2%

30.1%

28.1%

27.7%27.8%

28.5%

25.2%

23.3%23.4%23.3%23.2%23.2%

24.2%24.3%24.7%

25.1%25.4%

25.6%

26.1%

26.5%

25.6%

24.7%

22.3%

22.9%23.2%

20%

22%

24%

26%

28%

30%

32%

34%

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

Per

cen

t

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 13The 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:





Similarly for the Reagan Tax cuts:





In both cases, a greater response by upper-income taxpayers raised the total share of taxes they paid.

True

Marginal

Tax Rate

=

Statutory

Marginal

Tax Rate

x

Incremental

Tax Base

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.

Tax Rate and Tax Base interact; Both Matter!True Versus Statutory Marginal Tax Rates

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).

-20%

-10%

0%

10%

20%

30%

40%

50%

12,000 16,000 20,000 24,000 28,000 32,000 36,000 40,000

Earned Income

Mar

gin

al T

ax R

ate

Chart 17 Cumulative Marginal Tax Rate For A SingleTaxpayer Earning $12,000 to $40,000 With 2 Children

Child Tax Credit (-15%)

EITC Phase-Out (21.06%)

Payroll Tax (7.65%)

Federal Income Tax (10%, 15%)

State Income Tax (3%)

Cumulative Marginal Tax Rate

46.71%

25.65%

41.71%

26.71%16.71%

-4.35%

Chart 18Effective Federal* Marginal Tax Rates for Social Security Recipients

Marginal tax rates as Social Security benefits become taxable, in tier 1 (50% phase-in range) or tier 2 (85% phase-in range)

Statutory Income

Tax Rate

Income from savings, pensions **

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%

Statutory Income

Tax Rate

Wage Income ***

If not subject to earnings test Subject to earnings test if between ages 62 and “normal retirement age”

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 19Multiple 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 20aIncome 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

After-tax interest

% increase in cost of activity due to tax

No income tax exists

Income consumed

$100 $0 $100 -- -- -- --

Income saved

$100 $0 $100 $4 $0 $4 --

Ordinary income tax levied at 20% rate

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%

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 Saving Deferred Returns ExemptOrdinary Income

TaxPretax earnings to be saved

$100 $100 $100

Tax on saving 0 20 20

Amount saved 100 80 80

Is interest on inside build-up taxed?

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

Cost to saver of ordinary tax treatment

--- ---20 (= 160 – 140)

(a third of the interest)

$0

$50

$100

$150

$200

$250

$300

$350

$400

$450

20 25 30 35 40 45 50 55 60 65 70Age

Ass

ets

(th

ous

and

s o

f $

)

Saving from age 20 onward, under tax-deferred system and ordinary "double taxation"(7.2% interest rate, 20% tax rate).

TaxDeferred

Ordinary (Biased)

Tax Treatment

Chart 21 Advantage Of Tax Deferred SavingOver Ordinary (Biased) Tax Treatment:

Build-up Of $1,000 Saved per Year

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

4) Individual income tax at top rate (dividends as ordinary income, retained earnings as capital gain)*

$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

* 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 23Present Value of Current Law Capital Consumption Allowances per Dollar of Investment Compared to Expensing (First-Year Write-Off)

Asset lives:3Yrs

5yrs

7yrs

10yrs

15yrs

20yrs

27.5 yrs

39yrs

Present value of first-year write-off of $1 of investment:

$1.00 $1.00 $1.00 $1.00 $1.00 $1.00 $1.00 $1.00

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 24Expensing Versus Depreciation: Depreciation Overstates Taxable

Income and Depresses Return on Capital

Expensing (Full Cost Recovery) Depreciation

Revenues from machine, present value

$115Revenues from machine,

present value$115

Full cost of machine $100 Full cost of machine $100

Full cost write-offfor 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%

22

Marginal Tax Rates On Estates And Income Contributed To Estates, 35% Estate Tax Rate

73%

78%

58%

35%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Estate Tax Estate Tax andGeneration

Skipping Trust

Tax on a Dollarof Interest

Left in an Estate

Tax on a Dollarof Wages (self-employed)

Left in an Estate

Mar

gin

al T

ax R

ate

State Income Tax

Estate Tax

Estate Tax

Estate Tax

Estate Tax

Payroll Tax

Federal Income

Tax

Federal Income

Tax

State Income Tax

GSTGST

GST

* 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

*

Chart 26 Marginal Tax Rates On Estates And Income Contributed To Estates, 2009

81%85%

70%

45%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

Estate Tax Estate Tax andGeneration

Skipping Trust

Tax on a Dollarof Interest

Left in an Estate

Tax on a Dollarof Wages (self-employed)

Left in an Estate

Ma

rgin

al

Ta

x R

ate

State Income Tax

Estate Tax

Estate Tax

Estate Tax

Estate Tax

Payroll Tax

Federal Income

Tax

Federal Income

Tax

State Income Tax

GST

GST

GST

* 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.

*

Chart 19Multiple 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 DEFERRALOR 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.

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.

Elements of Neutral Taxes

29

Form 1040: Individual Tax Form, Inflow Outflow Tax

1. Sum of: Labor compensation, Pension receipts, Taxable Social security, Transfer payments (from W-2 forms). $33,000

2. Net saving (+) or net withdrawals (-) (from Schedule B) $ 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. -$ 100

11. If overpaid, fill in: Amount to be refunded $100 ; or

Amount to be applied to estimated tax .

Chart 27 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

Chart 27, cont. Inflow Outflow Tax

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-growth-related rebates, nothing good has happened.

Why it Matters

25

800

850

900

950

1,000

1,050

1,100

2000 2001 2002 2003 2004 2005Quarter

Bil

lio

ns

of

Do

lla

rs (

20

00

$)

200

220

240

260

280

300

320

340

Bil

lio

ns

of

Do

lla

rs (

20

00

$)

Data Source: BEA, National Income and Product Accounts, Table 5.3.6, accessed via www.bea.gov.

Real Private InvestmentAnd 2001, 2002, and 2003 Tax Cuts

2002 Tax Cut

2001TaxCut

2003 Tax Cut

Equipment and Software<-- Left Axis

Nonresdidential StructuresRight Axis -->

0

5

10

15

20

25

30

35

40

45

1975 1980 1985 1990 1995 2000 2005

Year

0

1

2

3

4

5

6

7

8

Rea

lize

d G

ain

s as

Per

cen

t o

f G

DP

Capital Gains Realizations Rise When The MaximumTax Rate on Long-Term Gains Falls, 1976 - 2007M

axim

um

Tax

Rat

e o

n L

on

g-T

erm

Gai

ns

Top Tax Rate on Long-Term Gains

Realized Gains as Percent of GDP

Data from U.S. Treasury

27

7.7%

-3.2%

1.0% 1.0%

2.8%

10.2%

-0.9% -0.5%

-2.1%

1.2%

8.0%

-3.4%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

Kenned

y

Johnso

n

Nixon

Ford

Carte

r

Reagan

(I)

Reagan

(II)

GHW B

ush

Clinto

n (I)

Clinto

n (II)

GW B

ush

Obama

Chart 1 Change in GDP Due To Tax Law Changes During Presidential Administrations

Source: Calculations by author

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.

Objective: Growth

30

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.

Objective: Simplicity

31

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.

Objective: Fairness

32

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.

Objective: Visibility

33

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 govern-

ment so that they can make informed decisions about how much government activity to support.

Recap

34

-5%

0%

5%

10%

15%

20%

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

Quarterly Data, 1960:Q1 to 2008:Q4

Per

cen

t o

f G

DP

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.

Gross Saving

Business Saving

Personal Saving

Government Saving

Chart 28 Government And Private SavingOften Move In Opposite Directions

2008

The Circular Flow Diagram

INCOME (= WHAT

WE PRODUCE)EQUALS

HOW WE USE

THE INCOME

C + I + G + (X - M) = C + S + T

BASIC MACRO EQUATION

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 = S + T

G - T = S - I

I + (G - T). = 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

orCurrent acct.

surplus =

U.S. lending abroad -Foreign loans to U.S.

orCapital account

deficit orNet capital outflow

Trade: Absolute Advantage

United States Malicloth (yds/hr) 100 5

peanuts (lbs/hr) 1000 100relative price 10/1 20/1

workers output workers output total cloth (yds/hr) 25 2500 25 125 2625

peanuts (lbs/hr) 25 25000 25 2500 27500

Shift workers to the relatively advantaged workworkers output workers output total

cloth (yds/hr) 27 2700 0 0 2700peanuts (lbs/hr) 23 23000 50 5000 28000

Trade: Comparative Advantage

United States Germanycars (#/mnyr) 50 75

wheat (tons/mnyr) 1000 600relative price 20/1 4/1

workers output workers outputcars (#/mnyr) 25 250 25 1875 2125

wheat (tons/mnyr) 25 5000 25 15000 20000

Shift workers to the relatively advantaged workworkers output workers output total

cars (#/mnyr) 20 1000 30 2250 3250wheat (tons/mnyr) 30 30000 20 12000 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.

Desired Amount of Capital

Ret

urn

to

Cap

ital

Chart 6b Effect of Tax On Desired Capital Stock

Net Return

Gross Return

Required Return to Capital (Supply)

Tax

Drop in Capital

K1

Marginal Product of Capital (Demand)

K0

Employment

Wag

e

Labor Supply

MPL (K0)

W0

N1

MPL (K1)

W1

N0

Chart 6c A Smaller Stock Of Capital Reduces Wages

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.

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

Chart 1a Inflation, 1965 - 1988 * Quarterly data from 1965-I to 1988-IV.

Documents

Transcript of Chart 1a Inflation, 1965 - 1988 * Quarterly data from 1965-I to 1988-IV.