AEI » Latest Content American Enterprise Institute: Freedom, Opportunity, Enterprise Thu, 20 Nov 2014 20:48:48 +0000 en-US hourly 1 Capitalism and compassion: Why morality matters in a market economy Mon, 17 Nov 2014 17:53:20 +0000 ananta-AEI-logos_800px

Please note this event is Indian Standard Time.

In much of the world, including India, the free enterprise system has come to be associated with material greed, or wealth creation for its own sake. AEI President Arthur C. Brooks believes that supporters of the free market system need to develop a new way of addressing the big human questions of our time. Based on both empirical research he conducted as an economist and his interactions with some of the world’s leading spiritual figures — including the Dalai Lama and Sri Sri Ravi Shankar — Brooks argues that supporters of free enterprise must make not just an economic but also a moral case for their ideas.

During this event at the Ananta Centre in New Delhi, India, Brooks and acclaimed Indian author and commentator Gurcharan Das will discuss the dynamic between making money and doing good.

Full video of this event will be posted 2-3 business days after.

Email or click here to RSVP.

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Banter #164: Cami Anderson Thu, 20 Nov 2014 19:50:08 +0000 We’re joined this week by Superintendent of Newark City Public Schools, Cami Anderson. Appointed by Governor Chris Christie, Anderson has been implementing an aggressive reform agenda that expands charter school options, allows for merit pay, makes room for the dismissal of ineffective teachers, and provides “open enrollment” to students so that they can choose which schools they attend. We talk with her about what she’s accomplished since taking over in 2011 and what she hopes to accomplish going forward. Enjoy!

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Yikes. Here’s just how high the corporate tax rate is in the US Thu, 20 Nov 2014 19:11:09 +0000 The Tax Foundation recently came out with a compilation of charts on “Business in America” that look at US economic growth, labor force, corporate tax rates and more. Here are three charts that illustrate just how high the US corporate tax rate is compared to other countries.

1.)    The US corporate tax rate has stayed basically constant for the last 25 years. As seen below, this breaks from the norm, as other OECD countries have reduced their corporate tax rate, increasing their economic competitiveness. Alan Viard and Eric Toder write that “The current method of taxing the profits of large, publicly traded corporations was designed for an economy in which international investment was relatively unimportant and most corporate profits were produced by tangible assets, such as machinery and buildings. It doesn’t work well in today’s economy, which features increasing globalization and a rising share of profits produced by patents, brand reputation, and other intangible property.” Read their full piece to see the two structural reform options they suggest.

US corporate tax rate is out of line with our trading partners

2.)    Because the US has not cut corporate tax rates, we now have the highest corporate tax rate — 39.1%— in the OECD, beating out Japan, Sweden, and France (see featured graph). In fact, we are 10% above the weighted average and about 14% above the simple average for OECD countries. Jim Pethokoukis notes, “for many US multinationals, there is little incentive to stay officially based in America and remain subject to a complex, confiscatory tax code. … There’s no mystery as to why companies are going through all this trouble to escape the Treasury Department. It has nothing to do with a lack of patriotism, or the evasion of some sort of national duty, and everything to do with reducing costs and maximizing profits. That’s what businesses do — at least the ones that want to stay in business.”

3.)    When matched up with 163 countries’ corporate tax rates, not just OECD ones, the US is beat only by Chad (40%) and UAE (55%). Something to think about.

Corporate tax rates throughout the world have declined over the past decade

Follow AEIdeas on Twitter at @AEIdeas, and Natalie Scholl at @Natalie_Scholl.

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Why are some generic drugs skyrocketing in price? Thu, 20 Nov 2014 18:36:49 +0000 ...]]]> In our economy for medicines, the dual principles of market-based rewards that attract entrepreneurship and deep value once patents have lapsed are longstanding features of our system. The competition between branded and generic drug makers has enabled remarkable advances in science, and vibrant competition on price.

The compromises struck in the Hatch-Waxman legislation decades ago, have endured even as the market has changed. Generic drug makers have grown more sophisticated at challenging patents and unlocking new value for consumers. At the same time branded drug makers — recognizing this competition — have moved into new areas of science where resulting products are more specialized, unique, and beneficial. The competitive interplay between branded and generic firms, and the benefits that it affords, grows more relevant as the industries continue to evolve.

Recently, questions have been raised whether this competitive landscape is giving way to new economic features that erode some of the original intent of Hatch-Waxman. Market observers have made note of the substantial price increases observed with a select number of drugs, even though these medicines have been long subject to generic price competition. Yet in observing these cases, while all the facts surrounding each particular circumstance are not fully known, there is no one discernable feature, or policy shortcoming, that explains all of the events. In each case, there are some unique features that seem to have led cost of goods to rise, or competition to temporarily erode. At the same time, market-wide generic drug prices continue to decline when you look across all of the drugs.

So what is one to conclude?

Read the full testimony here.

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G7 broadband dynamics: How policy affects broadband quality in powerhouse nations Fri, 07 Nov 2014 20:44:31 +0000 ...]]]> G7 Report   Bennett Op-Ed

The United States is the birthplace of the technology that underpins global broadband. Our leadership in broadband infrastructure continues today, but it is rarely acknowledged. Conventional wisdom tells us that we are falling behind, but do the data support the need for radical policy change?
Please join us for a discussion of AEI visiting fellow Richard Bennett’s new study, “G7 broadband dynamics: How policy affects broadband quality in powerhouse nations.” Following Bennett’s presentation, a panel of experts will discuss the issues raised in his research.

If you are unable to attend, we welcome you to watch the event live on this page. Full video will be posted within 24 hours.

If you have trouble registering, please contact

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Banter #164: Cami Anderson Thu, 20 Nov 2014 16:51:34 +0000 We’re joined this week by Superintendent of Newark City Public Schools, Cami Anderson. Appointed by Governor Chris Christie, Anderson has been implementing an aggressive reform agenda that expands charter school options, allows for merit pay, makes room for the dismissal of ineffective teachers, and provides “open enrollment” to students so that they can choose which schools they attend. We talk with her about what she’s accomplished since taking over in 2011 and what she hopes to accomplish going forward. Enjoy!

Subscribe to AEI’s Banter series on iTunes.

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Obama’s immigration move: Sliding towards the Rubicon Thu, 20 Nov 2014 16:32:14 +0000 Almost a year ago, I wrote on the Corner that President Obama was not the cause of today’s constitutional tensions, but rather a symptom of an imperial presidency that has grown far beyond what the Founders intended. A chief executive who was not also head of state and symbol of the nation would be easier to counterbalance than the magnified president of the early 21st century.

While I still think that’s true, Obama is doing his best to prove that indeed he is the problem. The latest but perhaps most serious danger is over his proposed unilateral amnesty for millions of illegal aliens. The lack of critical attention this showdown is getting except among conservative circles is leading many to assume a “been there-done that” attitude, namely, that Obama is not doing anything different from his predecessors. But when serious commentators across the political spectrum begin sounding the tocsin, it is time for the rest of the country to pay attention. When Charles Cooke’s homepage piece powerfully predicts “chaos” and a “slow, tragic descent into … monarchy”; when the unflappable Ross Douthat decries Obama’s “will to power” and “creeping caudillismo”; and when liberal constitutional scholar Jonathan Turley calls Obama’s actions a “tipping point,” then maybe something rather serious is happening.

In a Twitter exchange with Charles, described in his piece, RealClearPolitics’s Sean Trende hits the nail on the head in his description of what is happening (though like Charles, I disagree with his solution): What is being undermined are the norms on which our system rests. Once those begin to go, they are extremely difficult to reassemble. Instead, that slow, irreversible slide towards ever-more destruction of laws and customs becomes the rule of the day.

That, then, leads to the obligatory Rome reference. No, we are not Rome and Barack Obama is not Julius Caesar. But he is, perhaps analogous to Sulla, whose crossing of hitherto sacrosanct lines and blatant disregard for timeless norms set the Republic on a dangerous path into chaos. What Sulla represented was the idea that anything was now conceivable, even though he justified his actions as responses to those taken by his political opponent Marius. Yet what he did could well be called the tipping point, and only inertia in the Republic’s system kept it going for another nearly half-century. As Julius Caesar crept towards the Rubicon, all of Rome could see it coming; all knew that two irresistible forces (Caesar and Pompey) were about to collide, yet the norms of restraint had been so eaten away, and creative politics so attenuated, that there was no chance of avoiding the explosion.

What Barack Obama sows in 2014 may not be reaped for years or decades. But it eventually will be reaped, unless the political leadership of this country today and tomorrow shows far more wisdom, self-restraint, and civic duty than it does now.

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Preparing for an immigration showdown on Capitol Hill: Barone on WBFF Fox 45′s ‘Your Voice, Your Future’ Thu, 20 Nov 2014 16:01:40 +0000

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Gruber’s bad political analysis driven by bad economics Thu, 20 Nov 2014 14:41:39 +0000 ...]]]> Like the never-seen “Secretary” in the “Mission: Impossible” series, President Obama and House Minority Leader Nancy Pelosi (D-Calif.) — she was the Speaker until the voters responded to the enactment of the Patient Protection and Affordable Care Act (ACA) — and their supporters now disavow any knowledge of the actions of Massachusetts Institute of Technology (M.I.T.) economics professor Jonathan Gruber. And with respect to his central role in the preparation of analyses in support of the ACA, or their numerous meetings with him in their offices or their proud invocation of his professional authority in response to fierce criticism of the legislation during that public debate: They now can barely remember him. The TV show was real entertainment — if only I could obtain one of those masks transforming me into a handsome secret agent man — but not nearly as amusing as the desperate effort now to relegate Gruber to the dustbin of political history by denying a link between the 2010 enactment of ObamaCare and Gruber’s analytic modeling of its purported effects.

Sadly, the Internet has a long memory, the upshot of which is that Gruber the politician turns out to have been too clever by half. Thus do the architects of the ACA now find themselves engaged in a massive clean-up operation because of Gruber’s recent comments on the various mendacities leading to passage of that law, the subject of loud front-page headlines. And thus has his proud honesty about his past dishonesty been highlighted in ways both conspicuous and deeply negative, and it is obvious that he now must wish that he had been rather less honest during various academic conferences and the like on the passage of the ACA. That he viewed the voters as “stupid” when he actively promoted disinformation during the ObamaCare debate suggests that he does not understand the difference between stupidity and the effects of imperfect information. This is darkly amusing for a member of the economics intellectual tradition, a significant part of which is driven by analysis of the behavioral implications of information costs. Nonetheless, stupid the people are, in Gruber’s view, as illustrated by his dim evaluation of the coverage choices made by seniors; like children, they would be better off were experts and officials to limit their options. More important, and far more appalling, is his explicit view of the proper relationship between the citizenry and the state in a constitutional republic: It is wholly appropriate to lie to the rubes as much as necessary so as to further leftist political aims. This guy is a “scholar”?

Forget Gruber’s earlier dissembling about whether some of the central provisions of the ACA are taxes: He now admits that, yes, they are taxes after all, even if not labeled as such, designed to redistribute wealth to constituencies favored by the White House and, presumably, by Gruber. Forget his obfuscations about the incidence of those taxes, that is, the identity of who would bear the attendant burdens, to wit, the young and the healthy and the beneficiaries of employer coverage. Forget Gruber’s glee at the success with which he and the congressional majority exploited the requirement that the Congressional Budget Office (CBO) analyze the fiscal implications of the bill as it was written, with frontloading of taxes, backloading of spending and the various other dishonesties designed to create an utterly false deficit-reduction narrative.

Forget his celebration of the “lack of transparency” as “a huge political advantage.” Ignore his silence as the president, as administration officials, and as supporters in Congress repeated the falsehood that “if you like your [insurance] plan, you can keep it”; from the very beginning that was a promise blatantly preposterous to anyone — obviously including Gruber — who understood the implications of a government mandate that employers offer coverage and that individuals buy it. (Any such mandate requires that the government define “insurance,” which means that some plans will not qualify.) Nor did Gruber comment on another reality: The effort to “reduce costs” (that is, payments) meant by necessity that physician and hospital networks would be narrowed. You might not be able to “keep your doctor” regardless of how much you liked him or her. And forget Gruber’s admission that under the plain language of the ACA, only coverage obtained on “exchanges established by the states” and not by the federal government is eligible for subsidies, a crucial issue now before the Supreme Court.

Instead, let us focus on a larger reality: Professor Gruber practices rather poor economics.

Can that possibly be true of a full professor at M.I.T.? Well, yes. Economists may disagree about many things, but absent among them is the central role of incentives as determinants of behavior, an eternal truth that applies fully to government. In the context of ObamaCare, government has interest groups rather than patients, and dollars not spent on a given constituency can be spent on others. Accordingly, government as a buyer of medical goods and services — or as a rule-maker for the ObamaCare exchanges and the insurers participating in them — has incentives to opt for lower-priced alternatives over higher-priced ones in ways that do not reflect the incremental advantages of the latter, if any. In particular, the drive to reduce explicit budget costs — to claim that the ACA is producing efficiencies — biases choices in favor of current budget savings at the expense of benefits enjoyed by the beneficiaries of a given program, even relative to the decisions that patients would make if confronted with the full costs of their choices. That the CBO estimates of budget costs themselves are biased by an expansion of price controls, whether explicit or implicit, makes matters worse by exacerbating the confusion of budget outlays with true resource costs. Nor does Gruber make any adjustment for the inefficiency costs (“excess burden”) of the tax system used to pay for expanded public insurance programs.

This powerful incentive on the part of government policymakers to view “costs” narrowly as the CBO estimates of budget outlays (or aggregate health care expenditures) for which constituencies compete is exacerbated by the short time horizons of public officials. Outlay savings are available today (or during a given policymaker’s term in office). To some substantial degree, the potential adverse effects of the bias toward limiting spending will be felt in the future. Other than, perhaps, the effects of the corporation income tax, there is little reason to believe that government as an institution has incentives to adopt a time horizon longer than that relevant for the private sector. And such policies as campaign finance restrictions may have had the effect of weakening the constraints that the political parties can impose upon officeholders: As the parties are long-lived institutions with some incentives to adopt time horizons longer than those of particular officeholders, the net effect may be a tendency to discount the future effects of policies more heavily.

Over the longer term, this bias toward savings defined in terms of spending may engender an adverse effect: a reduction in the flow of research and development investments in new and improved medical technologies, yielding fewer new medicines, devices and equipment. While research and development investments might be reduced quickly, the ensuing flow of new medical technologies clearly would not be affected for several years at a minimum. This means that there is an incentive for policymakers with short time horizons, again, to discount that effect relative to the spending savings that might be achieved quickly, to be used to subsidize other constituencies.

Nowhere in Gruber’s analytic pronouncements about the ACA do we find any consideration of such impacts. Instead, we find assertions to the effect that the (assumed) expansion of insurance coverage under the ACA will “increase economic activity” by increasing the demand for medical services and thus the number “of medium-skill jobs that our economy desperately needs.” He does not mention the aggregate incentive toward part-time employment created by the ACA; nor does he expand his analysis to the sectors that necessarily will shrink as resources are shifted into the medical sector. Is there a free lunch? Implicitly, Gruber says yes: Formerly uninsured individuals upon finding themselves “covered” will be able to take money out of “low interest liquid accounts,” saved for future medical expenses, and spend it on “consumer goods.” About those “low interest liquid accounts”: Are they stuffed into mattresses? Or are they part of bank reserves and thus available for lending?

Never mind. How does Gruber’s analysis apply to low-income groups with little savings but suddenly confronted with a mandate to pay nontrivial premiums and out-of-pocket costs? Medicaid is no answer, as the price controls (low reimbursements) that Gruber ignores have reduced access to actual healthcare even as “coverage” has expanded. Moreover, what becomes of Gruber’s argument now that premiums and out-of-pocket expenses (and thus the need for “low interest liquid accounts”) are higher for the losers (see above) in the ACA system? Even within Gruber’s analytic framework, it is far from clear that aggregate spending on consumption rises.

That intellectual problem is part of a larger one: Gruber seems actually to believe that an expansion of insurance “coverage” is the same as an expansion of actual healthcare, that is, that the ACA somehow by magic will produce the real resources needed to provide healthcare services to millions of newly insured people. As those resources are drawn out of other sectors, what becomes of prices, employment and the other relevant parameters there? Gruber does not tell us.

Professor Gruber has written a textbook on public finance, and one of the standard topics that he covers is the problem of pollution externalities, along with a discussion, again standard, of tax remedies. Does Gruber recognize that he is very likely to have polluted the public view of economists and their policy pronouncements? Perhaps he will consider a self-imposed tax on his consultant earnings paid by the taxpayers.

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Children are not science projects Thu, 20 Nov 2014 14:39:59 +0000 Last week I wrote an article for Bloomberg View about two recent studies that reinforce an accumulating body of knowledge: the usual environmental explanations of a child’s IQ actually don’t explain much. Those two articles dealt specifically with parenting practices and socioeconomic status. But they are just new additions to a large literature finding that parental influences and educational interventions that “should” explain a lot are attenuated to nearly nothing once genes are taken into account—not just regarding IQ, but educational achievement more generally, along with all sorts of personality and behavioral characteristics.

Among the responses I received was this affecting email from Ben Williams, which read in part:

My wife and I are adoptive parents with one natural child. And because of this we’ve spent more than a few minutes discussing our trials, tribulations, successes and failures with other adoptive parents. Often times these discussions have tended more to a “comparing notes” format, with a good portion of “you too” being passed back and forth.

With that background let me ask you a question about adoption……and it is kind of disconcerting and uncomfortable to both think about and ask……but here goes.

If as the article seems to suggest, IQ is gene-based to the greatest extent what will the policy impacts be on adoption? I mean, if it is a FACT that the not-so-bright have not-so-bright children and that WE cannot alter that by our efforts, and accepting that a predisposition of violence and all manner of other social problems may also be the same…….if that is so, then what information do we dispense about adoption? Do we pass this along to potential parents as a warning? And if we do does it make the prospect of more children, especially those from less intelligent birth parents (today a whole lot more information is usually dispensed about the genetic donors) to be left in permanent foster care, or in “homes”?

The whole thing is hard to figure out, and worrisome.

Mr. Williams raises a core issue that goes far beyond adoption. Ever since programs to help children became part of the federal government’s brief in the 1960s, they have been touted on the basis of how they will change children’s lives for the better—higher IQ and educational attainment, lower unemployment or drug use; you name it.

They don’t come close to delivering on their rhetoric. It turns out that children are not plastic. They are pretty much who they are from the get-go, for reasons that neither programs nor parents can do much to change. For those of you who bridle at that statement but have more than one child, I have a question: Were you ever under the impression that you could make one of your children more like the other in any significant way? I have yet to meet the parent who answers “yes, and I did it.”

But children aren’t science projects. Parents may hope to produce good results 20 years down the road, but that’s not why we love and nurture our children. Parents who have the terrible experience of learning that their children won’t be alive even a few years later don’t love and nurture them less, but more.

The same response should apply to all of our efforts to help children. A Head Start center that provides a child from a terrible home environment with a few hours a day of affection, warmth, and security has done a good thing. The fact that Head Start has been proved to have no long term effects is irrelevant to that good thing.

I don’t how many Head Start centers accomplish even that much, but that too is irrelevant to my broader point. All children need love and nurturing. Children who are not getting those things should be subjects of our concern. It is my belief that government is the worst of ways to respond to their needs, but we can argue about that. Let’s simply agree to dispense with long-term outcomes as the measure of success, and focus on how best to get love and nurturing to children in need of it.

That brings me back to Mr. Williams’s question about adoption. What do we tell to prospective adoptive parents? The first answer, and the only answer that ultimately counts, is that they are doing the Lord’s work. They have the opportunity to provide love and nurturing to a child who needs it. There are few better things that human beings can do with their time. The second answer is that they, like biological parents, are not miracle-workers. They will be unable to mold the child. Sometimes their adopted child will experience problems that are not the adoptive parents’ fault; sometimes they will reveal gifts of talent and character that are equally not to the adoptive parents’ credit. What is to the credit of good parents, adoptive and biological alike, is enfolding the child in love.

Follow AEIdeas on Twitter at @AEIdeas.

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Will Congress use executive order on immigration as excuse for more gridlock? Thu, 20 Nov 2014 13:34:15 +0000 First, and sadly, I need to acknowledge another death of a great figure from Congress, Bill Frenzel of Minnesota. Bill was my congressman and also a dear friend. I worked especially closely with him on the Office of Congressional Ethics, where he was a stalwart member, helping to ensure its integrity and providing some of the glue that meant that all of its decisions, from a diverse membership cutting across all partisan and ideological lines, were unanimous. That was Frenzel, a throwback to an earlier era both in Congress and in the Republican Party. He was a bridge-builder, not a bomb-thrower, a free-market, business-oriented conservative who knew how to find common ground and forge compromises. I mourn his loss and the loss of his model in the GOP, both in Washington and Minnesota.

Will there be anything left of compromise and common ground? With the apparent determination of President Obama to issue his executive order on immigration this week, the lame-duck session in Congress takes on a fascinating set of twists. I tweeted last week, “House Republicans say Obama exec action on immigration will make it toxic for a decade. From the lovefest it’s been for the past decade.” The reality is that there were ample opportunities over the past four years for the House of Representatives to take a constructive step on immigration, especially after the big, super-majority vote in the Senate on a comprehensive bill. It declined to do so. Meanwhile, the favorite GOP talking point on the subject has been that Democrats had majorities in both chambers in 2009 and 2010 and failed to act. Which neatly ignores another reality: During that time, the House passed handily the Dream Act, a major step toward broader immigration reform. There was majority support in the Senate. Guess what? Mitch McConnell led a filibuster that killed the Dream.

Regardless of that set of facts, and the additional fact that both Ronald Reagan and George H.W. Bush took sweeping executive actions on deferring deportations without a peep from Congress, it is the case that the president’s move will change the dynamics of policy-making and politics during the weeks ahead, and beyond. There are two areas, in particular, I am watching right now. The first is to follow the money.

Before the election, anticipating a Republican Senate, House Majority Leader Kevin McCarthy made clear that he wanted the new, all-Republican Congress to start out on a strong and positive footing by clearing the decks in the lame-duck session of troublesome and divisive matters, starting with spending bills—doing a clean continuing resolution through the current fiscal year that would move the budget and appropriations showdowns to later next year. As numerous news stories have pointed out, there is now a lot of pushback to that approach, a scramble to come up with a strategy to use the spending leverage to blow up the president’s executive order. That strategy starts with a set of short-term CRs that expire in January. Most programs would be extended through the year, but there would be a narrow, targeted bill cutting off funding to implement the EO.

Making that work is a very tricky and explosive business. First, if there is only a short-term extension, it might be blocked in the Senate, leading to a possible shutdown in December. Second, it will be difficult to construct a bill that would cut off funding for the executive order without cutting funding for immigration activities overall, including the Border Patrol. And in any case, the president could veto other spending bills and take the case to the country. Whether there is any circumstance in which a shutdown would not be blamed on Congress is an interesting thing to test. But if we segue right from an election that gave Republicans control, after which incoming Senate Majority Leader Mitch McConnell flatly pledged no shutdown, to a shutdown right before the holidays, that would not bode well for the public image of the new Congress. Will McConnell, House Speaker John Boehner, and McCarthy try to push the controversy to next year’s appropriations and budget? Will they argue that the best way to push back on immigration is to block the president’s nominee for attorney general? That would leave Eric Holder in place, while blocking a highly qualified and widely praised African-American woman. A big set of questions.

Second is the confirmation process. As Eleanor Clift pointed out last week, there are well over 200 stalled executive branch positions awaiting action in the Senate, including dozens of ambassadors to key countries around the world. Nearly all the nominations are noncontroversial. We also have a sizable number of judges awaiting confirmation. Four ambassadors and three judges have moved, without controversy, since Congress came back. Will Harry Reid and McConnell reach a deal to move the bulk of these nominees through without delays? Or will the immigration move by the White House make McConnell decide to block any level of cooperation with his Democratic counterpart?

Even with the rules change that reduced the confirmation filibuster bar to 50 from 60, if there is a filibuster, the time it takes to get cloture votes and go through post-cloture debate for each nominee is extensive. Without a deal, Reid would keep the Senate in session most likely until late December to push the confirmations through, and we would start the new year with an added level of friction and resentment.

I understand the president’s need to act on immigration; I hope he will issue his EO and delay its effective date until the end of January or mid-February, giving the House one last chance to do something on the issue. But put into context, including the history of the last six years, the renunciation of the comprehensive Senate bill by its chief sponsor, Marco Rubio, in the face of grassroots conservative opposition, and the history of actions by previous presidents, it is not nearly as explosive as the rhetoric or editorials would suggest. Will it be separated from other issues where there is an opportunity for constructive action, or will it be the excuse for another meltdown into gridlock in the 114th Congress? We will have an answer in the lame duck.

This article appears in the November 20, 2014 edition of NJ Daily as Lame-Duck Twist.

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Move to a progressive consumption tax Thu, 20 Nov 2014 13:31:06 +0000 Capital is a key determinant of growth, along with labor and technology. Yet, the U.S. tax system systematically penalizes saving, which finances capital accumulation. The tax penalty on saving could be eliminated by moving to progressive consumption taxation.

The Tax Burden on Saving

Income taxation is inherently biased against saving, which arises when individuals consume later than they work. Under income taxation, individuals who save part or all of their earnings pay tax on the return on their saving, in addition to the tax already paid on the earnings. This double taxation imposes higher percentage tax burdens on those who save than those who immediately consume their earnings.

Wage taxation avoids the double tax and the resulting saving penalty because only the original earnings are taxed, with no tax on the return to saving. Consumption taxation also avoids the double tax and the saving penalty because the saver is not taxed on the amount that is saved and is taxed only on the future consumption ultimately financed by the saving.

It is sometimes argued that the current U.S. tax system taxes savings lightly and therefore imposes only modest saving penalties. A common claim holds that income from saving is taxed at a special maximum rate of 20 percent, well below the 39.6 percent maximum tax rate that applies to wages. Also, capital gains are not taxed until realization. Moreover, retirement saving and some other types of saving can be done through tax-preferred accounts.

But the actual tax treatment of saving is quite different, as documented by Carroll and Viard (2012, 14-17) and Viard (2013, 3-6). The 20 percent maximum tax rate applies only to two types of income from saving, long-term capital gains and qualified dividends Full ordinary income tax rates apply to other income from saving, including the profits of S corporations and non-corporate businesses, interest income, short-term capital gains, and nonqualified dividends. Also, since 2013, most income from saving by high-income households has been subject to a special 3.8 percent “unearned income Medicare contribution” tax, over and above regular income taxes. Although capital gains are not taxed until realization, they are also not indexed for inflation, so investors must pay tax on nominal gains that merely offset the rise in the price level. And, tax-preferred savings accounts feature complexity and restrictive rules that reduce participation. Due to contribution limits, the accounts also offer no marginal incentives for those making the largest contributions.

The profits of C corporations are also subject to a separate corporate income tax, featuring a 35 percent statutory tax rate. The much-vaunted tax savings that corporate shareholders reap from the 20 percent maximum tax rate on their dividends and capital gains provide only a partial offset for the burden of the corporate income tax. And estate and gift taxes also apply to the savings of the nation’s wealthiest households. State and local tax systems impose further taxes on saving, including individual and corporate income taxes, property taxes, and sales taxes on business purchases of capital goods.

If reforms are not undertaken, the tax burden on saving may increase in upcoming years. The Obama administration has proposed an increase in estate and gift taxes and a “Buffet rule” that would effectively raise the individual income tax rate on some high-income households’ long-term capital gains and qualified dividends. More sweeping proposals are likely to arise from the fiscal pressures posed by the rise in Medicare, Medicaid, and Social Security spending. Viard (2013, 7-8) and Cowen (2013) called attention to calls for an annual wealth tax, a tax that gained added support when subsequently advocated by Piketty (2014, 515-534).

Progressive Consumption Taxation

As mentioned above, consumption taxation does not penalize saving. Replacing income taxation with consumption taxation would therefore be beneficial. One approach, which may well be adopted at some point, would replace part of the income tax system with a value added tax (VAT). That approach raises a number of concerns, which are not discussed here.

The greatest gains could be achieved by replacing the entire income tax system (the individual and corporate income taxes, the unearned income Medicare contribution, and the estate and gift tax) with a consumption tax. For distributional reasons, though, the consumption tax would need to be progressive, rather than a regressive tax like the VAT.

One progressive consumption tax is the personal expenditure tax, sometimes called a “consumed income” tax. This tax starts with a framework similar to the individual income tax, but with a crucial modification that strips out the income tax’s saving penalty. Households would report their income on annual tax returns, but would then claim a full deduction for all saving and add back in any dissaving. What’s left would be the household’s before-tax consumption for the year. That consumption amount would be taxed at graduated rates, with higher tax brackets for households with higher consumption. Exemptions and refundable tax credits would be provided to low-consumption households.

Under a personal expenditure tax, households would deduct deposits in savings accounts, the costs of purchasing stocks and other investments, any loans that they made, and any payments (interest or principal) that they made on their debts. Households would pay tax on withdrawals from savings accounts, the full proceeds from selling stocks and other investments, any payments (interest or principal) received from loans that they made, and the full amount of any borrowing that they did. Seidman (1997) provides a thorough analysis of the personal expenditure tax.

Another progressive consumption tax is the Bradford X tax, which is a graduated-rate variant of the Hall-Rabushka flat tax. The X tax and the flat tax start with a framework similar to the VAT, with a crucial modification that removes the VAT’s regressivity. The VAT tax base would be split into two. Households would be taxed only on their wages and business firms would be taxed on value added minus their wage payments, so that the total tax base would be the same as the VAT. The household tax would have graduated rates, with higher tax brackets for households with higher wages. Exemptions and refundable credits would be provided to low-wage households. The business tax would have a flat tax rate, equal to the top wage tax bracket.

Although the household tax might look like the individual income tax and the business income tax might look like a corporate income tax, they would actually be quite different in economic terms, with no vestige of those taxes’ savings penalties. The household tax would be imposed only on wages, thereby exempting interest, dividends, capital gains, and all other income from saving. The business tax (which would apply to both corporate and non-corporate businesses) would be imposed on business cash flow, not income. The key difference is that investments would be immediately deducted, as they are under a VAT, rather than depreciated. As under a VAT, there would be no tax penalty on a new break-even investment. Carroll and Viard (2012) provide a thorough analysis of the X tax.

Neither the personal expenditure tax nor the X tax is familiar to the general public and neither is likely to be enacted in the near future. The personal expenditure tax may draw criticism because it does not include a tax collected at the business level and because individuals are taxed on the proceeds of borrowing. The X tax may be criticized because it does not look like a consumption tax and because it does not collect tax at the household level from people who are consuming the proceeds of past investments. And, each tax would have to address a variety of challenges, including transition issues, the treatment of financial institutions, and international issues. Nevertheless, each tax would allow revenue to be raised in a progressive manner without penalizing saving.


The rise in the federal government’s revenue needs is likely to prompt efforts to increase the already-high tax burden on saving in upcoming decades. This threat to growth can be averted by moving to progressive consumption taxation.


Carroll, Robert, and Alan D. Viard. 2012. Progressive Consumption Taxation: The X Tax Revisited. Washington, D.C.: AEI Press.

Cowen, Tyler. 2013. Wealth Taxes: A Future Battleground. New York Times, July 20.

Pikkety, Thomas. 2014. Capital in the Twenty-First Century. Cambridge, MA: Harvard University Press.

Seidman, Laurence A. 1997. The USA Tax: A Progressive Consumption Tax. Cambridge, MA: MIT Press.

Viard, Alan D. 2013. Capital Income Taxation: Reframing the Debate. AEI Economic Perspectives, July.



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