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The Economics of Taxation: Theory and Evidence for Budget Evaluation

In 2011 I testified before the Minnesota House Tax Committee about the Economics of Taxation; Theory and Evidence for Budget Evaluation.

My PowerPoint Slides are available here.


The Marginal Cost of Public Funds

Taxes are generally distortionary.  That is the cost to individuals in our economy of collecting a dollar of tax revenue exceeds the tax revenue that is collected because people change their behavior in response to price changes that are caused by the tax.  The marginal excess burden of raising a dollar of tax revenue is the technical term for how much extra pain is imposed on people in order to collect another dollar of tax revenue.  Economic damage is a helpful, non-technical term I often used to explain the marginal excess burden of a dollar of tax revenue to non-economists.

According to the federal Office of Management and Budget (OMB) during the Bush, Clinton, Bush, and Obama administrations, “Recent studies of the U.S. tax system suggest a range of values for the marginal excess burden, of which a reasonable estimate is 25 cents per dollar of revenue.” (Item 11)

This means that the total cost of collecting a marginal dollar of additional tax revenue from slightly higher tax rates is $1.25.  This includes both the dollar that is collected from people in the private sector economy and the economic damage from the distortions caused by the tax.  The dollar of tax revenue is a transfer from the private sector taxpayers to the government.  The extra quarter of excess burden is the cost of distorting decision-making. It is a waste to society.  Instead of making decisions only for common sense reasons some decisions are changed when relative prices are changed by the tax.  This behavioral response makes our economy less efficient.  The benefits of public expenditures financed by taxation should be weighed against the marginal costs of raising taxes.

According to the Office of Management and Budget, “Where specific information clearly suggests that the excess burden is lower (or higher) than 25 percent, analyses may use a different figure. When a different figure is used, an explanation should be provided for it. An example of such an exception is an investment funded by user charges that function like market prices; in this case, the excess burden would be zero. Another example would be a project that provides both cost savings to the Federal Government and external social benefits.”

Alternatively, if the marginal tax rate is especially high, then both the excess burden and the marginal cost of public funds may be larger because generally the distortions created by taxation increase quadratically with the tax rate.

U-Haul Costs to and from Saint Paul, Minnesota

One way rentals for a 26 foot U-Haul between Saint Paul, MN and Naples, FL.  Hat tip: Mark Perry.

Naples, FL to Saint Paul, MN: $1258

Saint Paul, MN to Naples, FL: $2,226

Premium to Leave from Saint Paul, MN: 77%

One way rentals for a 26 foot U-Haul between Saint Paul, MN and Austin, TX.

Austin, TX to Saint Paul, MN: $1239

Saint Paul, MN to Austin, TX: $1,704

Premium to Leave from Saint Paul, MN: 38%  

Perhaps there is a way to use an internet bot to create a panel of U-Haul prices over time to better understand migration?

2009 Minnesota Governor’s 21st Century Tax Reform Commission

In 2009, the Minnesota Governor’s 21st Century Tax Reform Commission appointed by Governor Tim Pawlenty released its report.  Redesigns of the Minnesota Department of Revenue website keep changing the link to access this report.  I am posting the report of the Minnesota Governor’s 21st Century Tax Reform Commission and a brief summary of its recommendations on this blog so that it may be more easily accessed and read.

Good Question: How Much Do We Pay In Taxes?

WCCO asked me one of their Good Questions: How Much Do We Pay In Taxes?

Improving the Minnesota Tax Incidence Study

I testified to the Minnesota House Tax Committee about how to improve the Minnesota Tax Incidence Study by including the Federal Taxes paid by Minnesotans in the Minnesota Tax Incidence Study.  Rep. Greg Davids introduced legislation to provide this information to Minnesotans.

High school-college dual enrollment: Minnesota can do better

St. Paul Pioneer Press (MN) – August 21, 2016

Minnesota was the first state to create dual enrollment policies that let high school students take college courses for both high school and college credit. But we don’t lead the nation in providing the best dual-enrollment options to students anymore.

Post-Secondary Educational Options (PSEO) let students earn high school and college credit simultaneously for courses they take at two-year or four-year colleges. Concurrent enrollment programs, like College in the Schools, let students take college courses at their high school from instructors who meet college academic and experience standards.

Dual enrollment helps students several ways. Students participating in dual enrollment programs are more likely to graduate from high school and do better in college. Students also reduce college expenses by starting college with credits they earned in high school.

Today students in other states have dual enrollment opportunities that are not available to Minnesota students. Florida, New Mexico, Ohio and South Dakota allow their students to learn through dual enrollment during the summer.

Students in Ohio’s public schools can take classes at a college and receive dual high school credits during the summer with the minor restriction that each student can earn no more than 30 college credits during a school year. Ohio’s College Credit Plus program provides state funding for these courses regardless of the term when the course is taken until the student graduates from high school.

South Dakota has a more restrictive dual enrollment grant funded by the state. South Dakota’s grant program allows its high school students to take up to two summer courses at college if they have not already taken two college courses during the preceding spring term.

Currently, high school students in Minnesota can enroll in dual enrollment programs only during the school year. We can do better.

Minnesota should expand our dual enrollment programs to let students take dual enrollment courses during the summer that are funded the same way as courses taken during the school year.

College in the Schools courses at high schools are funded by a combination of state and local tax dollars just like other classes at a public high school. Minnesota funds PSEO classes by having a portion of basic state education funding follow the student for each college course he or she takes.

Creating more educational options by letting students take dual enrollment courses during the summer is a smart way to spend state funds to improve education.

Students who take dual enrollment courses have higher GPAs in the first year at college and are less likely to take remedial courses in college according to research by Brian An, a professor at the University of Iowa. Overall, about 25 percent of Minnesota public high school graduates require remedial courses when they reach college.

Some of the higher educational success of dual enrollment students may be because of a self-selection effect. Students who are more likely to be academically successful may also be more likely to take dual enrollment courses. An’s research finds that dual enrollment increases students’ first-year GPAs and reduces enrollment in remedial courses even when he uses statistical models to attempt to control for confounding effects and selection bias.

Summer dual enrollment classes will be a good option for some students for different reasons. Some students may choose to take the same number of dual enrollment classes, but will benefit from more flexibility in their schedule. Other students may be able to take more dual enrollment classes and save even more on the expense of college tuition. Some students may be able to explore taking their first dual-credit course at a community college or university in the summer.

Today only 33 percent of teenagers work at a summer job. That is down from 1989 when 60 percent of teenagers worked during the summer. Earning high school and college credits at the same time may be a great use of time during the summer for teens who don’t have a job.

Allowing students to take dual enrollment classes during the summer also will make better use of existing classrooms. Colleges have many underutilized classrooms during the summer.

Expanding educational options for our students by letting them take dual enrollment courses during the summer is a good step toward better educational outcomes.

John A. Spry is an associate professor in the Department of Finance at the University of St. Thomas.


How our broken tax code hurts Minnesota workers

By John A. Spry
St. Paul Pioneer Press (MN) – June 20, 2014

Medtronic’s announcement that it will move its official headquarters to Ireland provides a lesson in how America’s broken tax code hurts Minnesota workers by denying them good jobs purely for tax reasons.

Medtronic has promised to invest over $10 billion in the United States and create at least 1,000 new jobs in Minnesota after it merges with Dublin-based Covidien. Medtronic will be able to re-invest money earned outside the U.S. here without additional tax payments only if the newly merged firm is domiciled in Ireland instead of the U.S.

These investments could have already been made here and we could already have these jobs in Minnesota if our tax code wasn’t written to punish investments in America.

If Medtronic had used earnings from abroad to finance new job-creating investments in the United States, the U.S. corporate income tax on these repatriated earnings would have made these investments cost-prohibitive.

The irony, already noted by many observers, is that Medtronic had to engineer the Covidien deal in order to move its official headquarters to Ireland. The combined Irish medical-device firm will be able to make new job-creating American investments with cash earned around the world. These are job-producing investments that Medtronic has been so far unable to make as an American firm because of our broken tax code.

However, it would be unlikely that we would we see the promised new investment and more than 1,000 promised new jobs here if Congress passes legislation sponsored by U.S. Sens. Amy Klobuchar and Al Franken of Minnesota. If their bill to limit merged companies from locating their headquarters abroad passes, it would trigger language in the deal that could cancel the merger.

American businesses face a system of worldwide taxation, while most of the industrialized world uses territorial taxation.

Our corporations have to first pay corporate income tax in foreign countries where they operate. For example, an American firm has to pay the 22 percent Swedish corporate income tax on its Swedish income. Then when the American firm repatriates, or brings this money back home, it has to pay the 35 percent federal income tax rate and state corporate income taxes, while receiving credit for tax payments abroad. So an American firm faces an additional 13 percent repatriation tax.

In contrast, a Canadian firm operating in Sweden only pays the 22 percent Swedish tax rate on its Swedish income. It can then deploy its capital anywhere without any additional tax payments.

A worldwide system of taxation has several drawbacks.

First, it can result in a large pool of funds that are locked outside of the country to avoid repatriation taxes.

Secondly, it creates a significant competitive disadvantage for our firms operating in a system of worldwide taxation. They face a higher total tax rate than their competitors that only have to pay corporate income tax once in the country where they earned the income.

Finally, the complex system of worldwide taxation and credits for foreign tax payments increases accounting and tax-planning costs. Over $40 billion a year is wasted filing and auditing corporate tax forms. Our tax code wastes resources that could go toward productive, job-creating investments.

Our 41.4 percent combined-federal-plus-Minnesota statutory corporate income tax rate is 66 percent higher than the average rate in other industrialized nations. President Obama’s Job Council has noted that our uncompetitive corporate income tax hurts American workers through “reduced employment opportunities and lower wages.”

The Medtronic deal shows that companies do consider taxes when they make major investment decisions. Indeed, the President’s Job Council has observed, “In a global economy in which capital can move easily across borders, differences in corporate tax rates have a growing influence on where multinational companies decide to invest.”

Both Ireland and the United States collected 2.6 percent of their GDP in corporate income taxes in 2012. But Ireland used a 12.5 percent tax rate on a relatively larger tax base to collect the same share of their economy in corporate taxes as the U.S. collected with our much higher 35 percent federal tax rate.

Economists have suggested a variety of ways to move the U.S. toward the successful Irish corporate-tax model that seeks to raise revenue from a broad tax base at a lower tax rate. Yet proposals for corporate tax reform and a simpler, broader tax code with lower tax rates are going nowhere in Washington.

Why do we seem to be stuck with a broken tax code that wastes resources on costly paperwork and discourages investment in America?

I believe economists have failed to effectively explain that only people feel the burden of taxes, not corporations. After all, a corporation is simply a tool that connects people such as investors, workers, and customers through contracts.

A corporation can be made to collect taxes from its workers, customers, and investors. But the corporation itself never feels the burden of taxation.

Too many politicians and journalists talk about businesses paying taxes as if businesses were real, live breathing people that feel the pain of paying taxes. For example, Gov. Mark Dayton talks about making businesses pay their fair share. He erroneously claims that he hasn’t raised income taxes on low-income and middle-class Minnesotans. But both Gov. Dayton and the Statehouse press corps have ignored the Minnesota Department of Revenue analysis that concluded that the 2013 Minnesota corporate income tax hikes were regressive and lowered wages for Minnesota workers, raised prices for Minnesota consumers, and lowered returns to investors in Minnesota.

It may be impossible to pass pro-growth tax reform while politicians and journalists create the erroneous perception that taxes collected by corporations are not paid by real flesh-and-blood people. Proposals to lower tax rates on job-creating investments are too often attacked as favoring corporations instead of people.

Hopefully, the Medtronic news will spur politicians, journalists, and citizens to scrutinize our broken corporate tax code without ignoring the reality that corporate taxes are taxes on you and me.

John Spry of St. Paul is an associate professor in the Department of Finance at the University of St. Thomas. He’s on Twitter at @JohnASpry.

The Economics of Taxation and Dynamic Scoring

I testified about “The Economics of Taxation and Dynamic Scoring” to the Minnesota Senate Tax Committee on March 3, 2011.

Here are my PowerPoint slides for the hearing: Economics of Taxation and Dynamic Scoring

The video of the hearing:

Reject the 45 percent Trump Tax


Donald Trump recently proposed a 45 percent tax on American shoppers buying imported goods from China.

Trump told the New York Times, “I would tax China coming in — products coming in. I would do a tariff. And they do it to us. We have to be smart. I’m a free trader. I’m a free trader. And some of the people would say, ‘Oh, it’s terrible.’ I’m a free trader. I love free trade. But it’s got to be reasonably fair. I would do a tax, and the tax — let me tell you what the tax should be. The tax should be 45 percent.”

Higher tariffs on American buyers have always been a big mistake.

In 1930 the Republican controlled Congress passed the infamous Smoot-Hawley Tariff Act that raised taxes on American imports. This unwise policy raised the cost of living for all Americans. These new taxes made it harder for people to shop for their families.

GOP Congressman Willis Hawley claimed that his tariff would cause “a renewed era of prosperity.” Instead his legislation made an already bad depression worse.

The historical record agrees with Ben Stein’s assessment of Smoot-Hawley tariff in the movie “Ferris Bueller’s Day Off”: “It did not work and the United States sank deeper into the Depression.”

Our higher tariffs led to retaliatory taxes on American exports to other countries. The resulting trade barriers reduced sales and employment in exporting industries in the United States. Farmers and auto workers suffered as trade barriers reduced American exports of their products. World trade fell 63 percent from 1930 to 1933. International trade promotes cooperation and peace between nations. This tariff war fueled bitterness in international relations.

Our standard of living fell because of the Smoot-Hawley Tariff and a boatload of other bad policies in the 1930s.

Donald Trump’s claim that his new 45 percent tariff is smart is as wrong as Rep. Hawley’s boast that his tariff bill would lead to prosperity. Don’t trust promises that we can tax ourselves into prosperity.

Our economy prospered as trade barriers were lowered after World War II.

The value of U.S. manufacturing set a new record of over $2.1 trillion in output last year. Economist Mark Perry notes that U.S. manufacturing is about the same size as the combined manufacturing output of Germany, the United Kingdom, France, South Korea, Brazil, and Russia.

We have become more prosperous because of both increased international trade and technological progress. In 1947 Americans paid 42 percent of their after-tax disposable income for food, cars, clothing, and household furnishings including appliances. Now we only pay 15 percent of our after-tax disposable income for these purchases. Lower prices for clothing and household furnishings have freed up money in the family budget. Trump’s tariff proposal would work against this positive economic trend for American families by raising prices.

Trump’s 45 percent tax will raise the prices of many goods designed in the United States and assembled in China. Trump’s proposal would make Apple products unaffordable for many Americans. This tax will steer consumers toward buying Samsung products from South Korea instead of Apple. This government interference in the private sector economy is not good for workers at Apple and other companies that are part of global supply chains.

American exporters would justly fear retaliatory trade barriers from China on their exports. Trump’s proposal is likely to trigger a trade war that would be especially harmful to Minnesota grain and hog farmers wanting to sell to China. Trump doesn’t talk about the economic damage that would result from his policy proposals.

Trump is hoping that voters believe that his tariff will not hurt them. But Trump supporter Rep. Chris Collins (R-NY) told MSNBC that Trump’s tariff would raise inflation and that this higher inflation would be good for the American economy. Congressman Collins supports squeezing family budgets by raising the prices of consumer goods through this new tax.

Trump’s 45 percent tariff proposal is a loser. If we don’t want people to suffer its harm we have to speak out against it now.

As Santayana wrote, “Those who cannot remember the past are condemned to repeat it.”

John A. Spry is an associate professor in the Department of Finance at the University of St. Thomas. Find him online at @JohnASpry.