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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.

Testimony to Improve House Omnibus Tax Bill

Dear Chairman Davids and Members of the House Tax Committee:

I have some concerns about H.F. 848 because it has the potential to become a better bill that would further expand economic prosperity, simplify the tax code, and move Minnesota in the positive direction of treating equally situated taxpayers equally. The views expressed herein are solely those of the author and do not represent the views of the State of Minnesota or the University of St. Thomas. My testimony and all errors are my own.

Here are 35 ways that you can improve H.D. 848 and turn it into one of the “greatest hits” of Minnesota tax policy:

  1. Broaden the tax base and lower the tax rates.
  2. Broaden the tax base and lower the tax rates.
  3. Broaden the tax base and lower the tax rates.
  4. Broaden the tax base and lower the tax rates.
  5. Broaden the tax base and lower the tax rates.
  6. Broaden the tax base and lower the tax rates.
  7. Broaden the tax base and lower the tax rates.
  8. Broaden the tax base and lower the tax rates.
  9. Broaden the tax base and lower the tax rates.
  10. Broaden the tax base and lower the tax rates.
  11. Broaden the tax base and lower the tax rates.
  12. Broaden the tax base and lower the tax rates.
  13. Broaden the tax base and lower the tax rates.
  14. Broaden the tax base and lower the tax rates.
  15. Broaden the tax base and lower the tax rates.
  16. Broaden the tax base and lower the tax rates.
  17. Broaden the tax base and lower the tax rates.
  18. Broaden the tax base and lower the tax rates.
  19. Broaden the tax base and lower the tax rates.
  20. Broaden the tax base and lower the tax rates.
  21. Broaden the tax base and lower the tax rates.
  22. Broaden the tax base and lower the tax rates.
  23. Broaden the tax base and lower the tax rates.
  24. Broaden the tax base and lower the tax rates.
  25. Broaden the tax base and lower the tax rates.
  26. Broaden the tax base and lower the tax rates.
  27. Broaden the tax base and lower the tax rates.
  28. Broaden the tax base and lower the tax rates.
  29. Broaden the tax base and lower the tax rates.
  30. Broaden the tax base and lower the tax rates.
  31. Broaden the tax base and lower the tax rates.
  32. Broaden the tax base and lower the tax rates.
  33. Broaden the tax base and lower the tax rates.
  34. Broaden the tax base and lower the tax rates.
  35. Broaden the tax base and lower the tax rates.

I would be happy to work around my teaching schedule to help the committee draft amendments to broaden the tax base and lower tax rates for all Minnesota taxpayers.

CNN cited me in a story about lottery sales

CNN cited me in their story, “The lottery game that’s bigger than Powerball” by Chris Isidore on February 11, 2015 about the economics of state lotteries.

The odds of winning an instant game are actually better than they are for Powerball and MegaMillions. Scratch-off games typically pay out about 70% of the money spent on tickets. Only about half the money spent on Powerball is distributed to winners.

By comparison, a casino slot machine pays out between 90% and 99% of the amount wagered, according to John Spry, a finance professor at the University of St. Thomas in Minnesota, who studies lotteries

The odds aren’t the only difference between these games — the people who play instant games are typically poorer.

According to a study by Spry, about three out of four instant game tickets are purchased by people with below-average incomes. Wealthier players tend to enter the big multi-million drawings.

It would be better to say that people that cumulatively have the bottom 50% of income purchase 75% of instant game tickets. Instant, scratch games are more regressive than jackpot games like Powerball or Mega-Millions.

The following figure from my paper 2005 paper “The Relative Regressivity of Seven Minnesota Lottery Games.” (with Kathryn L. Combs and J.B. Kim) in the Proceedings of the National Tax Association Proceedings graphs the cumulative distribution of per capita income versus the cumulative distribution of lottery sales by zip code for seven Minnesota Lottery games. Lottery sales are a large share of income for lower income zip codes than for higher income zip codes.

Figure 2 Lotenz Curves






You can read the entire story here:

Minnesota and National Unemployment Rates

Minnesota’s unemployment rate is generally below the national average.  However, Minnesota unemployment rate often moves closer to the national average leading into a recession as shown in this graph of Minnesota and U.S. employment from 1976 to 2014.

Minnesota and US Unemplotment SA 1976 2014

The ‘pyramid’ problem with Gov. Dayton’s sales-tax hike

St. Paul Pioneer Press (MN) – Sunday, January 27, 2013

Gov. Mark Dayton wants to tax the sale of food, clothing, and just about everything else you buy in the worst possible way.

His budget proposes a $2.1 billion, or 20.7 percent, sales tax increase.

Since everyone pays sales tax, everyone will pay Dayton’s sales tax increase.

But it’s worse than that.

Dayton’s tax plan violates the basic principles of tax reform.

It intensifies the pain of taxation by imposing hidden taxes on intermediate business purchases. This causes “tax pyramiding,” which is a big mistake.

According to non-partisan legislative researchers, “Standard tax policy principles argue that intermediate business purchases should not be subject to consumption taxation. This follows from the purpose of the tax, to tax consumption, and the principle of horizontal equity — i.e., to tax taxable consumption on an equal basis or only once.”

Dayton’s proposal to tax business services would hurt all Minnesota households by causing the sales tax to apply at several levels of a supply chain.

The same non-partisan researchers explain: “The result of this typically would be to pass the tax along in higher prices at the next level of production (e.g., a manufacturer who sells to a wholesaler). The tax burden ‘pyramids’ or cascades at each level, so that the total burden on the consumer is higher than the statutory or nominal rate.”

For example, a 5.5 percent sales tax on auto repair that pyramids twice would result in an 11 percent effective sales tax rate, but the consumer would only see a 5.5 percent sales tax rate on the receipt. The other part of the sales tax is hidden as higher consumer prices.

Dayton’s tax plan is harmful for small business and the people who will lose their jobs at Minnesota’s small businesses.

Large, vertically integrated businesses will not have to pay sales tax on legal, accounting and other in-house services. Small businesses using independent law firms or CPAs will have to pay sales tax on the same business functions. This inequity violates basic fairness.

It also makes Minnesota’s employers less competitive in a competitive, global economy.

Minnesotans will also lose their jobs to competitors in other states that don’t levy sales taxes on business-to-business services.

Dayton’s sales tax proposal would add more complexity to the tax code. It also would create new administrative and compliance costs. Yet, Gov. Dayton has not addressed how much it would cost to enforce his new business-to-business sales taxes.

Economist Alan Viard also warns, “The tax on inputs pyramids into the price of the final goods in an uneven manner, causing effective tax rates to vary across goods subject to the same statutory tax rate, which can distort consumers’ choices between different goods.”

Dayton’s sales tax proposal would add new sales taxes to the price of food in the grocery. The hidden taxes paid by all of the businesses from the farm to the store will be baked into price of every loaf of bread that you buy, even though food would be nominally exempt from sales tax.

Dayton’s budget creates new hidden taxes throughout the Minnesota economy.

Visible taxes make the tax burden clear so that citizens can compare the costs of taxation to the benefits of government services funded by taxation. Hidden taxes allow elected officials to camouflage the true cost of taxes.

Increases in hidden taxes are an implicit admission that greater spending might not pass a cost/benefit test unless the costs of the higher taxes are camouflaged.

As the Legislature considers the budget, they should ask whether each dollar of spending is worth imposing higher, visible taxes on all of their constituents.

Time used my quote about lottery sales

Time magazine used a quote from me in their story, “Throwing Money Away in Record Numbers: All-Time High Lottery Ticket Sales” by Brad Tuttle on August 23, 2012 about how lottery product innovation has increased lottery sales.

The lottery has been innovating,” [University of St. Thomas business professor John] Spry said. “On the one hand you have $650 million jackpots. On the other hand, you can play a scratch game where you can win a $100,000. Different players like different profiles of risk. And the lottery has sort of over time learned what appeals to the different players.”

Don’t cherry-pick: Weigh the costs and benefits of higher taxes

St. Paul Pioneer Press (MN) – Sunday, May 19, 2013

Gov. Mark Dayton wisely urged Minnesotans to use facts in the budget debate in a speech to the Chamber of Commerce. Despite this sage advice, he continued to rely on a flawed analysis as an important rationale for his budget’s higher taxes.

“If the lowest taxes equaled the highest job growth and the highest per capita income, public policy would be clear and simple,” Dayton told the Chamber. “In fact, however, the opposite is true. If you look at the last chart, two pages of your handout, people living in the states with the lowest taxes generally have among the lowest per capita incomes. And those states have inferior job growth,” he stated.

Gov. Dayton’s data analysis has multiple statistical mistakes. One critical error is selection bias. He looks at a small subsample of the available evidence that was carefully cherry-picked, instead of drawing a conclusion from all of the available evidence.

Dayton showed data from only six states in one table and from only eight states in a second table before drawing the specious conclusion that these cherry-picked numbers prove that lower taxes equal lower job growth and lower per capita income.

New Hampshire, for instance, was clearly picked for one table to “prove” that New Hampshire’s low taxes lead to New Hampshire being 46th in job growth in 2012, while New Hampshire’s high per capita income failed to appear in the other table. Similarly, Dayton’s tables suggest that North Dakota’s job growth comes from its high tax collections, instead of the Bakken oil boom that has led to both North Dakota’s job growth and a gusher of energy-related tax revenue.

Dayton’s analysis also suffers from a tiny sample, a lack of statistical hypothesis testing, and the omission of any control variables. These serious statistical flaws mean that Dayton’s inference that higher taxes equal higher incomes and job growth is not supported by his methodology.

Most peer-reviewed research examining the aggregate effect of state taxes finds “a negative relationship between taxation and growth,” while a few papers “do not detect any significant negative impact of taxes on growth” according to a careful literature review by economists Ergete Ferede and Bev Dahlby in last September’s National Tax Journal. This literature review does not find a robust positive relationship between aggregate state taxes and income growth.

Research on the aggregate effects of taxes is complicated by several technical issues of data quality. Aggregate measures of taxes mix more- and less-distortionary types of taxes. Aggregation also conflates productive public expenditures with wasteful public expenditures.

Even careful analysis of the aggregate effects of typical state tax and spending patterns doesn’t provide the best guidance about the economic consequences of specific increases in taxes and spending.

A better way to understand the effects of higher taxes and spending is to consider each tax hike and spending program on a case-by-case basis.

Each dollar of government spending costs the private sector both the dollar taken from people in the private sector plus the economic damage from all the ways taxes distort decision-making.

People change their behavior in response to changes in taxes. Higher income tax rates are a disincentive to work, work overtime, or work multiple jobs. Higher income tax rates penalize education and on-the-job-training by lowering the after-tax rewards for investment in productive human capital.

At low tax rates, this economic damage from taxes is small. But at higher tax rates, these negative effects of taxes are larger.

The tax bills in St. Paul would increase effective marginal income tax rates above 50 percent for some primary earners and above 60 percent for affected secondary earners. In other words, these taxpayers would gain less than the government from additional hard work to earn another dollar of pre-tax wages.

At the proposed federal plus Minnesota income-tax rates, each extra dollar of government spending is likely to cost the private sector around $1.25 to $3. I applied standard economic formulas and the proposed tax rates to a range of estimated behavioral responses from other economists’ research to produce this imprecise estimate.

The logical case for higher taxes and spending requires explaining why the private sector should shrink by more than a dollar for each additional dollar spent by the public sector.

Gov. Dayton should lead elected officials from both parties to eschew flawed analysis in favor of careful enumeration and consideration of the real costs of additional taxes and the benefits of each spending program based on the best possible analysis.

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 .

Tax Incidence Analysis of 2013 Minnesota Omnibus Tax Bills

The Tax Research Division of the Minnesota Department of Revenue has release Tax Incidence Analyses for the House omnibus tax bill (HF 677), the Senate omnibus tax bill and the Governor’s Supplemental Budget Proposal.  There are available here:

House_Incidence_Analysis_2013 (5-11-12)

Senate_Incidence_Analysis_2013 (5-11-13)

Gov_Supplemental_Incidence_Analysis (5-11-13)

Updated Marginal Income Tax Rates over 60% on Secondary Earners

Did you know Minnesota is considering a 12.49% state income tax rate?  Or that some Minnesotans would face marginal income tax rates over sixty percent?

Let’s look at the numbers of how layers of taxes add up to effective marginal income tax rates over 60%:

Federal income tax rate             39.6%            (top tax bracket)

Federal FICA                            15.3%             (combined FICA tax rate up to $113,700 of each individual’s earnings)

Minnesota income tax               12.49%           (Revenue Estimate of a 8.49% tax rate + 4.0% surtax for the 2013 and 2014 tax years)

The combined effective marginal tax rate on secondary earners would almost never be equal to the simple sum of 39.6% + 15.3% + 12.49% = 67.39%.

This is because these hard-working taxpayers would better of deducting their Minnesota state income tax as itemizers on their federal taxes and because some of the FICA contributions may also be tax deductible.  However, even considering deductibility, the effective marginal tax rate would still be over 60%.

The type of taxpayer who would face effective marginal tax rates over 60% would be the secondary earner, filing jointly with their spouse who earned sufficient income to put the couple in the top federal tax rate, but as an individual makes under the FICA limit of $113,700.  For example a teacher, nurse, or home day-care provider filing jointly with a surgeon or successful owner of a business could have individual income below the $113,70 FICA limit, but enough joint income to be in the highest federal and Minnesota tax brackets.

Of course, the combination of several layers of taxes and phase-outs of government subsidies also produces extremely high effective marginal tax rates that can approach and exceed 100%!

Finally, Professor Steven Landsburg at the University of Rochester reminds us that “You Too Could Face 95% Taxation” from multiple layers of taxation on working now to spend when you are older.  (Source: Steven E. Landsburg, ‘‘You Too Could Face 95% Taxation,’’ The Wall Street Journal, March 15, 2011, p. A 22.)