Debt Burden & Principal vs. Interest

Who has a bigger debt? Both Expect to pay off their debt in 30 years at the monthly payment rate.

	Total Debt Outstanding	Interest Rate	Monthly Payments
John	$100k	3%	$422
Sally	$50k	10%	$439

Here is another example.  The numbers are rough ballpark estimates, but I think they show the issue pretty well:

	Total Debt Outstanding	Interest Rate (% of GDP)	Annual Interest Payments (% of GDP)
Obama (end of first term)	100% of GDP	< 3%	> 3%
Reagan (end of second term)	50% of GDP	< 10%	< 2%

This time I am only looking at interest payments rather than amortizing the principle, but the same principle applies as in the first table. It isn't clear if the real debt burden is higher in 2012 under Obama or in 1988 under Reagan.  Of course, these are not real interest rates and so the real expected future interest burden was much less in the high-inflation Reagan years, but the current burden of the debt is the current amount of income that must be sacrificed to pay for debt service which is shown in the graph below.
Dean Baker says that government interest payments are a better measure of our government debt burden than the actual amount of debt.  Note that although the interest burden is expected to rise rapidly, in 2012 we are still well below where Reagan and Bush ever got and that did not pose a big problem for the economy. 

And what would happen if interest rates rise?  Baker has a good answer for that too:

 Am I pulling a fast one here by switching from debt to interest payments? Not at all. Suppose we issue $4 trillion in 30-year bonds in 2012 at 2.75 percent interest (roughly the going yield). Suppose the economy recovers, as CBO predicts, and the interest rate is up around 6.0 percent in 4-5 years. The federal government would be able to buy back the $4 trillion in bonds it had issued for roughly $2 trillion, immediately eliminating $2 trillion of its debt. This will make those who fixate on the debt hysterically happy, but will not affect the government's finances in the least. It will still face the same interest obligation.

I am not as sanguine as Baker about rising interest rates, but he is certainly correct that they have no impact in the short run, ceteris paribus.  And one of the things that would raise interest rates is a growing economy which would help us pay off the debt too. 

Tax Incidence Questions

1. Why did Amazon get very upset that they will have to charge customers sales tax in California even though only Amazon's customers pay sales taxes? 
2. Should you care if your employer pays half of your payroll tax or if you pay all of it? 
3. Renters tend to be relatively poor on average and landlords are richer than average.  Are real estate taxes progressive because relatively rich landlords (and homeowners) pay them rather than relatively poor renters?  
4. Are property taxes on the value of land or on the value of buildings going to have a different impact on people? 

Who Pays Taxes?

Hamilton Project:

Who Pays Taxes?

 A popular myth swirling around Washington, DC, and throughout the media these days is that many Americans do not pay taxes, and are therefore free-riding off of our society without contributing themselves. This has even been referred to by some as a “new orthodoxy.”  The origin of this misconception is the observation that only about 54 percent of American households paid federal income taxes during recession-affected 2011.  But that statistic is misleading because it provides an incomplete picture of the overall tax burden on American families, and because it incorporates individuals who naturally shouldn’t be paying taxes because of their age or economic circumstances due to the Recession. A closer look reveals that nearly all Americans do, in fact, pay taxes.
To help illustrate this point, let’s start with some basic fiscal background. Over the last two decades, tax credits for low-income working families with children, like the Earned Income Tax Credit (EITC) and the Child Tax Credit (CTC), have indeed decreased the number of American households paying federal income taxes. These credits reduce or eliminate income tax liabilities and sometimes result in a net income tax refund for low-income families.
But these credits are also an important component of the progressive tax system that help offset the burden of other taxes and raise poor working families out of poverty. Credits like the EITC and CTC have helped to reduce poverty, provide economic security, and offset declining labor-market opportunities for low-income workers. The EITC alone is responsible for raising 6.6 million children out of poverty.  Perhaps most importantly, these credits expand the number of people contributing to the economy by causing many additional Americans to participate in the labor force and causing others to work more hours.
While this helps explain the declining number of low income families paying federal income tax, it does not address one key point: federal income taxes are only one component of the broader federal, state, and local tax system, and only one way in which Americans are able to contribute their fair share through taxes. Indeed, while some families do not pay federal income taxes, these households do pay other forms of taxes. Those who focus exclusively on the federal income tax ignore one of the most significant federal tax burdens on workers—the payroll tax.  In fact, most Americans pay more in payroll taxes than in income taxes.
As shown in the figure below, after incorporating payroll taxes, the proportion of American households who paid federal taxes in 2007, a non-recession year, jumps to 78 percent.

But, when we take the data a step further, even this statistic is misleading because it counts older households, who are often retirees, and young individuals, even if they are still in school. In fact, many households with no tax liability are young or old, meaning that they are likely to be led by students who subsequently will pay taxes or retirees who paid taxes over their lifetimes. The figure below illustrates the relationship between age and the odds of paying payroll and income taxes. The graph makes clear that younger individuals—those in their late teens and early 20s—pay taxes at relatively low rates, but that is largely because they are in school and not working.  But as they get older and find jobs, the evidence suggests that they will pay taxes. Similarly, after age 60, when more and more Americans are retiring and leaving the labor force, the fraction paying taxes falls rapidly. These retirees have certainly contributed to America’s revenue stream over their lifetimes. To this point, as the U.S. population ages into the future and a greater proportion of Americans reach the retirement age, it is inevitable that a growing percentage of the overall population will pay no income or payroll taxes.

But during middle age, almost all workers face a tax burden. When looking at those in middle-age, 84 percent faced a net payroll and income tax bill in 2007. This general theme also holds true for low-income households: even households that receive the child-related EITC generally only receive it temporarily, usually when their children are young. On net, even these families face a positive tax bill over time (Dowd and Horowitz 2008).
Furthermore, rising unemployment during the Great Recession has meant that the proportion of American families paying no federal taxes is unusually large today. Unemployed workers without incomes naturally don’t face tax liabilities. But as they find jobs and rejoin the labor force, they will once again contribute to the federal system. Indeed, some of the trends we see today are less illustrative of an unfair tax advantage for the poor; rather, the trends indicate the existence of a group of unfortunate families who have found themselves affected by hard times. And young people today have been particularly hard hit: many are unemployed or weathering the storm in graduate schools, meaning that they are, thus, not paying taxes. When looking more specifically at middle-aged workers with jobs, 96 percent paid federal income or payroll taxes.

Other Forms of Taxes Also Count

Finally, incorporating the additional—and significant—other forms of taxation into our calculation leads to the conclusion that nearly 100 percent of Americans pay taxes in some way, shape or form. All consumers bear the burden of state and local property, sales, and income taxes, as well as excise taxes on items like gasoline, alcohol, or cigarettes. These other taxes tend to be regressive, imposing more of a burden on low-income families than on high-income families—the state and local tax burden is over twice as large as the federal tax burden for the bottom fifth of households (Citizens for Tax Justice 2011). When you fill up your car with gasoline, you can’t avoid paying the tax. The pump does not differentiate between the richest Americans and the poorest families.

Tax Policy Center:

46.4% of Households Paid No Federal Income Tax for 2011

  But Nearly Two-Thirds of Households
 That Paid No Income Tax Paid Payroll Taxes

Who Paid Neither Income Nor Payroll Taxes?

More than half are elderly

Over one-third are nonelderly with income under $20,000

Only about 1 in 20 is nonelderly with income over $20,000

There has been a decline in the number of poor families that pay income taxes too.  It has been a longstanding bipartisan effort:

Tax cuts for the poor happened under Richard Nixon and under Ronald Reagan. Tax cuts for the poor was something the Clinton administration and the House GOP was able to agree on. Tax cuts for the poor were a small-but-real element of George W. Bush's 2001 tax cut. Democrats like to help poor people and Republicans don't like taxes, so helping the poor with lower taxes is often something they can agree on. It's a real shame that the official data doesn't capture how successful this is, but it's basically common sense. A conservative movement that can't bring itself to want to help poor people with lower taxes is one that really doesn't care about poor people in a profound way.

But don't take my word for it. Here's Ronald Reagan bragging about his plan to increase the number of low-income and disabled people who don't have to pay federal income taxes:

Death Penalty Incentives

The data is simply insufficient to know if the death penalty reduces homocides: See Justin Wolfers on a new National Academy of Sciences report.

Tax Expenditures = America’s Biggest Spending

Justin Wolfers:

If you’re at all like us, chances are you’ll spend Tuesday [April 15th] finishing your taxes. As you search for every last deduction and credit, it’s worth asking: Does any of this make sense?
Here’s a way to see through the fog. Instead of looking at all the breaks for mortgage interest, health care, retirement savings and so on as deductions, picture the government writing you a check for each item. This equivalence between tax deductions and government spending leads economists to call them “tax expenditures.” Reformers have hit on an even more pointed description: spending through the tax code.
The tax system is ...equivalent to a collection of individual mandates, like the one in the Obama health-care law, with penalties for Americans who fail to buy insurance. For many people, that’s how our system works. You and your neighbor might have the same income, but if, unlike your neighbor, you fail to have a mortgage or buy as much health insurance, then you have to pay higher taxes.
You may feel very differently about tax deductions, government handouts and mandates backed by penalties. Economically, though, they are identical. They yield the same outcomes and provide the same incentives.

Insidious Mechanism

...Unlike typical government spending, tax expenditures aren’t reauthorized each year by Congress, so they have immense staying power. Because they aren’t as visible as outright spending, they aren’t subject to the scrutiny of campaigns to pare back waste or assess effectiveness.
Indeed, spending through the tax code is so politically stealthy that it has won over enemies of government largesse, such as Grover Norquist... It’s a tribute to our psychological biases that getting a subsidy through the tax system is treated so differently from receiving a government check...
The result: Even as many areas of government spending have been cut to the bone, our tax code remains larded up with expenditures that cost taxpayers $1.3 trillion every year. According to the nonpartisan Tax Policy Center, the biggest tax expenditures apply to employer-provided health insurance, pension contributions and mortgages.
Popular as such tax breaks may be, they differ from typical government spending in that they give bigger subsidies to wealthier families. Imagine if we mailed checks to all homeowners to help them pay their mortgages. Would you support giving millionaires with mansions 25 times more than the typical family? That’s effectively what we do: Middle-class families get an average benefit from the mortgage interest deduction of $139, while families in the top 1 percent get $3,752.
Taken together, individual income tax expenditures are the equivalent of sending $686 each year to those in the bottom fifth of the income distribution, $3,175 to those in the middle fifth, and $30,714 to those in the upper fifth. The average member of the top 1 percent gets nearly a quarter of a million dollars a year...
The rich get such big subsidies for three reasons. First, they spend more on the things the tax system favors, such as homes and health care. Second, they are subject to higher tax rates, so they get more benefit from each dollar of deductions. Finally, they’re rich enough to take full advantage of their deductions. The poor typically have too little income to itemize, while many families in the upper middle class find themselves siphoned off into a separate tax system known as the alternative minimum tax, which allows fewer deductions.

Honest Discussion

...Here’s our proposal: Let’s replace all tax expenditures with explicit subsidies -- that is, with actual federal payments -- so we can really see the costs and debate all spending programs on an equal footing. Doing so would help us answer crucial questions, such as whether we get more bang for our buck by subsidizing homeownership or by spending more on schools. There’s one more payoff to getting rid of the myriad breaks hidden in our byzantine tax code: It will be a lot easier to get your taxes done before midnight.

Mitt Romney says he wants to reduce tax expenditures and reduce tax rates although he has not specified any significant deductions and loopholes that he would close because most of them are popular.  Although some analysts such as the Tax Policy Center judged that Romney's unsubstantiated goal to broaden the tax base would raise taxes on the middle class, that could arguably be good for economic growth:

Conservatives worry a lot that high taxes discourage growth. Liberals tend to downplay this. One way they downplay it is by noting that in addition to the incentive effect (higher rates give you less reason to work) there's an income effect (less money in your pocket gives you more reason to work). The genius of the Romney reform is that from a labor-supply viewpoint it pushes on both levers.

Thanks to the lower marginal tax rates, under Romney's plan everyone would face lower taxes on the next dollar of income he earns. That's a stronger incentive to work. But thanks to the elimination of deductions, most middle class families would see their total tax bill go up. Those lower after-tax incomes also create a stronger incentive to work. It's a double-whammy, staying revenue-neutral while turning the tax code into a much more work-friendly document.

Laffer Curve Effects?

The Congressional Research Service did another study of Laffer Curve effects and found nothing.  Kevin Drum:

Do lower tax rates produce higher economic growth? Everyone agrees that taxes produce deadweight losses, but those losses are fairly small and are often offset by the benefits that a strong central government provides to an economy. When you net everything out, low tax rates don't seem to have a big effect.
But this is in the news yet again, since Mitt Romney promises that his tax plan will be revenue neutral because his tax cuts will supercharge the economy and thus produce extra revenue to make up for his tax reductions. So the Congressional Research Service took another look at this question for the period 1945-2010, and... Low tax rates [on the rich] appear to be associated with:

• Higher investment
• Lower savings
• But no change in growth rates

None of these three results were statistically significant, but a fourth result was: lower top marginal tax rates mostly benefit the rich, leading to much higher income inequality. The study found similar results for capital gains tax rates...
One caveat: Generally speaking, marginal tax rates were high from 1945-1980 and low from 1980-2010. So the CRS results might just be an artifact of the fact that growth was higher during the postwar period and lower during the post-Bretton Woods era. In other words, it might have nothing to do with tax rates. But of course, that's the point...

The fact that the low-taxes-on-the-rich era has had lower savings and higher investment means that the US has been borrowing more from abroad and a reduction in net exports.    

Paternalistic Policy and Smoking

Moneybox:

Response to New York City's partial ban on very large sodas has featured a lot of commentary drawing heavily on the "futility" leg of Albert Hirschmann's three-legged stool of the rhetoric of reaction. But if I think back to the evolution of cigarette smoking policy since the late-1980s that you can see the same thing. Relatively few of the measures enacted—a price hike here, a ban on cigarette machines there—seem like public health game-changers on their own terms. But not only is the overall smoking rate steadily falling, but Gallup is out with survey evidence showing that the number of cigarettes smoked by those who do smoke is falling. ...For my part, I'm with Ray Fishman and think that taxing sweetened drinks is the promising policy in this regard. Among other things it would also raise revenue, and let us get by with fewer taxes on work and investment.

The big problem with moving from income taxes to consumption taxes is that these taxes are much more regressive.  

Optimal Wage for Public Employees?

The Buckeye Institute is a libertarian organization whose website (9/2012) suggests has the primary goal to reduce  the salaries of public employees.  This begs the question of what is the optimal salary of public employees?  Should we pay teachers and police at the minimum wage?  Arguably, one of the reasons that poor countries have poor-quality governments is that they pay public servants too little.  That leads to corruption.  If public employees are indifferent about losing their jobs, then they will be more tempted to be corrupt.  I think it is best to err on the side of having well-paid public servants and demanding a lot out of them, but they could certainly be overpaid.  The market signal is the number of applicants for public-sector jobs relative to private sector jobs.  If there is a bigger applicant pool for public jobs, then they are paid a higher real market wage, but the Buckeye Institute does not look for market signals.  Instead they ask readers to compare their own salaries with the salaries of public servants like teachers (the most common public-servant job).  This is a good way to develop public resentment, but teachers have college degrees and 70% of Americans do not, so a more apples-to-apples comparison would compare teachers salaries to other college-educated professions. 
Furthermore, Buckeye inflates teacher incomes.  For example, they claim that the lowest paid teachers get a salary of $38k and a total compensation of $53,898.70.  But Bluffton elementary school teachers salaries start below that according to Buckeye's own data and although Bluffton is well below the state average, Bluffton pays better than some districts.

A real problem in financing public servant wages is that politicians are always tempted to promise to pay more later rather than to pay more now.  That is one reason why public-sector employement has such large pension promises.  It is easier to cut taxes now in exchange for bigger pensions later because some other politician will face the burden of paying for the pension.  This kind of tradeoff is particularly unprofitable because most individuals have a very high discount rate and that makes these deals expensive. 

Obama Fail on Gov't Investment

Krugman on government investment during a recession. 

For future reference. In a depressed economy, with the government able to borrow at very low interest rates, we should be increasing public investment — the true cost of the resources is negligible, so the rate of return is very high, not to mention the desirability of creating jobs.

Here’s what has actually happened, as measured by the sum of state, local, and federal nondefense investment: