Lowering Taxes to Raise Revenue

Photo by vistavision

The budget negotations in DC have basically come to an end, and one of the things that got nixed was a tax increase on those earning more than $200,000 a year. Many are upset by this; making the usual cries for fairness that go with arguments in favor of progressive taxation. I can’t speak to that, but I can respond to claims that higher taxes on upper income brackets are a practical necessity for addressing the District’s projected budget gap.

My argument is not a new one: lowering tax rates can, and in the District’s case, almost certainly will increase tax revenue.

The most famous case where this occurred is of the course the Reagan tax cuts, where the top marginal rate decreased but tax revenue increased. This could be attributed to a recovering economy, of course, but the distributional changes were interesting:

The share of the income tax burden borne by the top 10 percent of taxpayers increased from 48.0 percent in 1981 to 57.2 percent in 1988. Meanwhile, the share of income taxes paid by the bottom 50 percent of taxpayers dropped from 7.5 percent in 1981 to 5.7 percent in 1988.

In other words, while the marginal rate decreased on top income earners, the percentage of tax revenue that came from those income earners actually increased–and this during a time when the overall amount of tax revenue had also increased.

I’m not going to pretend one example proves anything; I offer it up merely as evidence that the idea of lower tax rates yielding higher tax revenue is not at odds with reality.

It seems to me that the case for this in the District is particularly strong. DC’s political boundaries only account for one small part of the DC metropolitan region as a whole. As such, area residents are in a better position than most to “shop” for the most personally beneficial policy situation. Moreover, it should be obvious that the wealthier you are, the more options you have available to you. The “voting with your feet” option is more affordable to someone making more than $200K a year than to someone making $30K or $40K a year.

In short, raising the tax rate on people making more than $200K a year wouldn’t necessarily result in an increase tax revenue by a single dollar; it may just result in fewer people in that group filing their taxes in DC.

Moreover, I think a sufficient number of people who live in DC have relatives in Virginia or Maryland whose whom they could claim as their primary residence to make the tax base of the District more flexible than is typical.

The bottom line: I think that the most practical way for the DC government to increase its budget gap would not be to increase taxes on higher income earners, but to lower taxes across the board so that they are on par or slightly lower than the District’s neighbors. This would encourage many more people to file their taxes in DC.

Credibility

xkcd: Wikipedian Protestor

Credible commitment is the problem faced by anyone seeking to get something later from someone in exchange for giving up something now. Can the other party credibly commit, before the fact, to still go through with their end of the bargain when they already have what they want?

Now, it is in the interest of both parties for them to be able to credibly commit, because the first party is not going to do their part if they can’t reasonably expect the second party to go through with theirs. I’m not going to pay the car salesman if there’s no reason for me to believe that I’m going to get a car out of it. I’ll pay him because I expect that if he reneges, he will be punished for it. Maybe he will be fined in court, or have to serve jail time. Or maybe it’s just obvious that if he didn’t give people cars for their money, he wouldn’t have been in business for so long because he would have had a deservedly horrible reputation.

In any case, people are clever, and they’ve developed mechanisms to credibly commit in advance. Whether it’s through legal recourse, collateral, or any number of other means.

The problem is that government can always break its commitments.

When the government is the car salesman, it won’t be punished by the law–for the government is what enforces the law. It is much much harder for government actors to credibly commit than it is for private actors.

The best thing a government can do for its ability to encourage people to do business with it is to establish a very long track record of keeping its promises. The fact that the US federal government has never outright defaulted since Alexander Hamilton took on the debts incurred during the Revolutionary War has greatly augmented its ability to secure loans today.

So where do we stand in the District?

I saw this story today, which did bring up a credible commitment problem within the Council. But mostly it reminded me of an earlier story I’d seen:

Dozens of District residents who installed solar panels on their homes under a government grant program promoting renewable energy have been told they will not be reimbursed thousands of dollars as promised because the funds were diverted to help close a citywide budget gap.

When you are living beyond your means, it is no longer within your means to keep your promises. Does anyone think the Council’s promises will be worth much of anything in the future?

Contra Subsidized Housing

N. Capitol & K

Photo by Vince Kelley

Times are tough, and transportation programs help all residents, rich and poor, which is why it’s good for DC to be making the investment. Education, public safety, and much more are also critical. But it’s also unfair and unreasonable to make budget cuts disproportionately hurt the neediest residents.

-Greater Greater Washington, “DC budget unfairly hits affordable housing and more

It’s always interesting how specific spending cuts are picked on as “unfair” or cruel or immoral, but rarely do the critics go on to point out areas where spending could be cut that would be fair, humane, and moral. Take the Greater Greater Washington quote above–it applauds Mayor Gray for not cutting in some areas, then criticizes the one area under discussion where he does cut. Meanwhile, there is an expected budget gap of over $300 millionsomething is going to have to be cut.

Nevertheless, what should be cut is a legitimate discussion, so I will briefly state the case for putting this particular item on the chopping block.

At stake is a cool $18 million siphoned from the Housing Production Trust Fund (HPTF). According to the Washington Post;

The trust fund provides direct subsidies to developers to set aside units or, in some cases, entire buildings that they rent or sell for less than market rates. The developers must agree that rental units will remain affordable for 40 years and ownership units for 15 years.

In short, with HPTF the DC government offers developers a bargain–we will give you extra money if you use at least some of it to build apartments that you cannot charge a profitable rate for.

This bundles a housing subsidy with a very specific kind of rent-control. I think all all forms of both are counterproductive, but this one is stranger than most.

Granted this is way, way preferable to old-school rent-controls of the sort enforced in places like New York, where people were just categorically told they couldn’t charge more than a certain price to their tenants. This at least is as voluntary for the parties involved as anything funded with tax money can be.

Nevertheless, subsidies don’t make sense in a city where the supply of housing is increasing like gangbusters (if subsidies in the housing market ever make sense to begin with!). And rent-controls of any kind always suffer from the same problems.

The problem stems from lack of real ownership. Oh sure, some of these HPTF funded rental buildings may be owned by someone. But not in the important economic sense of being a residual claimant.

Econ 101–people have an incentive to invest in their property because they can personally benefit from any increases in its value. When I say “invest”, spending money can be involved, but also things like time and attention.

The pathologies associated with rent control and housing projects are well documented–landlords underinvest in the maintenance of rent-controlled flats, housing projects become dens for crime and violence. When no one owns something, no one has any incentive to see that it is properly maintained, or protected.

When the price system is allowed to work, any increase in the value of a property is reflected in the price. If the price can’t rise, then a big incentive to increase or maintain the value of that property has been erased.

Building entire rent-controlled buildings, or even just rent-controlled units within otherwise free buildings, is to sink resources into something that will inevitably fall into disrepair and display other, worse symptoms of negligence.

So I don’t think cutting HPTF is a bad thing, especially when the District government is already spending above its means.