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This essay will explain why they might want to do that—and how you can get income from MLPs without paying corporate tax.

Energy MLPs, which account for the bulk of the MLP sector, handle hydrocarbons, using pipelines, storage tanks, fractionation plants or railcars. Enterprise Products Partners (EPD), a classic of the genre, owns all those things.

MLPs are boring but they pay fat dividends. EPD’s yield is 6.7%. Buckeye Partners (BPL) hands out 11.4%; Magellan Midstream Partners, 5.8%. Sheltered by pipeline depreciation, dividends tend to be tax-free in the early years of an investment. A fund containing many MLPs would be a terrific way to get diversification combined with a nice income stream.

Except for a little problem. A peculiarity of the tax code is that a fund’s tax exemption is snatched away if the fund puts more than 25% of its assets in partnerships. So if you want your fund to be a pure play on MLPs, the fund must lose a chunk of your profits to taxes. That’s why the Alerian fund’s average annual return since it opened its doors in August 2010 has been only 1.7%, while the MLP index it follows has delivered 4.2%.

The simple way for an energy fund to duck the corporate tax is to broaden its portfolio. It can blend a 25% allocation to MLPs with a 75% allocation to other energy companies, taking advantage of the fact that many pipeliners, like Targa Resources, Oneok and Williams, are organized as corporations rather than partnerships.

But the tax-light funds are outsold by the taxable ones. Why is that? Is it that investors want a concentrated dose of high-octane MLPs and won’t tolerate the blending fuels? Is it perhaps that they don’t understand the weird accounting? Read the explanation of the tax expense in Alerian’s financials and you will be ready to check yourself into an insane asylum.

Whatever the reason, the fact that Alerian and other taxable MLP funds are big sellers is a source of unending frustration to Simon Lack of SL Advisors, a manager of energy portfolios. Lack runs two 25/75 funds that have, between them, a mere $157 million of assets. “People are invested in AMLP even though their performance is only 50% of the index return,” Lack complains.

Jeremy Held, director of research at Alps, the firm that operates the Alerian fund, insists that his fund’s buyers know what they’re doing. They want diversified exposure to the MLP sector and they don’t want to tangle with the pile of K-1 tax forms they’d get if they owned partnerships directly. Held says that it’s not just small investors who opt for the fund. He has seen buyers with seven-figure stakes.

Like Lack’s 25/75 funds, the Alerian MLP ETF gives investors a 1099 dividend report instead of a K-1. That cuts their tax preparation bills, and it also enables them to put energy infrastructure in a tax-deferred account like an IRA. (Direct ownership of partnerships in an IRA creates chaos.)

How much do you sacrifice when you use a fund organized like the Alerian ETF?

To illustrate, we’ll start with a hypothetical MLP trading at $10 a share and paying a $1 annual dividend. Depreciation, we’ll assume, is more than enough to shelter the dividend (this is typical), so that the entire payout is considered a “return of capital,” not immediately taxable.

If you own the share directly you pocket the $1 without owing any tax for now. Your $10 cost gets adjusted down to $9. That will boost your taxable gain when you do sell. But if you have your wits you never sell.

Now suppose the share is held in a taxable MLP fund. For simplicity we will assume that the fund has no management fee.

The fund, too, will enjoy $1 of income not immediately taxable. But it must allow for the possibility that the MLP share will be sold tomorrow. If the fund did have to sell the MLP to meet redemption orders, it would owe corporate income tax on a $1 gain. The federal tax rate is 21%; state taxes add another 2 points or so. That means the fund has to set aside 23 cents for future corporate tax.

The fund may choose to disburse the entire $1 of income to fund shareholders (again, typical), in which case the fund’s books will show an asset of $10 (the MLP share) and a liability of 23 cents (potential income tax). The fund’s reported net asset value will be $9.77. Someone holding the fund will see, on his brokerage statement, a 7.7% return; had he held the MLP directly he would have seen a 10% return.

What if the MLP share appreciates? Let’s assume no dividend, simply a bull market that sends the MLP up 10% to $11. Again, a fund that pays corporate tax has to allow for 23 cents of deferred tax liability. If the fund did sell its MLP it would owe income tax on the $1 gain, and at the usual corporate rate, since corporations get no break on long-term capital gains.

Allowing for the potential future tax, the fund holding the appreciated MLP will report an NAV of $10.77, for a total return of 7.7%. The buy-and-hold direct buyer of the MLP share would be up 10%.

MLP funds

Here you see the gap between index returns and fund returns that Simon Lack is complaining about. (Note: For 2018 and later years the gap will be smaller because of the Trump tax cut.) The gap is at first only on paper; the diminished NAV doesn’t damage the $1 of income coming from the MLP. But on eventual liquidation those years of corporate tax will be felt in a shriveled sale price for the fund.

What if there’s a bear market? Since the tax-burdened fund delivers only 77% of the return going up, can it limit your damage to 77% on the way down? That depends on the sequence of events.

If the MLP share goes from $10 to $11 and then back to $10 the fund investor will be cushioned on the way down, as the NAV falls only 77 cents, from $10.77 to its starting point. In general, funds that have delivered years of positive returns wind up with a deferred tax liability, and if losses then ensue those losses will be cushioned as the tax liability shrinks.

But funds that have piled up losses are usually left with no cushion against further declines. Picture a fund whose assets sink from a starting value of $10 a share to $9. That fund has a deferred tax asset worth, in some theoretical sense, 23 cents a share, because it’s in a position to earn $1 a share without owing tax on that gain. But it would be very hazardous for the fund to report its net asset value as $9.23. Departing fund investors could walk out the door with $9.23 of cash, leaving behind meager hard assets and a pile of tax loss carryforwards that never get used.

In such a fix most funds display a deferred tax asset of 23 cents and then, in the very next line, erase it with a “valuation allowance” of minus 23 cents. The tax situation is visible but doesn’t alter the NAV, which will be just the $9 value of the portfolio.

Funds with deferred tax assets that are duly erased should be appealing to a bullish investor. You don’t pay anything for the tax shield and so you can enjoy, at least for a while, 100% of the return on the portfolio. You are also exposed to 100% of the losses. Once the fund climbs into the black (in cumulative total return), it starts showing a deferred tax liability and you start getting 77% of the upside and 77% of the down.

So far we have described what happens to investors who hang on indefinitely. What happens to investors who sell?

Take the case of an MLP that climbs from $10 to $15 over a period of years while paying a cumulative $6 in return-of-capital dividends. On sale, the direct holder will have a $5 long-term gain plus something like $6 in what I call boomerang income. (The concept is explained in 2018 Tax Guide to MLPs.)

Including Obamacare at 3.8%, the maximum federal tax on the long gain will be $1.19. The boomerang is taxed at ordinary-income rates but benefits from the recently enacted 20% deduction on pass-through business income; Obama arrives again, with no mercy from the new deduction. Maximum boomerang tax = $6 x (0.038 + 0.8 x 0.37) = $2. Net realization from the sale: $11.81.

Now put the MLP inside a taxable fund. The fund will be accruing corporate tax liability all along. Since corporations don’t get the 20% pass-through deduction the ending NAV will be $15 – 0.23 x $11 = $12.47. The investor will have a cost basis of $4 ($10 purchase price of the fund, minus dividends). Tax on the $8.47 of long gain would be $2.02, for a net realization of $10.45.

Advantage: direct ownership.

As noted, you’d be a fool to sell an MLP, unless, perhaps, it’s such a disaster that the capital loss deduction is worth more than what the boomerang will cost you. Moreover, the advantage of holding directly grows over time. Bear in mind that unrealized appreciation (on either MLPs or MLP funds) becomes tax-free on your death, and so does boomerang income.

The accounting laid out so far in this story assumes high depreciation deductions. That pretty well describes the world we are living in. But the day will come when those write-offs peter out. What would happen if the entire $1 distribution from an MLP were taxed as ordinary business income?

The taxable fund would have 77 cents left, which would come to you as a qualified dividend. After maximum federal taxes you’d have 59 cents to spend on yacht fuel. If you owned the MLP directly you’d benefit from the pass-through deduction and would owe 33 cents, for a net of 67 cents.

There would be a transition period between the point when most of the profits in the system are a return of capital to the point where most are ordinary business income. During that transition the corporate-taxed fund would have one advantage, says Robert Velotta, an MLP expert at Cohen & Co. in Cleveland: the ability to marry an operating loss from one MLP to the operating income from another. Direct holders have to keep their MLPs, and their loss carryforwards, in separate silos.

But as a direct holder you have something else going for you. Once you’ve recovered your purchase price in cumulative dividends, further dividends can give rise to a blessed pairing of ordinary deductions (suspended losses from earlier years, now usable against salaries and interest) with capital gains (taxed at low rates, or, if you have a loss carryforward from your General Electric shares, not taxed). Explanation. With a fund in the middle you can’t do that.

In tax burdens the 25/75 funds fall midway between direct ownership and ownership via an Alerian-style fund. They don’t pay corporate tax. They can pass through return-of-capital money, but they can’t pass through losses.

Add it up. For investors who are equipped to deal with K-1s, the tax laws powerfully favor direct ownership.

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The Chicago Tribune recently wrote about how the decision to reduce the expected-return assumption from 7.5% to 7.0% for the Illinois Teachers Retirement System resulted in the governor calling for approximately $400 million in additional taxes.

While the political positioning behind this small move of 0.5 percentage point is fascinating, it more importantly brings to the forefront the issue of how large future obligations are, and why there is a lot of fear and an incentive to hide.

If reducing the expected return assumption from 7.5% to 7.0% results in an additional $400 million- 500 million a year of taxes, then moving the liability discount rate to something closer to a risk-free rate of 3% may imply additional $5 billion in additional contributions (Note: the actual number is likely several times higher than this – see the illustration below for some simplified math).

The dilemma we face is that we have made future promises and don’t have enough money set aside today to pay them. Therefore someone has to make up the shortfall. Instead of trying to determine who makes up the shortfall, we try to bury our heads in the actuarial sand of high expected returns.
But where can Illinois get the additional $5 billion a year? And where can America get the additional $6 trillion?

Investment returns aren’t going to help:

The Teachers Retirement System assumes that investment returns over the long-term will average 7%. With liabilities of $108 billion, and assets of $41 billion, even if investments return 7% per annum, the hole will only continue to grow (see Illustration below). This is why using investment-return expectations to discount liabilities isn’t appropriate.
But investments don’t return 7% year-in, year-out. For simplicity, let’s assume the long-term horizon to be 10 years. Even if there is one year where returns are negative-20%, this results in an asset value that is over $20 billion lower (see illustration below).
When risk-free rates were around 6%-7%, generating 8%-10% expected returns required minimal risk and complexity. However, with risk-free rates at 2%-3%, generating even 7% is a lot harder. While investment teams at pension funds such as Teachers are extremely capable, high expected returns are forcing them to take on additional risk, either in the form of increased leverage or complex investments.

The Rockefeller Institute of Government points out that “taxpayers and citizens may or not want this risk taken on their behalf, but they have little say in the matter. And they have no easy way out: If they want pension funds to take less risk, they’ll have to increase government contributions by even more than contributions have gone up already”.

Inflation may not help either.

Arguments in favor of using higher discount rates tend to revolve around the “artificially low” level of interest rates fueled by central-bank actions, and a belief that discount rates would return to a more “normal” level in the future. However, a return to “normal” is likely to be accompanied by an increase in inflation. For public plans, higher inflation could actually be a problem, as benefits tend to be linked to inflation, and therefore liabilities would likely get larger, not smaller, with inflation.

Therefore, by not putting in the money today, we are effectively making a leveraged bet on the stock market, and hoping it pays off, and praying that inflation stays low.

If average returns are only 6%, state funds in aggregate will run out in 2024. That’s only eight years from now.
And if the bet doesn’t work then who will pick up the pieces?

In 2010, Stanford Prof. Josh Rauh estimated that if state pension funds earned an average return of 8% on their assets, then states would in aggregate run out of funds in 2028. If average returns are only 6%, then state funds in aggregate will run out in 2024. That’s only eight years from now.

According to Rauh, funds would need to earn at least 10% per annum out to 2045 in order to sufficiently meet their obligations.

Higher inflation and lower investment returns would only make this situation worse. Current taxpayers and lawmakers are either unwilling or unable to shoulder the burden, as recent events in Illinois have highlighted.

This then shifts the burden to future taxpayers. As this burden becomes more apparent, Rauh speculates that taxpayers may choose to relocate from states with high unfunded pension liabilities. This would, in his opinion, increase the likelihood of a federal taxpayer bailout. Failing that, states would have to resort to what has so far been unthinkable — cutting benefits. In the absence of a federal bailout or a cut in benefits, it’s likely that municipal-bond holders would have to take a hit, as tax dollars get used to fund pension benefits.

Quantifying the true extent of liabilities is the first step in recognizing the magnitude of the problem; the amounts involved are too large to ignore, and it impacts almost everyone. Hopefully policy makers can make informed decisions before its too late.

If decisions aren’t made, then our only hope is that we earn over 10% investment returns each year. Would you take that bet with your future?

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The revelations about offshore accounts that came to light in the so-called Panama Papers will reinvigorate government efforts to rein in not just tax evasion, which is illegal, but tax avoidance, too.

They will also add to popular frustration that will challenge the authority of some government officials. The uproar will bring about enhanced enforcement measures. Yet there also will be unintended consequences that will further erode the credibility and effectiveness of the political establishment, including its ability to govern from the center, which is already being tested.

In the wake of the global financial crisis, and given the alarming surge in wealth inequality, the governed will prove far less accepting of the legal distinction between tax evasion and tax avoidance. Both are now viewed not just as “tax dodges,” but also as the unfair perks of the better-off and more-connected members of society in many countries.

Enter last week’s “Panama Papers,” the trove of more than 11 million pages of documents from Mossack Fonseca, a Panama-based law firm. The documents suggest that in both advanced and developing countries, some of those who hold power, and those with access to them along with the “rich and famous,” used the firm to establish and manage offshore entities that are designed to protect capital and minimize taxation.

The political repercussions were immediate, and are likely to spread. Already, the scandal has led to the resignation of Iceland’s prime minister, to a political outcry that has required U.K. Prime Minister David Cameron to release his tax returns (a first for Britain’s top elected official), and has abruptly ended the political honeymoon of Argentina’s new president, Mauricio Macri.


In addition, countries including Germany are stepping up efforts to look into curbs on legal, but morally questionable tax avoidance schemes that benefit the wealthiest. As with earlier steps to limit money laundering, the focus will be on more stringent reporting requirements, better international sharing of data, and more closely coordinated cross-border verification and enforcement efforts.

These changes will be quite visible; and will have a meaningful impact for those who, until now, have found it easy to use offshore financial vehicles to reduce their tax payments. The measures’ effects on politics and governance, while they will be less visible, could be more consequential for broader segments of society.

The Panama papers are yet another blow to the political establishment. They amplify popular resentment toward governments that already are perceived by a significant segment of the population as turning a blind eye to tax-dodging. That anger is stoked by disclosures that some high-ranking officials also availed themselves of the shelters. And though no laws were broken in most cases, the documents will feed the perception that the privileged are allowed to play by different rules.

Indeed, for many, the Panama Papers are reminiscent of a broader phenomenon that played out in the run-up and the aftermath of the 2008 global financial crisis: The perception of a system run and managed by a political establishment that serves the rich and connected and fails to hold these elites accountable for the damage they cause to the rest of society. There is still notable residual resentment that very few bankers were brought to justice for their role in a financial debacle that caused significant misery and almost tipped the world into a devastating multiyear depression.

By stoking residual anger and fueling anti-establishment movements, the Panama Papers will make it even harder for the established parties to come together and implement policies aimed at overcoming years of sluggish economic growth, worsening inequality and artificial financial stability.

In addition, two other developments last week also eroded the credibility of the political establishment: the failure of the Dutch government to convince citizens to back a trade and cooperation agreement between the European Union and Ukraine, and the turnaround of a growing number of members of the Republican establishment (including Lindsey Graham, Mitt Romney and Scott Walker) who lined up behind Ted Cruz as their preferred candidate.

There will be even less appetite to govern from the bipartisan political center, thus making it more difficult to secure sufficient buy-in for pro-growth structural reforms, better demand management and more timely solutions for excessively high levels of over-indebtedness.

There’s no doubt that the Panama Papers will produce greater efforts to reduce tax minimization (whether through legal avoidance or illegal evasion). That is good news for liberal democratic systems that rely on a rule of law that is viewed as fair and credible. But in the short-term this will be accompanied by even stronger resistance to the kind of political unity that is needed in several countries to deliver high growth and genuine financial stability.



The fundamental relation of capital to income has been much discussed by economists, the former being likened to a tree on the land, the latter to the fruit or the crop; the former depicted as a reservoir supplied from springs, the latter as an outlet or stream to be measured by its flow during a period of time…Here we have the essential matter; not a gain accruing to capital; not a growth or increment of value to the investment: but a gain, a profit, something of exchangeable value proceeding from property, severed from capital.


Income concepts can be viewed as a pyramid. As one moves from the broad notion of psychic income through the foundation and accounting concepts of income to the legal concept, the interpretation of income continually narrows. More and more items are excluded from income as one progresses from one discipline to the next and in doing so one moves further away from the ‘ideal’ taxation target. Taxation is based on the legal concept of income – the concept farthest removed from the ‘ideal’ on the income pyramid.


Federal Revenues

The economy growing slowly as measured by tax receipts.

The cliff.

JPMorgan Chief U.S. Economist Mike Feroli believes small, periodic increases in a national sales tax, combined with parallel reductions in other taxes, would permanently right the ailing economy.

Here’s his idea in full: needless to say, I’ll have some comments later.

“One crazy idea I like is to institute a series of periodic, small increases in a national sales tax. This would have the effect of creating deeply negative real interest rates by increasing the incentive to pull forward demand into the current period when it is less expensive. To offset the disposable income drag it would need to be coupled with equal and offsetting decreases in income and other taxes. This idea has been kicked around by mainstream economists (Feldstein, Kocherlakota, etc.) and nobody has been able to poke any major theoretical holes in the argument, but at the same time people realize it is a politically tough sell, so it has remained in the realm of obscure academic journals even though it is a guaranteed demand igniter.”

Her resume appears at the end of the piece, for those who know, she requires no introduction.

Published: March 17, 2012

AT least since Calvin Coolidge, politicians have trumpeted the supply-side benefits of cutting marginal income tax rates. Lower rates will unleash economic growth and the cuts will largely pay for themselves — or so it’s often said. Yet careful studies find little evidence of such effects. Perhaps it’s time to reform tax policy based on facts, not worn-out assumptions.

Here we have the perfect example of the scientific methodology of the physical sciences, trying to be applied to the social sciences, of which economics, or rather econometrics is the scientised version. This empirical methodology is incorrect.

A family’s marginal tax rate is what its members pay to the government if they earn another dollar. If the government takes a smaller chunk of that dollar, a family has more incentive to earn it. Workers may choose to work additional hours, or a stay-at-home spouse may decide to work outside the home. Likewise, entrepreneurs may invest in a new enterprise or expand an existing one. Lower marginal rates also reduce people’s incentives to shield income from taxes, through legal and illegal means.

The marginal tax rate is correctly defined. Assumptions on the actions of individuals are just that, assumptions, as likely to be right as wrong. As such, the empirical method is immediately doomed to failure: one set of individuals may do “X” the next set “Y”, with the first set switching to “Y” next time round. Wrong methodology.

The main question is whether these incentive effects are large. If they are, cutting marginal rates could cause a sustained surge of hard work and entrepreneurial activity — and thus reported income. This idea was the essence of President Ronald Reagan’s theory of supply-side economics, and his justification for large, permanent tax cuts in the early 1980s. Mitt Romney, now seeking the Republican nomination for president, cited a similar argument when he proposed cutting all income tax rates 20 percent.

The answer lies in ‘diminishing marginal utility’ and ‘time preference’. All individuals will allocate their money into cash balances, consumption spending and saving/investment. These ratio’s may fluctuate, in fact, you can say that they will fluctuate, depending upon changed and changing circumstances.

What then, what set of conditions, would increase the saving/investment proportion relative to cash balance holdings? [i] An increase in the purchasing power of money. If money held, increased it’s purchasing power, less of a reserve would need to be held to accomplish the same ends. The spare, or surplus, could now either be saved/invested, or consumed.

Even if the decision was to consume, viz. higher time preferences, diminishing marginal utility’ would limit this consumption spending in all but the poorest, who essentially have to spend all income just on necessities to survive.

For the rest, surplus money, would now be saved/invested, a lowering of time preferences, which would do three things: [i] lower the market rate of interest through lowering the natural rate of interest [ii] thus promoting longer, more roundabout production methods [iii] which increase supply, thus lowering nominal and real prices [iv] which again increases the purchasing power of money, thus reinforcing the virtuous cycle.

If the incentive effects are small, however, the situation is very different. Cutting taxes would still raise output for a while by putting more money in people’s pockets, and so increasing their spending — a temporary demand-side effect. But lower marginal rates wouldn’t greatly raise output over the long haul through the supply side.

Romer has considered only a single possibility, and just assumed this case will hold. That is simply incorrect.

History shows that marginal federal income tax rates have varied widely.

An empirical time series data. A historical fact pertaining to the individuals and circumstances that pertained uniquely to them. Empirical data have no predictive power, much as the econometric’s wish that they did.

Since World War II, the top rate has ranged from less than 30 percent (at the end of the Reagan presidency) to more than 90 percent (throughout the Eisenhower years). The 1964 Kennedy-Johnson tax cut significantly reduced the typical marginal rate paid by American families, but rates rose greatly over the next 15 years as inflation pushed people into higher tax brackets. Rates fell sharply under President Reagan, rose under President Bill Clinton and fell again under President George W. Bush.

And who created that inflation? Why government. Inflation, after all, is nothing more than a tax that is hidden as much as possible from view. Pure theft.

If you can find a consistent relationship between these fluctuations and sustained economic performance, you’re more creative than I am. Growth was indeed slower in the 1970s than in the ’60s, and tax rates were higher in the ’70s. But growth was stronger in the 1990s than in the 2000s, despite noticeably higher rates in the ’90s.

First, what taxes are we referring to? Corporate tax or individual tax? What drives growth? Savings, which are investment. The nineties saw unprecedented investment in the US stockmarkets through individuals. Investment in common stocks is investment, which drives more roundabout production and increased supply. The investment was driven by a paradigm of technology creating a new era. Let’s look at further data.

It can be seen that the trend in ‘income tax’ the tax that us poor slobs have to pay, was trending lower. Yes the tax was higher in the 2000’s, but it was lower than 70’s & 80’s. In addition capital gains taxes were falling, driving investment in risk assets. The whole story spun by Romer, is designed to mislead.

The government, has systematically shifted the tax burden, not only in marginal rate terms, from the corporation to the individual, who it must be said, has far less opportunity to shield his tax obligation than does the corporation.

Of course, many factors affect the economy, so a lack of correlation doesn’t prove that marginal-rate changes have little impact. That’s why economists have devoted thousands of pages in journals to testing the effects more scientifically.

Of course, and they are called individuals. On aggregate, time preferences drive the consumption, hoarding & saving/investment decisions. The higher the tax rate, the higher time preferences have to go, as you remove money from individuals thus forcing an adjustment in their diminishing marginal utilities.

ONE standard approach is to look for natural experiments in the tax code. Often, a law changes the marginal rate for one group and not others. For example, the 2001 Bush tax cut lowered marginal rates sharply for married couples with taxable incomes of around $50,000, but did little to rates for couples earning slightly less. Using household survey data, economists can compare the behavior of taxpayers whose rates did and didn’t change.

Change the groups via a different time period and conditions and you can alter the result. Econometrics is simply untenable as economics.

A useful summary measure of such changes’ supply-side effects is the sensitivity of reported income to marginal rates. If people work and invest more in response to tax cuts, their reported income will rise when marginal rates fall.

If their marginal tax rate falls, they will earn the same, just keep more of it. After that it is all conjecture. Some might, some might not. What is important are individual allocations proportionally, to their time preferences.

True supply-siders believe that this sensitivity is well over a value of 1, implying that cuts in marginal rates raise reported income enough that government tax revenues nevertheless rise. But a critical review of several natural-experiment studies concluded that the best available estimates of this sensitivity range from 0.12 to 0.40. The midpoint of the range, 0.25, implies that if the marginal tax rate for high earners decreased from its current level of 35 percent to 28 percent (which Mr. Romney proposes), reported income would rise by just 2 1/2 percent.

Again, change the group, change the circumstances, and you potentially change the result. One simple example should suffice: the expectations of the individuals, and thus their planning of desired ends – can totally change the results.

The fact still remains: increase taxes, you increase time preferences. You have to, there is no alternative as you alter the diminishing marginal utility of money. Only those who retain surplus income past consumption and cash balances can allocate to saving/investment. The higher the marginal rate, the smaller that group.

In a new study, David Romer and I found that changes in marginal rates in the 1920s and ’30s had even smaller effects. (Mr. Romer is my husband and a colleague at Berkeley.)

Different time period, different individuals. I like the appeal to authority, viz. we work at Berkley, therefore we must be smart. Not half as smart as you think old girl.

The rate shifts in that era make those after World War II look tame, and varied greatly across income groups. The Revenue Act of 1935, for example, raised marginal rates on the very highest earners to 79 percent from 63 percent, but barely raised rates at all for those below the top one-fiftieth of one percent of households. (Now that was class warfare!)

That may well be true, but look at the increase in the tax base of individuals now required to file a tax return.

We found that an increase in marginal rates on an income group leads to a decrease in its reported taxable income relative to other groups. Indeed, because the variation is so large, the effect can be pinned down much more precisely than in most postwar studies. But the estimated impact is very small — almost at the bottom of the postwar studies’ range. One likely reason is that the tax system between the two world wars was very simple — all the instructions and tax forms for the personal income tax fit on just six pages. As a result, there were few legal methods of shielding income.

She raises two points here as a result of her studies: [i] that an increase in marginal rates on an income group reduces taxable income [ii] the estimated impact is small. Then a reason, simple tax code legislation. The entire paragraph says what?

Where does this leave us? I can’t say marginal rates don’t matter at all.

Of course not. They do. They alter time preferences for individuals.

They have some impact on reported income, and it’s possible they have other effects through subtle channels not captured in the studies I’ve described.

Indeed they do. You can’t measure them at all. All that you can observe is the historical outcome that the time preferences of individuals resulted in. They are predictive in stating that, the higher the tax rate, the higher the time preference has to be. This will result in lower proportionally, savings/investment. Lower investment results in lower production and lower supply, which means that prices will remain higher than they otherwise would.

But the strong conclusion from available evidence is that their effects are small. This means policy makers should spend a lot less time worrying about the incentive effects of marginal rates and a lot more worrying about other tax issues.


Most obviously, the federal budget is on a collision course with reality. Reining in the long-run deficit will have to involve slowing the growth rate of spending. But unless we choose to gut Medicare and Medicaid, additional tax revenue will be needed. This essential truth is the No. 1 factor that should be driving tax policy. And anyone who tells you that the way to raise revenue is to cut marginal tax rates is arguing from ideology, not solid evidence.

Government revenue. But really, who cares about government revenue. Government needs to cut spending, not concern themselves with raising additional tax revenue. I note she mentions the two scary, and with a political demographic in mind, Medicare & Medicaid, add to that Social Security, and you have the so called third rail of American politics.

Many people have proposed raising revenue by cutting back on deductions and loopholes — so-called tax expenditures. Indeed, all else being equal, such changes are preferable to raising marginal rates. After all, higher rates do have some disincentive effects. Eliminating special tax provisions would also simplify tax preparation, and give people less incentive to try to game the system.

Higher rates lower production. That is bad. End of story.

But if moderate increases in marginal rates wouldn’t much affect behavior, a mix of rate increases and cuts in tax expenditures might be a sensible path.

Increases in tax always effect a change in time preferences higher. Fact. Cutting government spending is the only viable way forward.

Some tax expenditures, like the favorable tax treatment of employer-provided health insurance, may have worrisome effects (by encouraging overly generous plans) and so should be trimmed. But others, like deductibility of charitable giving, may be worth keeping.

All rules that prevent, or shield income from tax must be kept, although the two mentioned still result in less income to the producer. The government has still forced a redistribution.

Finally, income inequality has surged in recent decades.

Yes it has. There is a good way and a bad way. If I as a producer supply a product or service that individuals demand, I provide a service, and am rewarded for my foresight. In this, if my income rises, that is for the good.

When you income rises due to incompetence, dishonesty, bailouts at the expense of the taxpayer, well that is something else entirely. That is why the banks are so universally despised currently. It would be hard to find another group of individuals who are as corrupt, greedy and plain fucking stupid, than the bankers.

Raising marginal rates on the wealthy is a straightforward, effective way to counter this trend, while helping to solve our looming deficit problem.

Incorrect. All you succeed in doing is altering the final group’s time preferences from saving/investment to horading and consumption. Rather, you lower taxes to expand the saving/investment choice to a larger base of individuals.

Given the strong evidence that the incentive effects of marginal rates are small, opponents of such a move will need a new argument. Invoking the myth of terrible supply-side consequences just won’t cut it.

Your evidence, proves nothing.

Christina D. Romer is an economics professor at the University of California, Berkeley, and was the chairwoman of President Obama’s Council of Economic Advisers.

Which is what makes this so scary. That such an incompetent fool was responsible for driving policy, truly, is terrifying. That she may, or may not still have political influence, well, let’s hope not.

Never a meaningful cut in spending, just higher taxes. Clueless.

• Top individual income tax rate of 39.6%, starting in 2013 (up from 35%)

• Long- term capital gains top rate of 20%, up from 15%.

• 3.8% tax on unearned income of couples earning $250,000 or more; individuals making$200,000 — is to take effect in 2013 to pay for the 2010 health- care reform law.

• Dividends are treated like ordinary income. Top Federal bracket for some taxpayers = 43.4% (including dividends). Top dividend tax rate is now 15%

• The AMT is replaced with a 30% minimum tax for individuals with annual incomes of at least $1 million.

• The Carried Interest option benefiting hedge fund managers and private equity managers moves to ordinary income rates instead of a preferential 15%

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