Thank you, Mitt Romney, for making us care about capital gains taxes

Back in 1999, I produced a chart showing the relationship between capital gains tax rates and economic growth in my book, The Labyrinth of Capital Gains Tax Policy: A Guide for the Perplexed (p. 81). Some economists had made miraculous claims for the effects of lower tax rates on the economy, which I argued should be apparent in time series data.  The correlation between the two time series was basically zero.  I've updated this chart periodically (for example, here), but it never got much attention until I included it in my congressional testimony last week.  In the last two days, columnists at the Washington Post and New York Times have cited the chart and my testimony.

My wife, Missie, asked why there's been such a surge of interest.  I think it's Mitt Romney's 14 percent effective tax rate, which comes largely from the light taxation of capital gains and dividends.  So thanks, Mitt Romney, for getting Americans to care about the way we tax capital gains.

Here's the press coverage (aka shameless self-promotion):

Ruth Marcus, “Romney’s tax plan,by the numbers” (Washington Post, 9/26)

Leonard Burman of Syracuse University’s Maxwell School looked at capital-gains rates over six decades and found no correlation with economic growth. Look at his graph and you’ll see: The two lines — capital-gains rates and growth — bear no relation to each other.

Burman tried adjusting for time lags, of up to five years, and looking at moving averages of tax rates and growth. Still no correlation. “There is no apparent relationship,” Burman told the Senate Finance Committee last week. “Cutting capital gains taxes will not turbocharge the economy, and raising them would not usher in a depression.”

Joe Nocera, “Romney and theForbes 400” (New York Times, 9/25)

In 2009, according to recent Congressional testimony by Leonard E. Burman, a professor at Syracuse University, the 400 highest-income taxpayers reaped an astounding 16 percent of all capital gains.

…

In the printed copy of his Congressional testimony, Burman has a chart that plots the ups and downs of the economy since the 1950s with changes in the capital gains rate. There is no correlation between the two. The idea that a lower capital gains rate spurs economic growth is one of the enduring myths of conservative thought.

Ezra Klein, “The case for raising capital gains tax rates” (Washington Post (Wonkblog), 9/25)

Tax expert Len Burman has graphed capital gains rates and economic growth and found no relationship at all.  Burman says he also “tried lags up to five years and using moving averages, but there is never a larger or statistically significant relationship.” 

What he is sure of is that a very low capital gains rate incentivizes very complex tax avoidance. “Since ordinary income is taxed at rates up to 35 percent while long-term capital gains are taxed at a maximum rate of 15 percent, there is a 20 percent reward for every dollar that can be transformed from high-tax compensation, say, to low tax capital gains.”

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Mitt Romney's Self-Imposed Buffett (Lite) Rule and Other Observations

Governor Romney’s release of his final 2011 tax return and an affidavit from his accountant that he’d really paid tax in prior years provoked a feeding frenzy from the press and the blogosphere, despite the fact that there was almost no news.  His final return was not much different from the unfiled version posted earlier, except for this:

The Romneys voluntarily limited their deduction of charitable contributions to conform to the Governor’s statement in August, based upon the January estimate of income, that he paid at least 13% in income taxes in each of the last 10 years.  (Source:  FAQ on MittRomney.Com)

I find that part interesting.  Gov. Romney voluntarily imposed a kind of Buffett Rule on himself.  Recall that the Buffett Rule, as stated by President Obama, was the principle that millionaires should not pay lower tax rates than their secretaries.  This was codified in the Senate as a minimum effective tax rate of 30%.

Gov. Romney has apparently decided that the minimum tax should be 13%, so I guess both parties have agreed on the principle and are bickering about the rate.  (Or, perhaps, Gov. Romney misheard “thirty” as “thirteen.” Romney’sphysician’s letter, also released yesterday, makes no mention of hearing loss, although the doctor does seem confident that Gov. Romney will be the “next president of the United States.”)

Josh Barro has pointed out that the Governor can file an amended return to claim the unused charitable deductions, so he views the voluntary tax reduction as a kind of campaign donation–and one that will be paid back if the candidate loses and people lose interest in his tax returns and campaign promises.

Jacob Weisberg at Slate argued that Romney’s Buffett-Lite Rule violates another campaign promise:

“I don’t pay more than are legally due and frankly if I had paid more than are legally due I don’t think I’d be qualified to become president. I’d think people would want me to follow the law and pay only what the tax code requires.”  [emphasis added]

So, earlier in the week, the candidate writes off half of voters and a big chunk of his base.  Yesterday, he did something that he had earlier said would disqualify him for the presidency.  Do you think that, perhaps subconsciously, the Governor is deliberately trying to undermine his candidacy?  (The physician’s letter also did not comment on Romney’s mental health.)

But, if I may digress into substance for a moment, there is one point that I think most reporters have missed about Mitt Romney’s tax returns:  he pays much, much less than a 15% rate on his capital gains.   Most observers have noted that the 13 or 14% rate that the Governor pays reflects the fact that most of his income comes in the form of capital gains and dividends, both of which are taxed at a maximum rate of 15%.

However, Romney was able to avoid capital gains tax entirely on nearly $1 million of assets simply by donating them to charity.  He reported $920,573 of noncash donations to his foundation, all of which were shares of appreciated stock.  If the Romneys had sold the shares, they would have had to pay tax on any accumulated capital gain. By donating the shares directly to charity, they saved potentially tens of thousands of dollars (depending on how much the assets had appreciated in value).  And they got the charitable deduction on top of that.

An even bigger capital gains loophole is what columnist Michael Kinsley has called the “Angel of Death loophole.”  If you hold onto appreciated assets until you die, the capital gains are never taxed.  Your heirs get to pretend that they bought the asset on the day you died.  Heirs will avoid $44 billion in tax through the Angel of Death loophole in FY 2013 according to Congress’s Joint Committee on Taxation.  Presumably, the Romneys are planning to take advantage of it too.

All of these techniques are perfectly legal.  And they are one reason why wealthy taxpayers can pay much lower effective tax rates on their capital gains than the advertised rates.  And the very light taxation of capital gains is more than an issue of equity.  It surely results in much economically unproductive tax sheltering activity.

I discussed the economic issues surrounding the taxation of capital gains at ajoint hearing of the House Ways and Means and Senate Finance Committeeson Thursday.  A video link is on C-Span.

Once again, I’m grateful to Gov. Romney for creating a teachable moment on an important subject.

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In Mitt's World, My Limo Driver Is Not Trying Hard Enough

I’m on my way to the University of Michigan to participate in a forum on the presidential candidates’ tax plans.  I’m thinking about Mitt Romney’s statement that the 47 percent of Americans who do not pay income tax are lazy and dependent (and beyond the reach of his campaign).  One thought is that if Mitt is really the numbers guy that Bain legend makes him out to be and he really believes that the bottom 47 percent is lost, then he should give up now, since lots people in the top 53 percent are going to vote for Obama.  (Look at the polls.)  Or maybe he is counting on voter suppression to nullify the 47 percent’s votes.

Mitt and I disagree about whether seniors and low-income working families should pay more tax.  (I previously posted a pointed critique of Rick Perry’s assertion of dismay at the 46 percent—the correct statistic—who don’t pay income tax here.)

But what’s really galling is the implication that lower-income Americans just aren’t trying very hard.  Yes, theoretically, tax breaks can enable people to slack off, but Americans work really hard—even in difficult, poorly paying jobs.  My limo driver, Jeff, works 7 days a week to try to make ends meet.  My dad drove a taxi 6 days a week, 11 hours a day, before the advent of refundable tax credits and barely scraped by.  I’m certain that the existence of earned income tax credits would not have lessened his effort, although they would have reduced my family’s financial insecurity drastically.

Mitt, talk to the people tending one of your gardens or polishing the silver in one of your houses.  The work is hard—really much less rewarding than being a master of the universe (you) or a college professor (me), even before accounting for the discrepancy in pay.  I wouldn’t take my dad’s job even if offered 10 times my current salary.  I did it for a summer during college.  It was exhausting and often demeaning.  In my current job, I get treated with respect.  Even the occasional limo ride.

Jeff, my driver, used to work in a factory earning much more money, but was injured on the job, which is why he’s now driving back and forth to the airport seven days a week.  That’s terrible luck—something with which the governor has little experience, but a common feature among those in that 46 percent.  I’m glad a safety net exists to keep Jeff’s bad luck from jettisoning him from the middle class?

Yes, it would be wonderful if working hard were sufficient to guarantee a comfortable middle class existence, but it’s not.  Tens of millions work really hard and some of them benefit from tax breaks intended to reward work.  That’s a good thing.

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(This rant is from Tuesday, but I've been running around all week so am only just now posting it here. Sorry for the delay.)

Stephen Strasburg and the Limits of our Medical Knowledge

English: Stephen Strasburg (Photo credit: Wikipedia)

Tonight, Washington Nationals pitching phenom Stephen Strasburg will make his last start for the year in DC.  He’ll pitch one more game on the road and then become just another spectator as the Nationals make their run for the playoffs and, I hope, the World Series.

The Nationals early made the decision to limit Strasburg’s innings to protect him from a possible career threatening injury in the aftermath of his Tommy John surgery in 2011. (The procedure, named after the Dodgers pitcher who first had the surgery in 1974, repairs a damaged elbow ligament using a graft taken from somewhere else in the body. There’s a great article about it here.)  The Nationals are following the advice of Strasburg’s surgeon, Lewis Yocum, who had recommended the same course after pitcher Jordan Zimmerman’s surgery in 2010. Zimmerman has had a great year in 2012.

It’s impossible to argue with the Nats’ baseball decisions.  They’ve put together the best team in baseball through a methodical course of brilliant drafts and trades, excellent player development, strategic acquisitions, and a terrific manager (Davey Johnson).  I also don’t doubt Dr. Yocum’s proficiency as a surgeon.

But I do wonder whether the innings limit comes from careful research or simply the best guess of physicians like Dr. Yocum based on their own patients’ post-operative experiences and conventional wisdom among their peers.  The fact is that in many cases, doctors are just guessing about best practices.

The right way to test the conventional wisdom about Tommy John surgery would be to randomly assign pitchers who have undergone the surgery to two groups—one with an innings limit and one without. Watch them for many years, and see who tends to have the better outcome, presumably measured as quality games (or innings) pitched.  The relevant research question is whether pitchers can expect to gain at least as many games down the road as they sacrifice via the earnings limit.  It might well be that the innings limit will prolong careers, but it could also be that the innings forgone are simply lost forever.

As an economist, it is natural for me to think about this as a cost-benefit problem.  We know there is a cost:  the value of the starts the pitcher skips.  In the case of Jordan Zimmerman, pitching for a mediocre Nats team in 2011, the cost of his missing starts was pretty minimal.  In Strasburg’s case, the cost could be a World Series ring.  It would be nice to know the benefits as well.

Dr. Yocum has clearly convinced Mike Rizzo, the brilliant general manager of the Nats, that there are substantial benefits to shutting Strasburg down.  But the doctor might be misled by the evidence that he sees.  Even if there were no therapeutic benefit to an innings limit, pitchers who continue pitching for an entire season are obviously more likely to suffer an injury than those who pitch for part of a season since every start creates a small risk of injury.  This is true not only in the year after surgery, but every year that a pitcher plays.  So Dr. Yocum is more likely to see pitchers who exceed his recommended innings limit than those who don’t, which seems to confirm his supposition that the practice is ill-advised, but it might simply reflect the fact that pitchers can’t get hurt pitching if they’re not doing it.  The real question is whether Strasburg would be statistically more likely to suffer an injury pitching this September and October than he would be next year or the year after.

Washington Post columnist Tom Boswell thinks he knows the answer. He called continuing to pitch Strasburg a “high-risk high-reward gamble” and unethical to boot.  He cited anecdotes about pitchers who threw too much after Tommy John surgery and ultimately had short careers.  Chicago Cubs pitcher Kerry Wood is the poster child, but Wood himself has pointed out that he pitched well for several years after his surgery and doesn’t think that his recovery regime led to his ultimate injuries.  The problem, though, is that neither Boswell nor Wood nor anybody else really knows whether the risks are large or small.  We need to know what would have happened to Wood if he had limited his innings after surgery; for Strasburg, we’d like to know what would happen if he didn’t sit out the last month and a half.  We will never know.

Beyond baseball, this is a poignant example of what is wrong with our healthcare system.  In so many cases, docs are flying by the seat of their pants.  We need to know which courses of treatment are effective and which aren’t.  In too many cases, we don’t know.  There are lots of examples where the conventional wisdom was exactly wrong.  It used to be that physicians thought that bed rest was the right course of treatment for back pain. It sort of makes intuitive sense—just like resting Strasburg does. Now it appears that keeping active despite the pain results in quicker healing.  Prostate surgery used to be routinely recommended for older patients with prostate cancer or even just enlarged prostates.  Now it appears that in most cases the treatment does more harm than good.  And for decades, hysterectomies were routinely prescribed for a host of “female troubles.”  Talk about a “war on women!”

Fortunately, policy is moving in the right direction.  The stimulus bill includedfunding for effectiveness research and the Affordable Care Act continued that effort.  Regardless of your favorite health reform option, having more information about what works and what doesn’t would make the health system work better for patients and those who pay the bills.  Someday, it might even work for baseball players and fans.

Go Nats!

PS, I lived in the DC area for 25 years before coming to Syracuse and still attend more Nationals games every year than 95 percent of DC-area residents.  (I just made up that statistic, but am sure that it is true. :-)

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