Random thoughts

To call or not to call?

Whether ’tis nobler in the mind to suffer
The slings and arrows of a special session,
Or to take arms against a sea of campaign troubles

We’ll have to wait and see how Governor Walz and, of course, the legislators he is negotiating with resolve that question. I’m sure he will not foolishly call a special session without an ironclad agreement on what will be passed. If he has contrary thoughts, he should chekc iwth Tim Pawlenty as to how that works.

Based on my experience hanging around legislative politicos, I’m sure the political tacticians on both sides are in hyperdrive trying to figure out the advantages and disadvantages of a deal or no deal. When they say we need some time off to decompress, they really mean “we need to do some formal and informal polling on how this may play in November.”

I have mixed feelings. On the one hand, going through the 2023 filing season without federal conformity is more than an inconvenience for taxpayers, preparers, and DOR. On the other hand, I still think the revenue uncertainty is palpable (see below for more). Although I haven’t spent the effort to analyze it, my instinct is that much of the $4 billion committed to reserves is onetime money (i.e., most of the spending and tax cuts are permanent commitments leaving little structural balance). And there is the supreme stupidity of the social security exclusion. Delaying that by even one year would be a blessing on the slight chance some more semblance of reason may prevail (unlikely, I know).

What will happen is anyone’s guess. I certainly have no special insight.

Lotterman Column on SS taxation

I like very much Ed Lotterman’s columns in the PiPress. He typically applies economic analysis to policy and other issues in ways that the average newspaper reader can easily grasp and that (to me anyway) make intuitive sense. I am glad that his column has endured for so long, given the cutbacks and general carnage that has been visited on the paper by its tightfisted hedge fund owners (old WaPo story). Columnists are cheaper than reporters, I’d guess.

His most recent column is on one of my favorite topics, the foolishness of the state exempting social security benefits from taxation, Parsing Social Security taxation. It’s worth reading but underwhelmed me.

I think it is fair to distill his column, drawn from MFCE and Minnesota Budget Project publications, down to two basic points. A full exclusion of benefits would:

• Be regressive.
• Have little effect on concerns about seniors moving to low-tax states.

Both points are valid, of course. For an economist, the classic policy tradeoff is between efficiency (essentially maximizing well being for the overall population) and equity (fairness). Typically increasing equity comes at the cost of reducing efficiency (e.g., Okun’s leaky bucket metaphor). Here, a full exclusion is simultaneously inequitable (measured vertically) and inefficient (doesn’t work as an incentive to counter tax-based migration?). No need to worry about tradeoffs. It flunks both tests, a no-brainer to reject. As a good economist, Lotterman also points out the opportunity cost of the resources used for an exclusion; better uses are available whether your priors bend left or right. I whole heartily agree. Great points.

So, why was I underwhelmed? The best case against the exclusion is stronger in my view:

• From an equity perspective, the big objection is horizontal. By favoring one type of income (social security) and one class of taxpayers (seniors), it treats similarly situated people unequally. It favors the old over the young and the retiree over the worker, regardless of age. To my lights, a bigger deal than its regressivity, which could be offset by restructing rates to neutralize the regressivity (not the tax cut) IF the exclusion made any policy sense. It doesn’t. MCFE (not the publication Lotterman references) has made the horizontal equity point, just to be fair (no pun intended).
• Trying to structure the state’s tax system to attract people to live here is a fool’s errand. It would require attracting people who make net contributions to the state’s economy and budget, a sort of laser-targeted migration mercantalism policy that is impossible in practice. But if you’re going down that path, focusing on seniors has to be the wrong target. The state by most accounts faces a looming workforce shortage. So, we’re focusing our incentives on retirees? It’s not just that it doesn’t work; it’s aimed at the wrong target. And it means, all else equal, that workers will pay higher tax rates for the same level of state and local services.

Putting this in opportunity cost terms, it’s not just that we lit a bunch of dollar bills on fire, preventing their use for something more productive. It’s worse – to extend the metaphor to the breaking point – we burned them in the fireplace when we were already running the a/c to keep the house cool. Sigh

CBO Budget Outlook

The Congressional Budget Office (CBO) is out with its Budget and Economic Outlook: 2022 – 2032 (May 2022). As anyone paying attention knows, the feds have had strong revenue flows similar to what Minnesota has been experiencing. Striking evidence for that is this statement:

CBO expects individual income tax receipts to rise by 28 percent in 2022, to $2.6 trillion. At 10.6 percent of GDP, that total is expected to be the highest amount of individual income tax receipts recorded since 1913, when ratification of the Sixteenth Amendment authorized the federal government to begin collecting income taxes.

Budget and Economic Outlook, pp. 86 – 87.

Federal individual income tax revenues typically have been about 8% of GDP since the early 1960s. CBO is forecasting them to be just under 10% for the entire period. (Small detail: CBO assumes – but contrary to the GOP game plan – that TCJA’s individual income tax provisions will expire in 2026 as provided by current law. That is 0.8% of GDP’s worth of revenue. If the experience with EGTRRA’s expiring tax cuts is any guide, I would not bet on that. At best, some portion that affects high income filers seems more likely and that is premised on the Dems controlling the presidency or one house of congress, no sure thing.)

Like most of us, CBO is not sure what has caused this revenue growth. It estimates that capital gain realizations (“significantly above that historical average in the past two years”) is much of the explanation. But some mystery is afoot:

[R]eceipts from individual income taxes in the past few years have been larger than expected given currently available data on economic activity and the past relationship between tax revenues and the state of the economy. Those larger-than anticipated receipts may have resulted from several possible developments. They may reflect higher wage or nonwage income than the Bureau of Economic Analysis has reported for the past two years. Realizations of capital gains in those years may have been larger than CBO has estimated, or a larger share of those realizations may have come from sales of assets held for less than a year, which are subject to higher tax rates. Also, the temporary tax provisions enacted in response to the pandemic may not have been as widely used as anticipated. And the distribution of taxable income may have been skewed more toward higher-income taxpayers (who, on average, are subject to higher tax rates) than CBO estimates.

Budget and Economic Outlook, p. 89.

In other words, we don’t have much of a clue. CBO is estimating over time that these effects go away, as one would expect for a phenomenon the cause of which is unknown. It’s safer to bet on “regression to the mean” than “this time is different.” CBO also, in a piece of bad news, estimates wages, salaries, and pensions will decline as percentages of GDP. Lets hope they’re wrong, but I would not bet on that.

With regard to corporate collections, they are also rising nicely – up 61.5% for 2022 over the pre-pandemic (FY 2019) level. But CBO is similarly uncertain why:

Corporate tax collections were larger in 2021 and early 2022 than can be fully explained by currently available data on business activity for those years. The factors that contributed to the unexplained strength in receipts will not become fully apparent until information from tax returns becomes available over the next two years. Depending on the factors that caused those larger receipts, their effects might be expected to continue indefinitely, end suddenly, or even change direction.

Budget and Economic Outlook, p. 91.

Because Minnesota has forgone taxing GILTI or conforming on bonus depreciation, state corporate collections will not track federal as closely as they have traditionally, for whatever that is worth.

Bottom line: more than the typical level of uncertainty seems to be the order of the day. CBO reports its typical (mean) error would be 1% of GDP for 2023 and 1.8% for 2027. I personally would not bet on individual income tax revenues continuing at 25% higher than their historical average without seeing a longer trend than two years. My instinct is that aggressive federal fiscal policy in response to the pandemic is a big part of the explanation. And it’s going away now.

Tax expenditure tidbit from the report: “The exclusion of pension plan contributions and earnings is the single largest tax expenditure in the tax code; including effects on payroll taxes, the tax expenditure resulting from that exclusion is estimated to equal 1.8 percent of GDP in 2022.” (p. 97). Stepped up basis on death equals 0.2% of GDP.

TCJA as the cause?

As I noted, CBO is uncertain as to why federal corporate income tax revenues are up so much. TCJA’s acolytes are not similarly sanguine and think it’s responsible. See Tyler Goodspeed and Kevin Hassett, The 2017 Tax Reform Delivered as Promised (WSJ May 8, 2022) for an “I told you so” account. Brookings economists have doubts. William G. Gale, Kyle Pomerleau, and Steven M. Rosenthal, The booming economy, not the 2017 tax act, is fueling corporate tax receipts (June 3, 2022) (“TCJA is not a plausible explanation for the large recent increase in corporate tax receipts”). Count me a skeptic about TCJA being the cause, although there is some evidence it increased in-bound international investment, a primary goal of its international changes. But not enough to offset the rate cuts and certainly not a 62% bump for 2022 over the last pre-pandemic year, 2019. Nice try – good enough for the WSJ editorial page, I guess.