Tuesday, April 21, 2015

Why Did Sweden, of All Places, Abolish Its Century-Old Inheritance Tax?

The US House of Representatives voted on April 16 to repeal the estate tax. The bill seems unlikely to become law. The US Senate seems unlikely to pass such legislation, because it would be filibustered by Democrats,and President Obama has said he would veto the measure if it passed through Congress. But did you know that Sweden, with its well-earned reputation for egalitarian social policy, abolished its century-old inheritance tax in 2004? Indeed, Portugal also abolished its inheritance tax in 2004, as did Austria in 2008 and Norway in 2014.

Why did Sweden abolish its inheritance tax? Magnus Henrekson and Daniel Waldenström provide background in "Inheritance Taxation in Sweden, 1885–2004:The Role of Ideology, Family Firms and TaxAvoidance,"  written as the Research Institute for Industrial Economics (IFN) Working Paper No. 1032 (October 27, 2014).

For context, here's a figure that offers an illustration of Sweden's inheritance tax over time. The top tax rate rose sharply through much of the 20th century, topping out at 65%. Perhaps more interesting, the horizontal axis gives a sense of the income level where those top rates kicked in. For example, in 1985, although the very top tax rate applied only to those with inheritance levels at roughly 30 times annual income of a worker, many of those with inheritances that were only 10 times the annual income of a worker or less also could end up paying inheritance tax.

Of course, Sweden is not extraordinary in having some high top-level inheritance taxes. Here's a figure with some international comparisons of countries, including the United States, where the top rate of inheritance taxes exceeded 60% over time. However, notice that in all of those countries the peak inheritance tax rates are in the past--often several decades in the past. Top rates for inheritance taxes have been coming down.
Of course, each country has its own distinctive politics and history that go into the decisions about inheritance taxes. What caused Sweden to abolish the tax in 2004? Here are some of the reasons from Henrekson and Waldenström, with my own thoughts about the arguments apply in a US context.

1) In Sweden, a relatively large share of inheritances owed some inheritance tax. The authors report: "In the last year of the tax, the exemption level was a mere one-quarter of an annual production worker’s income (SEK 70,000), and the top marginal rate was reached at an inherited amount of just over two times the annual income of a production worker." This is probably the main difference with US inheritance tax, which has high exemptions. For example, in 2015 only estates of more than $5.4 million will even potentially need to pay any estate tax at all. Historically, only about 1 in 700 deaths in the US results in paying any estate tax.

2) Sweden had built a number of "safety valves" into its inheritance tax. For example, "owners of unlisted business equity"--often those inheriting a family business--had strict limits on what they would pay. Apparently, someone inheriting a family business in Sweden under no circumstances paid an inheritance tax of more than 9%. There were prominent examples of how wealthy Swedish families (Wallenberg, Söderberg) had created foundations to shield family wealth from the inheritance tax. There were a variety of ways to reduce the estate tax owed: for example, family holdings could be loaded up with debt, to reduce their current value. Money could be passed between generations through real estate holdings, which faced different tax rules, or buy purchasing large life insurance policies, because in Sweden life insurance payments were tax-free for the beneficiary. Of course, one of the easiest ways to pass wealth between generations is to do so before death, by hiring the next generation into the family business at an exorbitant salary. Obviously, when those with high wealth levels have many ways to find ways to avoid or minimize an estate tax, while still passing along wealth to future generations, such a tax ends up looking unfair and pointlessly symbolic. A globalizing economy surely adds to the ways in which wealth can be accumulated and passed on in other nations, where the estate tax rules may be more lenient.

3) The authors point out that in Sweden and in other countries, the tax funds raised by estate taxes are are often around 1-2% or even less of total government revenues. Thus, whether you think that  dropping the estate and inheritance tax is wise or unwise, it makes much less difference to the government bottom line than many other tax changes.

As regular readers know, I'm concerned about the extent to which economic inequality is transmitted between generations. But in the modern US economy, inherited fortunes don't matter in the same way that they did, say, back in 19th century Europe. Instead, I think the transmission of economic inequality in the modern economy happens primarily because of parents who have the resources to do so provide all kinds of extra support and opportunities to their children. I find it hard to get much excited over the current debates about the US estate tax, which are essentially arguments over whether the labyrinthine rules of the tax code will make it harder or easier for a tiny slice of the very wealthiest households--together with their high-priced estate lawyers--to pass along resources after death. I worry a lot more about all the children growing up whose families don't have the resources and connections to provide a special added turbo-boost to their development, and how their life opportunities are being shaped and determined.

Monday, April 20, 2015

The Data Revolution and Economic Research

Empirical research in economic is being revolutionized (and no, that word is not too strong) by two major new sources of data: administrative data and private sector data. Liran Einav and Jonathan Levin explain in "Economics in the age of big data," which appears in Science magazine, November 7, 2014 (vol 346, iossue 6210; the "Review Summary" is p. 715 and the "Review" article itself is pp. 1243089-1 to 12403089-6). Science is not freely available online, but many readers will have access through library subscriptions.

To grasp the magnitude of the change, you need to know that a two or more decades ago, economists had only a few main sources of data: there was data produced by the government for public consumption like all the economic statistics from the Bureau of Economic or the Bureau of Labor, the surveys from the US Census, and a few other major surveys. Sometimes, economists also constructed their own data by working in library archives or carrying out their own surveys. For example, I remember as an undergraduate back around 1980 I remember doing basic empirical exercises where you wrote programs (stored on punch cards!) to find correlations between GDP, unemployment, interest rates, and car sales. I remember as a graduate student in the early 1980s compiling data on the miles-per-gallon of new cars, which involved collecting the annual paper brochures from the US Department of Transportation and then inputting the date to a computer file (no more punchcards by then!).  As Einav and Levin put it: "Even 15 or 20 years ago, interesting and unstudied data sets were a scarce resource."

One of the major new sources of data is "administrative data," which is data collected by the government in course of administering various programs. As Einav and Levin point out, some of the most prominent results in empirical economics in recent years are based on administrative data.

For example, the evidence that most of the rise in income inequality is at the very top of the income distribution is based on IRS tax data. Evidence on wide variation in health care spending, how people and providers react to different health insurance provisions, and the use of certain health care treatments across states (thus implying that some health care providers in some states may be overdiagnosing or underdiagnosing) is often based on administrative data from Medicare and Medicaid. Evidence on how teachers can affect student academic achievement is based on a combination of student test scores and the patterns of how teachers are assigned to classrooms.

Of course, the use of administrative data for research raises legitimate privacy issues. But  just to be clear, it's the existence of this data in government hands that raises the privacy concerns in the first place. Before the administrative data is received by researchers, it is "anonymized" so that it should be impossible to identify individuals. Einav and Levin sum up:
The potential of administrative data for academic research is just starting to be realized, and substantial challenges remain. This is particularly true in the United States,where confidentiality and privacy concerns, as well as bureaucratic hurdles, have made accessing administrative data sets and linking records between these data sets relatively cumbersome. European countries such as Norway, Sweden, and Denmark have gone much farther to merge distinct administrative records and facilitate research. ... However, even with today’s somewhat piecemeal access to administrative records, it seems clear that these data will play a defining role in economic research over the coming years.
The other major source of new data comes from private efforts, either by firms or by researchers. Your credit card company, your insurance company, your cable access provider, and many other firms have a lot of information about your life and your preferences. They are already doing in-house research on this data, but in some cases, they are pairing with research economists to work on anonymized forms of the data. For example, Einav and Levin have done research with eBay data on how Internet sales taxes affect online shopping.

Some companies are taking the next step and publishing data. Einav and Levin write:
Already the payroll service company ADP publishes monthly employment statistics in advance of the Bureau of Labor Statistics, MasterCard makes available retail sales numbers, and Zillow generates house price indices at the county level. These data may be less definitive than the eventual government statistics, but in principle they can be provided faster and perhaps at a more granular level, making them useful complements to traditional economic statistics. 

Similarly, Google publishes a "Flu Trends" list which seeks to provide early warning of flu outbreaks, faster than the Center for Disease Control statistics, by using data from search queries.

 Researchers can create their own data sets by "scraping" the web: that is, by writing programs that will download data from various websites at regular intervals. One of the best-known of these projects is the Billion Prices Project run by Alberto Cavallo and Roberto Rigobon at MIT. Their program downloads detailed data on prices and product characteristics from websites all over the world every day on hundreds of thousands of products. For a sense of the findings that can emerge from this kind of study, here's one graph showing the US price level as measured by the Billion Prices Project and the official Consumer Price Index. They are fairly close. Next  look at the price level from the Billion Prices Project and the official measure of inflation in Argentina. It's strong publicly available evidence that the government in Argentina is gaming its inflation statistics.

Finally, many more economists are creating their own data by carrying out their own social experiments and surveys.

The new sources of data are changing the emphasis of published economic research. If you go back about 30 years, the majority of papers appearing in top research journals were theoretical--that is, they contained either no data or a few bits of illustrative data. Now, about 70% of the papers in top economics journals are primarily empirical and data-based. Einav and Levin offer evidence that for empirical papers (not including experiments designed by the researcher), only about 5-10% of the papers used administrative or private data back in 2006-2008, but by 2013 and 2014, the share of empirical papers using administrative and private data was nearly half. The tools for collecting and using this administrative and private-sector data are different in many ways from what economists have traditionally done. Careers, reputations, and eventually even Nobel prizes will be built on this body of work.

Friday, April 17, 2015

Snapshots of Global Military Spending

For an overview of patterns of global military spending, my go-to source is the Stockholm International Peace Research Institute. SIPRI has just published "Trends in World Military Expenditure, 2014," by Sam Perlo-Freeman, Aude Fleurant, Pieter D. Wezeman and Siemon T. Wezeman. Here are some patterns that jumped out at me.

As a starter, here's the overall pattern of global military spending since the late 1980s. Since the Great Recession hit, global military spending has dropped a bit (as measured in inflation-adjusted dollars).

Here's a table showing the 15 countries with the highest level of military spending. US is one-third of all global military spending, or to put it another way, US military spending is roughly equal to the next seven nations on the list combined. Of course, it's worth remembering that military spending doesn't buy the same outcomes in all countries; for example, the pay of a soldier in India or China is considerably lower than that in the United States. It's also interesting to me that US military spending as a share of GDP is higher than for  most of the other countries in the top 15, with the exception of Russia, Saudi Arabia, and UAE. And it's thought-provoking to compare, say, military spending in China to that in Japan and South Korea, or military spending in Russia to that in Germany and France.

Finally, here's a list of the countries where military spending is more than 4% of their GDP.
As the report notes: "A total of 20 countries—concentrated in Africa, Eastern Europe and the Middle East—spent more than 4 per cent of their GDP on the military in 2014, compared to 15 in 2013.
Only 3 of the 20 countries are functioning democracies, and the majority were involved in armed conflict in 2013–14 or had a recent history of armed conflict."
I won't editorialize here, except to note that when countries devote very high levels of GDP to military spending, they are putting their money behind a belief that using or threatening military force is in their near future.

Thursday, April 16, 2015

Natural Disasters: Insurance Costs vs. Deaths

The natural disasters that cause the highest levels of insurance losses are only rarely the same as the natural disasters that cause the greatest loss of life. Why should that be? Shouldn't a bigger disaster affect both property and lives? The economics of natural disasters (and yes, there is such a subject) offers and answer. But first, here are two lists from the Sigma report recently published by Swiss Re (No 2, 2015).

The first list shows the 40 disasters that caused the highest insurance losses from 1970 to 2014 (where the size of losses has been adjusted for inflation and converted into 2014 US dollars). The top four items on the list are: Hurricane Katrina that hit the New Orleans area in 2005 (by far the largest in terms of insurance losses), the 2011 Japanese earthquake and tsunami; Hurricane Sandy that hit the New York City area in 2012; and Hurricane Andrew that blasted Florida in 1992. The fifth item is the only disaster on the list that wasn't natural: the terrorist attacks of September 11, 2001.

Now consider a list of the top 40 disasters over the same time period from 1970 to 2014, but this time they are ranked by the number of dead and missing victims. The top five on this list are the Bangladesh storm and flood of 1970 (300,000 dead and missing); China's 1976 earthquake (255,000 dead and missing),  Haiti's 2010 earthquake (222,570 dead and missing), the 2004 earthquake and tsunami that hit Indonesia and Thailand (220,000 dead and missing), and the 2008 tropical cyclone Nargis that hit the area around Myanmar (138,300 dead and missing). Only two disasters make the top 40 on both lists: the 2011 Japanese earthquake and tsunami, and Japan's Great Hanshin earthquake of 1995.

The reason why there is so little overlap between the two lists is of course clear enough: the effects of a given natural disaster on people and property will depend to a substantial extent on what happens before and after the event. Are most of the people living in structures that comply with an appropriate building code? Have civil engineers thought about issues like flood protection? Is there an early warning system so that people have as much advance warning of the disaster as possible? How resilient is the infrastucture for electricity, communications, and transportation in the face of the disaster? Was there an advance plan before the disaster on how support services would be mobilized?

In countries with high levels of per capita income, many of these investments are already in place, and so natural disasters have the highest costs in terms of property, but relatively lower costs in terms of life. In countries with low levels of per capita income, these investments in health and safety are often not in place, and much of the property that is in place is uninsured. Thus, a 7.0 earthquake hits Haiti in 2010, and 225,000 die. A 9.0 earthquake/tsunami combination hits Japan in 2011--and remember, earthquakes are measured on a base-10 exponential scale, so a 9.0 earthquake has 100 times the shaking power of a 7.0 quake--and less than one-tenth as many people die as in Haiti.

Natural disasters will never go away, but with well-chosen advance planning, their costs to life and property can be dramatically reduced, even (or perhaps especially) in low-income countries. For an overview of some economy thinking in this area, a starting point is my post on "Economics and Natural Disasters," published November 2, 2012, in the aftermath of Hurricane Sandy.

Wednesday, April 15, 2015

How Milton Friedman Helped Invent Income Tax Withholding

[In commemoration of US federal income taxes being due today, April 15, here's a repeat of a post originally published April 12, 2014, about the beginnings of the practice of having income taxes withheld in advance from your paycheck.]

In one of the great ironies, the great economist Milton Friedman--known for his pro-market, limited government views--helped to invent government withholding of income tax. It happened early in his career, when he was working for the U.S. government during World War II. Of course, the IRS opposed the idea at the time as impractical. Friedman summarized the story in a 1995 interview with Brian Doherty published in Reason magazine. Here it is:

"I was an employee at the Treasury Department. We were in a wartime situation. How do you raise the enormous amount of taxes you need for wartime? We were all in favor of cutting inflation. I wasn't as sophisticated about how to do it then as I would be now, but there's no doubt that one of the ways to avoid inflation was to finance as large a fraction of current spending with tax money as possible.
In World War I, a very small fraction of the total war expenditure was financed by taxes, so we had a doubling of prices during the war and after the war. At the outbreak of World War II, the Treasury was determined not to make the same mistake again.
You could not do that during wartime or peacetime without withholding. And so people at the Treasury tax research department, where I was working, investigated various methods of withholding. I was one of the small technical group that worked on developing it.
One of the major opponents of the idea was the IRS. Because every organization knows that the only way you can do anything is the way they've always been doing it. This was something new, and they kept telling us how impossible it was. It was a very interesting and very challenging intellectual task. I played a significant role, no question about it, in introducing withholding. I think it's a great mistake for peacetime, but in 1941-43, all of us were concentrating on the war.
I have no apologies for it, but I really wish we hadn't found it necessary and I wish there were some way of abolishing withholding now."

Tax Expenditures

[In commemoration of US federal income taxes being due today, April 15, here is an updated version of a post that appeared on April 15, 2013, with the table and numbers updated to reflect the information in the proposed federal budget released by the White House Office of Management and Budget in February of this year.] 

In the lingo of government budgets, a "tax expenditure" is a provision of the tax code that looks like government spending: that is, it takes tax money that the government would otherwise have collected and directs it toward some social priority. Each year, the Analytical Perspectives volume that is published with the president's proposed budget has a chapter on tax expenditures.

Here's a list of the most expensive tax expenditures, although you probably need to expand the picture to read it. The provisions are ranked by the amount that they will reduce government revenues over the next five years. It includes all provisions that are projected to reduce tax revenue by at least $10 billion in 2015.

Here are some reactions:

1) The monetary amounts here are large. Any analysis of tax expenditures is always sprinkled with warnings that you can't just add up the revenue costs, because a number of these provisions interact with each other in different ways. With that warning duly noted, I'll just point out that the list of items here would add up to about $1 trillion in 2014.

2) It is not a coincidence that certain areas of the economy that get enormous tax expenditures have also been trouble spots. For example, surely one reason that health costs have risen so far, so fast, relates to the top item on this list, the fact that employer contributions to health insurance and medical care costs are not taxed as income. If they were taxed as income, and the government collected an additional $206 billion in revenue, my guess is that such plans would be less lucrative. Similarly, one of the reasons that Americans spend so much on housing is the second item on the list, that mortgage interest on owner-occupied housing is deductible from taxes. Without this deductibility, the housing price bubble of the mid-2000s would have been less likely to inflate. Just for the record, I have nothing personal against either health care or homeownership! Indeed, it's easy to come up with plausible justifications for many of the items on this list. But when activities get special tax treatment, there are consequences.

3) Most of these tax expenditure provisions have their greatest effect for those with higher levels of income. For example, those with lower income levels who don't itemize deductions on their taxes get no benefit from the deductibility of mortgage interest or charitable contributions or state and local taxes. Those who live in more expensive houses, and occupy higher income tax brackets, get more benefit from the deductibility of mortgage interest. Those in higher tax brackets also get more benefit when employer-paid health and pension benefits are not counted as income.

4) These tax expenditures offer one possible mechanism to ease America's budget and economic woes, as I have argued on this blog before (for example, here and here). Cut a deal to scale back on tax expenditures. Use the funds raised for some combination of lower marginal tax rates and deficit reduction. Such a deal could be beneficial for addressing the budget deficit, encouraging economic growth, raising tax revenues collected from those with high income levels, and reducing tax-induced distortions in the economy You may say I'm a dreamer, but I'm not the only one. After all, a bipartisan deal to broaden the tax base and cut marginal rates was passed in 1986, when the president and the Senate were led by one party while the House of Representatives was led by the other party.

When Government Pre-Fills Income Tax Returns

[In commemoration of US federal income taxes being due today, April 15, here's a repeat of a post from April 15, 2014, on the subject of government filling out your taxes for you.]

As Americans hit that annual April 15 deadline for filing income tax returns, they may wish to contemplate how it's done in Denmark. Since 2008, in Denmark the government sends you a tax assessment notice: that is, either the refund you can receive or the amount you owe. It includes an on-line link to a website where you can look to see how the government calculated your taxes. If the underlying information about your financial situation is incorrect, you remain responsible for correcting it. But if you are OK with the calculation, as about 80% of Danish taxpayers are, you send a confirmation note, and either send off a check or wait to receive one.

This is called a "pre-filled" tax return. As discussed in OECD report Tax Administration 2013: Comparative Information on OECD and Other Advanced and Emerging Economies: "One of the more significant developments in tax return process design and the use of technology by revenue bodies over the last decade or so concerns the emergence of systems of pre-filled tax returns for the PIT [personal income tax]." After all, most high-income governments already have data from employers on wages paid and taxes withheld, as well as data from financial institutions on interest paid. For a considerable number of taxpayers, that's pretty much all the third-party information that's needed to calculate their taxes. The OECD reports:
"Seven revenue bodies (i.e. Chile, Denmark, Finland, Malta, New Zealand, Norway, and Sweden) provide a capability that is able to generate at year-end a fully completed tax return (or its equivalent) in electronic and/or paper form for the majority of taxpayers required to file tax returns while three bodies (i.e. Singapore, South Africa, Spain, and Turkey) achieved this outcome in 2011 for between 30-50% of their personal taxpayers. [And yes, I count four countries in this category, not three, but so it goes.] In addition to the countries mentioned, substantial use of pre-filling to partially complete tax returns was reported by seven other revenue bodies -- Australia, Estonia, France, Hong Kong, Iceland, Italy, Lithuania, and Portugal. [And yes, I count eight countries in this category, not seven, but so it goes.] Overall, almost half of surveyed revenue bodies reported some use of prefilling ..."

For the United States, the OECD report notes that in 2011, zero percent of returns were pre-filled. Could pre-filling work in the U.S.? Austan Goolsbee provided a detailed proposal for how prefilling might work for the United States in a July 2006 paper, "The Simple Return: Reducing America's Tax Burden Through Return-Free Filing." He wrote:

"Around two-thirds of taxpayers take only the standard deduction and do not itemize. Frequently, all of their income is solely from wages from one employer and interest income from one bank. For almost all of these people, the IRS already receives information about each of their sources of income directly from their employers and banks. The IRS then asks these same people to spend time gathering documents and filling out tax forms, or to spend money paying tax preparers to do it. In essence, these taxpayers are just copying into a tax return information that the IRS already receives independently. The Simple Return would have the IRS take the information about income directly from the employers and banks and, if the person's tax status were simple enough, send that taxpayer a return prefilled with the information. The program would be voluntary. Anyone who preferred to fill out his own tax form, or to pay a tax preparer to do it, would just throw the Simple Return away and file his taxes the way he does now. For the millions of taxpayers who could use the Simple Return, however, filing a tax return would entail nothing more than checking the numbers, signing the return, and then either sending a check or getting a refund. ... The Simple Return might apply to as many as 40 percent of Americans, for whom it could save up to 225 million hours of time and more than $2 billion a year in tax preparation fees. Converting the time savings into a monetary value by multiplying the hours saved by the wage rates of typical taxpayers, the Simple Return system would be the equivalent of reducing the tax burden for this group by about $44 billion over ten years."
Most of this benefit would flow to those with lower income levels. The IRS would save money, too, from not having to deal with as many incomplete, erroneous, or nonexistent forms.

For the U.S., the main practical difficulty that prevents a move to pre-filling is that with present arrangements, the IRS doesn't get the information about wages and interest payments from the previous year quickly enough to prefill income tax forms, send them out, and get answers back from people by the traditional April 15 timeline. The 2013 report of the National Taxpayer Advocate has some discussion related to these issues in Section 5 of Volume 2. The report does not recommend that the IRS develop pre-filled returns. But it does advocate the expansion of "upfront matching," which means that the IRS should develop a capability to tell taxpayers in advance, before they file their return, about what their parties are reporting to the IRS about wages, interest, and even matters like mortgage interest or state and local taxes paid. If taxpayers could use this information when filling out their taxes in the first place, then at a minimum, the number of errors in tax returns could be substantially reduced. And for those with the simplest kinds of tax returns, the cost and paperwork burden of doing their taxes could be substantially reduced.