Will Tax Cuts Spur Economic Growth?

The assertion that tax cuts will spur economic growth is now Republican orthodoxy, incessantly repeated by the party’s leaders and surrogates.  Most often, these proponents cite the Reagan tax cuts in the 1980s as proof that cutting taxes will boost the economy.  But a close look at the historical record shows there is scant correlation between cutting taxes and economic growth.

Immediately after WWII, the highest marginal tax rate on earned income was 91%.  Johnson lowered the rate to 70% in the mid-60s.  It was unchanged until President Reagan lowered the rate three times, to 50% in 1982, then to 38.5% in 1987 and finally to 28% at the end of his term.  The rate stayed at 28% for only three years.  In 1991, Bush 41, faced with a growing deficit, raised the rate to 31%.  Immediately after Clinton was elected, the top rate was raised to 39.6%.  The rate was temporarily cut in the now-famous “Bush tax cuts” to 35%.  That cut expired in 2013 and the rate returned to 39.6%.

When we graph these changes in the marginal tax rate with GDP growth it is apparent that both have been falling since 1960.  If lowering the marginal rates guaranteed higher growth, we should see these moving inversely, i.e., as tax rates came down, GDP growth should have improved.  But the opposite is true.

As for the oft-cited Reagan tax cuts, there was a snapback in GDP growth in 1983 and 1984 from the 1982 recession which occurred just after the reduction in the marginal rate from 70% to 50%.  But after 1984, GDP growth dropped back to historic norms notwithstanding the additional cuts in 1987 and 1988.  By 1991, the country was back in recession.

So, what about cutting the corporate tax rate, which is the centerpiece of the current proposal?  Once again, the effective corporate tax rate has also been trending down since 1960.  So, neither is there any historical correlation between reducing the corporate rate and economic growth.

So, how are we to interpret the lack of any positive correlation between marginal tax rate cuts and economic growth?

First, of course, we should always keep in mind the fundamental rule of statistics that correlation does not equate to causation, and, conversely, a lack of correlation does not disprove a potential causal link.  This is because there are innumerable other economic factors simultaneously at work on outcomes.  For example, at the same time the Reagan tax cuts were enacted in 1982, the Federal Reserve was also dramatically reducing interest rates.  So, it is very difficult to parse out the effect of changes in tax rates from the other background economic activity.

Second, it may be that the marginal rate and corporate rate are not as important as we think.  The Tax Policy Center estimates that the average income tax rate paid by households from 1979-2012 ranged from 17-22%, a much narrower range than the 28%-70% range for the marginal rate during that time.

Also, payroll taxes have been steadily increasing since WWII, both in absolute and relative terms.  That rate has more than doubled, from 6% to 15.3%.[i]  Payroll taxes as a percentage of federal tax receipts have nearly quadrupled from about 10% in 1950 to just under 40% today.

When you add the payroll taxes and income taxes together, the average tax rate since 1960 narrows even more to a range of 29-31%.[ii]  In other words, while the marginal rates have varied widely, the average rate paid by taxpayers has stayed in a pretty narrow range and, as a result, the overall tax burden has changed very little.

Notwithstanding that economists have difficulty quantifying the effects of tax policy on the economy, most nonetheless believe that tax reform, as opposed to just tax cuts, would boost growth.  This is because our tax code is both oppressively complex and creates enormous market inefficiencies.  The real question is whether the proposals now on the table are the kind of tax reform that will lead to growth or whether it is just tax cuts that may benefit some companies and individuals but have little effect on the larger economy.

Whether the tax reductions will spur growth or not is critical because if the growth fails to materialize, the tax cuts will blow an even bigger hole in the federal deficit.  If the tax cuts merely add to the deficit, there may be a short-term sugar high for the economy, but lead to lower growth down the line.

Most economists are skeptical that the proposed tax cuts will even come close to paying for themselves.  Twenty-one of twenty-six top economists surveyed by Bloomberg opined that the cuts would increase deficits.  Even the President’s alma mater, the Wharton School of Business, has released a study which finds the tax bill will add significantly to the deficit.  From what I have read, the consensus among economists seems to be that an increase in growth might pay for about a quarter of the proposed tax cuts.  If that is right, the tax cuts will blow a hole in the deficit and lead to lower growth in the future.

The most persuasive analysis I have seen comes from the Committee for a Responsible Federal Budget (“CRFB”).  It is co-chaired by Mitch Daniels, the former Indiana Republican Governor and director of the Office of Management and Budget under Bush 43, and Leon Panetta, also a former director of the Office of Management and Budget, White Chief of Staff, and Secretary of Defense under Clinton and Obama.    The CRFB disputes that the bill will produce the .4% GDP increase claimed by its backers and projects that the Senate version of the proposed tax bill will add $2.2 trillion to the federal debt over the next ten years.  [Click here and here to read.]  And that is on top of the deficits we are already expecting, largely driven by the acceleration Social Security, Medicare and Medicaid payments as more Baby Boomers retire.

Regardless of the effect of tax policy on GDP, we should always be attempting to minimize the tax burden on the American people.  Every tax dollar collected should be treated as a sacred trust to be spent wisely, efficiently and only for functions for which there is no viable private sector option.  But if we pin our hopes for a dramatic economic upturn from just cutting taxes, history suggests we will likely be disappointed and be passing on an even larger federal debt to our children and grandchildren.


[i] This includes the employer and the employee portions.
[ii] The sole exception to this range was 2011-12 when there was a temporary decrease in the payroll tax rate.
 
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City Comptroller Releases Rebuild Houston Audit: It is a Farce

In the 2015 mayoral election, all of the candidates except Steve Costello agreed that the drainage fee adopted by voters in 2010 had serious problems.  Each of the candidates had various prescriptions.  Turner agreed, expressing his concerns about how the money was being spent and promised a complete review of the program.  Two years later we are still waiting.

In response to some questions from Council, Controller Chris Brown has been promising an “audit” of the Dedicated Drainage and Street Renewal Fund (DDSRF), which was finally released last week.  It is a farce.

The audit examined three projects which totaled about $44 million.  Through the end of this fiscal year, about $1.4 billion will have been deposited into the DDSRF.  So, this audit covers a whopping 3% of the total.  [Click here to read the audit.]

The report includes an appendix which lists 35 projects that it indicates are completed “using the drainage utility fee component” from 2014-2016 at a cost of $246 million.  There is no explanation of that phrase nor are there any supporting schedules.  Presumably, the report is suggesting that these are the projects that were paid for by the drainage fee.  Beyond that, there is no detail other than a general description of the location of these projects and no indication that the audits did any review of them.

Even if we accept that $246 million was spent from the dedicated fund on these projects, that would only be about 76% of the drainage fee collected for those years and only 39% of the total amount deposited into the dedicated fund.  Where was the rest spent?  That was the question we were all hoping an audit would answer.

We used to have a better idea of how the money was spent.  During the Parker Administration, the budget document available to the public had 13 pages of information that included a reasonably detailed description of the expenditures and a list of personnel paid from the fund by position type.  [Click here to read 2015 budget.]  It was from that detail that we were able to determine that most of the positions paid by the fund were office personnel.  But since Turner took office, the budget document has only seven pages and omits most of that detailed information.  [Click here to see 2018 budget.]

The drainage tax was sold to taxpayers on the promise it would be dedicated to alleviate flooding.  Remember this guy telling that us, “The best part is that the politicians cannot divert a single cent.”

 

Since the drainage fund was set up in 2011, Houston taxpayers have paid over $750 million in drainage fees and an additional $650 million has gone into the fund from other taxpayer sources.  Does anyone think we have gotten $1.4 billion worth of value in flood control or street improvement projects?

Judging Administrations by the Stock Market

Since Donald Trump was elected, the stock market has been on a tear.  The S&P 500 Index has soared from 2085 to 2579, a nearly 24% increase.  The president’s supporters point to this increase as evidence of the effectiveness of his administration.  So, I thought it would be interesting to look at the market’s performance under previous administrations to see how the Trump administration compares.  I used Macrotrend’s inflation adjusted historical data to make comparisons [click here].

This is what the chart looks like for the total increase/decrease during each administration since Carter.

The market increases during the Clinton administration dwarfs all others.  I found it interesting that the appreciation during the Reagan administration was only about average, since that period is often heralded by Republican as some kind of golden age of economic growth.

Of course, looking at the aggregate increase for the entirety of each administration is not a fair comparison for the Trump administration, since it has only been one year since his election.  If we look at the average annual increase for each year, the Trump bump looks much more impressive, coming in second only to Clinton (22% vs. 21%).

 

But, if you look at the increase during the first year after the election, Trump takes first place, edging out Bush 41 and Obama (23% vs. 21% vs. 18%).  Note that the index was actually down during the first year of the Reagan administration.

So, what are we to make from this mishmash of data?  The answer is: not much.  While the political backdrop is important for the stock market, there are nearly an infinite number of other factors that also affect the markets, not the least of which is interest rate policy as set by the Federal Reserve.

It is undeniable that there has been a surge in business optimism since Trump’s election -most likely a wave of relief after eight years of the business-unfriendly, regulation-happy, Obama administration. And frequently psychology is as important, if not more so, than economics to the stock market.  But in the long run, economics wins out.

The real reason the market has steadily increased since 1950 is that corporate profits have increased.  In fact, there is nearly a perfect correlation.

 

If corporate profits keep going up, so will the stock market.  Of course, if the Republican tax bill is approved and corporate income taxes are slashed, those savings will immediately go to the bottom line and further support higher stock prices, at least to the extent that this is not already baked into the market.

The bottom line is that while who the president is and what his or her policies are obviously have an effect on the stock market, it is a mistake to credit any president with causing the markets to go up or down.  To believe otherwise, one must credit the Obama administration with causing the largest dollar increase in corporate profits and stock prices in the nation’s history, a proposition many would have a hard time accepting.

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Reform TIRZs, Don’t Repeal Property Tax Cap

My former colleagues at the Houston Chronicle editorial board opined this week that the City’s property tax cap should be repealed and that the tax increment reinvestment zones (TIRZs) need to be reformed.  [Click here to read.]  They are wrong on the first count but right on the second one.

To begin, let’s get some facts straight that were mangled in the editorial.

First, the City does not have a revenue cap; it has a property tax cap.  Property taxes make up about 25% of the City’s total revenue.  That is the only source of revenue that is limited under the City charter amendment that was approved by voters in 2004.  The other 75% of revenue is not restricted.   There is a cap on all revenues in the charter that was also approved by the voters in 2004, but because the property tax cap got more votes, the City only enforces the property tax cap.

Repeal advocates insist on mischaracterizing the limitation as a “revenue” cap to mislead the public into believing that the City’s ability to raise any form of revenue is impaired by the restriction.  But since the charter amendment was enacted, City revenues have increased by a whopping $2 billion (67%), including the enactment of the drainage fee, which was the largest single tax increase in the City’s history.

Second, the increase in taxes is not “constrained by an arbitrary algorithm.”  The limit is the lesser of population growth and inflation or 4.5%.  Limiting Council’s ability to increase property taxes to population growth and inflation is a reasonable limitation and should be a rough estimate of the need to increase taxes.  If the City’s population and inflation were growing by more than 4.5%, I would have to agree that the limitation is arbitrary.  But because the City’s population has been growing at a very slow pace and inflation has been low since 2004, the 4.5% limitation normally does not come into play.

Third, and most importantly, the property tax cap repeal advocates always omit that the charter amendment begins with this clause: “The City Council shall not, without voter approval . . .”  In other words, in any year that the Mayor and Council believe that the City needs more tax revenue than the limitation allows, all they need to do is ask for the voters’ approval.  If they feel handcuffed by the charter amendment it can only be because they believe they cannot make a credible case to the taxpayers to pay more.

My former colleagues are right about the detrimental effect the TIRZs are having on the City’s finances.  Last year, the TIRZs collected $132 million in property taxes, nearly 14% of the City’s total property taxes.  That is more money than the drainage fee brought in last year.

They are also correct that the taxes collected by the TIRZs are excluded from the property tax cap.  As a result, TIRZ tax receipts have soared.  Last year the property taxes collected by all TIRZs increased 13%.  The receipts for the six richest TIRZs went up by an astonishing 27%!

Of course, the City has devised a number of clever ways to claw back more and more of this revenue over time and subvert the voters’ intention as expressed in the cap.  Each TIRZ pays the City an administrative fee and most make other contributions toward “shared” expenses.  But there is no question that if the City had all of this revenue back, it would go a long way toward solving its long-term structural deficit.

One of the challenges in bringing any of this revenue back to the City is that the TIRZs have been on a debt binge in recent years.  They currently owe around half a billion dollars.  So, much of their revenue is committed to repaying that debt.  Of course, voters had no say in the creation of this debt, notwithstanding that property taxes will be used to repay it.

There are certainly some good projects that are undertaken by the TIRZs.  But increasingly they are grasping for projects on which to spend their largess; witness the idiotic $200 million bus lane project in Uptown.

Of course, our benevolent State Legislature has its finger in all of this.  All of the TIRZs were created by state statute.  So, the State will have to be involved in any restructuring.  Given numerous conflicts of interests between our local delegation and the TIRZs and their first cousins, the management districts, good luck with that.

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State of Texas Debt has nearly Doubled in Last Seven Years

Want a killer Trivial Pursuit question?  How about this?

While Barack Obama was President, did the debt of the Federal government or the State of Texas increase more on a percentage basis?

Republicans are quick to point out that while Obama was president the federal debt increased far more than under any other president.  But what they rarely share is that during that same period, the debt of the State of Texas rose even faster, at least, on a percentage basis.

At the end of 2009, the Federal government was just under $12 trillion in debt.  By the end of 2016, the number had grown to $19.5 trillion, a 64% increase.  For the same period, the State’s debt went from $62 billion to $121 billion, a 92% increase.*

 

You may be tempted to explain this unfavorable comparison away by noting that Texas is growing faster than the rest of the country and, therefore, a larger increase is to be expected.  There is some validity to this argument, but even if we look at the growth of the debt on a per capita basis, Texas still comes out ahead, 70% versus 54%.  And these numbers do not count the billions in debt incurred by local governments.  We’ll be looking at that in the coming weeks.

To be fair, the State was starting at a much lower base.  Its per capita debt as of 2016 was about $4,300 compared to over $39,000 for the Federal government.  And as a percentage of GDP, the State’s debt is also much lower, although I am not sure the comparison of that metric means much in this context.

The lion’s share of the increase in the State debt has come from an explosion of its unfunded pension liability.**  I will be writing more on this issue soon, but the State’s pension debt, based on its own accounting, has gone from zero in 2000, to over $60 billion at the end of 2016.  In other words, according to the State Comptroller’s numbers, the Legislature has “borrowed” over $60 billion from the State’s pension plans by not contributing enough to fund the benefits they have promised.

It is important to note that both the Federal government and the State dramatically understate their liabilities associated with future retirement payments.  A recent Moody’s report has calculated that the State’s true pension liability is over $100 billion and, of course, the Federal government has never included a realistic estimate of the future cost of Social Security or Medicare in its accounting.

Please do not misunderstand.  I am not a debt-phobe.  Every businessperson knows that there is a time and place to use debt.  Some of you will recall that during the 2015 mayoral campaign I was the only candidate who advocated using pension bonds as tool in solving the pension crisis.

But the reality is that government at every level and both of our political parties are drunk on debt.  The Democrats gorge on debt to increase expenses; the Republicans to cut taxes, or to keep from increasing them.  Neither want to have an adult conversation with their constituents about what services do we really want government to provide and what does it costs to provide those services.  Instead, one party demagogues social issues and the other engages in class warfare and identity politics to distract the public from the fact that both are bankrupting future generations.

*  This graph begins with the increase in debt from 2009 to 2010.  Those who argue the Federal debt doubled during the Obama administration begin from the time he was sworn into office.  However, since the federal budget fiscal year ends in September, the incoming administration has a limited impact on the financial results for its first year.  It would probably be fairer to included FY2017, but those numbers are not yet available.  It is interesting to note that the rate of increase did not slow down when the Republicans took control of the House of Representatives in 2010 or the Senate in 2014.

**   Much of the increase in the pension debt was realized when the accounting rules changed in 2015 forcing governmental entities to more realistically report their pension liabilities.

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City of Houston Sales Taxes Continue to Stagnate

The Texas Comptroller reported yesterday that the City’s sales tax receipts for November (which reflect September sales) were up by 2.3%.  This followed a decline of 3.9% in October.  The October decline was to be anticipated because of Harvey.  However, I had expected to see more of a rebound in November from storm repair purchases.  Perhaps delays from receiving insurance payments have pushed some of those sales out a bit further.

The City had a bump in sales tax receipts early this year from the Super Bowl, with month-over-month increases in March and April of 6.5% and 5.3%, respectively.  But longer term trend appears to be that precipitous decline when oil prices fell has leveled out.

The current City budget projects a 1% increase in sales taxes and it is running only slightly behind that through the first four months of the fiscal year.

Houston continues to  be significantly outperformed by its suburban neighbors.  I have been tracking six cities nearby cities.  Their sales tax receipts were up 9% this month.  I am working on a longer term comparison which I will be sharing with you soon.

If you are interested in looking at sales tax receipts for yourself, you can access that information for any entity in the State [here].

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Court Rules Montrose Management District Illegally Collected $6 Million in Assessments

The trail of TIRZ/Management District horrors continues.  This time it is the Montrose Management District (MMD).

The MMD was formed in 2011 from the merger of two earlier improvement districts which had been authorized by the Legislature.  Since the merger in 2011, MMD has collected over $12 million in assessments from businesses in the Montrose area.  Last week, a District Judge ruled that the petition used by MMD to assess a tax against Montrose businesses did not have the requisite 25 signatures.  Of course, the fact that the Legislature passed a law that would allow as few as 25 property owners to authorize a tax on hundreds of property owners is absurd on its face.  But MMD, according to the Court’s ruling, could not even meet this ridiculously low bar.

Most problematic for MMD is that the Court ruled that it must reimburse the $6.5 million in illegally collected assessments.

[Click [here] to see the Court’s ruling.]

Of course, the MMD does not have anywhere close to $6.5 million.  According to its most recent audit, it only had about $600,000 in cash at year-end and according to recent monthly reports, it appears to have even less now.

But MMD’s problems don’t end there.  After it levied the 2011 assessment, property owners in Montrose began collecting signatures to dissolve the MMD.  According to the statute, that requires property owners owning 75% of the land in the District.  Pretty fair don’t you think?  It only takes 25 property owners to authorize an assessment, but 75% of everyone in the district to undo it.  Just in case you had any doubt about our Legislature being in the bag for these special districts.

Over several years, the dissident owners collected nearly 900 signatures which they contend constitutes over 80% of the land in the MMD.  But when they submitted the petitions, MMD took a page out of the City of Houston’s playbook and invalidated about a third of the signatures.  One of the property owners I interviewed said the MMD invalidated his petition on the four properties he owned without anyone ever contacting him to verify whether he owned the properties or had actually signed the petitions.

When you look at how the MMD has been spending its money you can understand why the vast majority of business owners in Montrose want to dissolve the district.  The following is a table of the revenue and expenses taken from the MMD’s audits.

From 2011-2017, the MMD has collected over $12 million from Montrose businesses and has spent about $11.5 million.  Forty-three percent (43%) of its expenditures, right at $5 million, have been for administrative expenses, legal fees and business development expenses.  The management consultant for the MMD alone has been paid nearly $1.5 million and is currently being paid over $30,000 per month.  No wonder the property owners want to get this monkey off their backs.

Management districts and TIRZs were originally formed to assist neighborhoods with redevelopment.  If they are doing their jobs, they should be welcomed by the businesses and residents they serve.  Increasingly though we are seeing situations like the Uptown TIRZ and now the Montrose Management District where these entities are at war with the neighborhoods they are supposed to be serving.  And to make matters worse, the bureaucrats and lawyers running these districts are getting rich in the process.

Hopefully the next Legislature will take a hard look at these special districts.  But given some of the conflicts of interest that abound with respect to these districts in the Legislature, that may be wishful thinking on my part.  More on that topic soon.

The next meeting of the MMD Board is next Monday (November 13) at noon at University of Saint Thomas, Carol Tatkon Boardroom, 3807 Graustark, Houston, TX 77006.  Parking is available at the Moran Parking Garage.  The vast majority of Montrose business owners who are opposed to the continued existence of this district should show up at this meeting and make it plain to the board:  Go away!