New IRS reporting requirements force U.S. banks to disclose interest-earning accounts of non-resident aliens to the government. (Apparently this is tax-authority mutual back-scratching: foreign nations are expected to reciprocally report this type of information about U.S. citizens with accounts abroad.) Under this regulation, refusing to disclose non-resident alien accounts results in a fine.

The Florida and Texas Bankers Associations are trying to challenge this regulation, but are being frustrated by interpretative jiggery-pokery that prevents their serious legal arguments from even being heard. While the federal district court allowed this lawsuit to proceed, the U.S. Court of Appeals for the D.C. Circuit reversed course and held that the associations couldn’t challenge the regulation because, under the Anti-Injunction Act (AIA), one can’t challenge a tax until the government has attempted to enforce the allegedly improper law and collect the attendant tax. The D.C. Circuit—seemingly imitating Chief Justice Roberts’s reasoning in NFIB v. Sebelius—held that the penalty triggered by failing to follow the new reporting requirements was a tax, thus subjecting the lawsuit to the AIA.

Cato has banded together with the National Federation of Independent Business to file an amicus brief in support of Supreme Court review. The AIA’s statutory language should be interpreted as the Supreme Court has interpreted the Tax Injunction Act (TIA)—confusing, but not the same law—because they contain almost exactly the same language. Under the TIA, one cannot challenge a regulation that deals with either the “assessment” or “collection” of taxes. Similarly, the AIA only prohibits challenges that have the “purpose” to “restrain” “assessment” or “collection” of a tax. Since the fine at issue is a penalty for regulatory non-compliance, not a tax as properly understood, the AIA shouldn’t bar judicial challenges.

Moreover, with the way in which the D.C. Circuit read the “penaltax,” it created an issue under the Administrative Procedure Act (APA). The APA contains a “strong presumption” of judicial review prior to enforcement of substantive regulations like the one at issue here. Congress intended that all agencies’ substantive regulations would be subject to such review under the APA—not that the IRS would have no accountability before federal courts. People have a right to be sure of a regulation’s meaning before engaging in costly compliance efforts—and that’s exactly what pre-enforcement judicial review provides.

Finally, the APA contains stringent procedural requirements for how regulations are to be promulgated. For example, there must be an adequate explanation of the rule, notice and an opportunity for comment, and publication of proposed rules in the Federal Register. The Treasury Department and IRS frequently ignore these requirements—recall the various Obamacare delays, waivers, rewrites, and suspensions—and these agencies must be reigned in.

The Supreme Court should take up Florida Bankers Association v. U.S. Department of Treasury and reverse the lower court’s dangerous precedent. You shouldn’t need to wait until the government attempts to enforce a penalty against you before being able to challenge it.

An important and timely paper from Columbia University economist Karl Mertens finds that amount of income reported on tax returns is highly sensitive to marginal tax rates, and that the effect is mainly from changes in real activity not tax avoidance.

Mertens estimates “elasticities of taxable income of around 1.2 based on time series from 1946 to 2012. Elasticities are larger in the top 1% of the income distribution but are also positive and statistically significant for other income groups.… Marginal rate cuts lead to increases in real GDP and declines in unemployment.” Other recent research also shows that “higher marginal tax rates reduce income mobility” while eliminating higher tax brackets improves upward mobility.

Both Democratic candidates for the presidency, Sanders and Clinton, want to greatly increase marginal tax rates on high incomes and on realized capital gains. By contrast, all Republican candidates propose to reduce marginal tax rates.

Mertens’ research unambiguously predicets that economic growth would slow or stop under the Democrats’ proposed tax increases, but accelerate under Republicans’ tax reforms.

The U.S. is bankrupt. Of course, Uncle Sam has the power to tax. But at some point even Washington might not be able to squeeze enough cash out of the American people to pay its bills.

President Barack Obama would have everyone believe that he has placed federal finances on sound footing. The deficit did drop from over a trillion dollars during his first years in office to “only” $439 billion last year. But the early peak was a result of emergency spending in the aftermath of the financial crisis and the new “normal” is just short of the pre-financial crisis record set by President George W. Bush. The reduction is not much of an achievement.

Worse, the fiscal “good times” are over. The Congressional Budget Office expects the deficit to jump this year, to $544 billion.

The deficit is not caused by too little money collected by Uncle Sam. Revenues are rising four percent this year, and will account for 18.3 percent of GDP, well above the last 50-year average of 17.4 percent. But outlays are projected to rise six percent, leaving expenditures at 21.2 percent of GDP, greater the 20.2 percent average of the last half century.

Alas, this year’s big deficit jump is just the start. Revenues will rise from $3.4 trillion to $5 trillion between 2016 and 2026. As a share of GDP they will remain relatively constant, ending up at 18.2 percent. However, outlays will rise much faster, from about $4 trillion this year to $6.4 trillion in 2026. As a percent of GDP spending will jump from 21.2 percent to 23.1 percent over the same period,

Thus, the amount of red ink steadily rises and is expected to be back over $1 trillion in 2026. The cumulative deficit from 2017 through 2026 will run $9.4 trillion. Total debt will rise by around 70 percent, to roughly $24 trillion in 2026.

Reality is likely to be worse. So-called discretionary spending, subject to annual appropriations, is to be held to record, and probably unrealistically, low levels. In contrast, entitlements will be exploding.

Last June, CBO published a report looking at the federal budget through 2040. Warned the agency: “the extended baseline projections show revenues that fall well short of spending over the long term, producing a substantial imbalance in the federal budget.” By 2040 the agency imagines revenues rising sharply, to 19.4 percent of GDP, but spending going up even further, to 25.3 percent of GDP.

Using its revised figures, CBO warned: “Three decades from now debt held by the public is projected to equal 155 percent of GDP, a higher percentage than any previously recorded in the United States.” Even when exiting World War II—106 percent in 1946, the previous record.

CBO noted the potentially destructive consequences of such indebtedness. Washington’s interest burden would rise sharply. Moreover, “because federal borrowing reduces total saving in the economy over time, the nation’s capital stock would ultimately be smaller than it would be if debt was smaller, and productivity and total wages would be lower.” Americans would be poorer and have less money to fund the steadily rising budgets.

Worse, investors could come to see federal debt as unpayable. Warned CBO: “There would be a greater risk that investors would become unwilling to finance the government’s borrowing needs unless they were compensated with very high interest rates; if that happened, interest rates on federal debt would rise suddenly and sharply.” This in turn “would reduce the market value of outstanding government bonds, causing losses for investors and perhaps precipitating a broader financial crisis by creating losses for mutual funds, pension funds, insurance companies, banks, and other holders of government debt—losses that might be large enough to cause some financial institutions to fail.”

As I wrote for American Spectator: “There’s no time to waste. Uncle Sam is headed toward bankruptcy. Without serious budget reform, we all will be paying the high price of fiscal failure.”

New data from Gallup suggests that residents in US states with freer markets are more optimistic about their state’s economic prospects. In their 50-State Poll, Gallup asked Americans what they thought about the current economic conditions in their own state as well as their economic expectations for the future. North Dakota (92%), Utah (84%), and Texas (82%) top the list as states with the highest share of residents who rate their current economic conditions as excellent or good. In stark contrast, only 18% of Rhode Island residents, 23% of Illinois residents, and 28% of West Virginians rate their state’s economic conditions as excellent or good. Similarly Americans most optimistic about their state’s economic futures include Utah (83%) and Texas (77%) while states at the bottom include Illinois (34%) and West Virginia (36%).

What explains these stark differences in economic evaluations and expectations across US states? Could differences across states in economic freedom, such as government regulations on business, tax rates, government spending, and property rights protection, be part of the story?

Figure 1: Relationship Between State Economic Freedom Scores
and Residents’ Evaluations of Current Economic Conditions

_{Source: Economic Freedom Index 2011, Freedom in the 50 States; Gallup 50-State Poll 2015}

To investigate, I examined the Freedom in the 50 States Economic Freedom Index, calculated by Jason Sorens and William Ruger and published by the Mercatus Center, to compare. I then contrasted this data with Gallup’s public opinion numbers. It turns out there is a strong relationship between economic freedom and public economic optimism. Americans who live in states that have lower taxes, lower government spending, fewer regulations on business, better property rights protections, better tort system, etc. also tend to have more confidence in their state’s economic conditions.

Figure 1 shows the relationship between states’ economic freedom scores and public evaluations of current economic conditions. As you can see, states that are more economically free—meaning less government regulation, lower taxes, and less government spending, etc.—also tend to have residents that say their state economies are excellent or good. This correlation¹ between economic freedom and residents’ evaluations of their state’s current economic conditions is .55.

Next, Figure 2 shows the relationship between each state’s economic freedom score and share of residents in each state who think their state economy is getting better. As you can see, states that are more economically free tend to have residents who are more optimistic about their the states’ economic futures. The correlation between economic freedom and residents’ positive economic outlook is .44. Notably, economic optimism in states like New York and California that have less free economies tend to be the exception rather than the rule when compared to the nation as a whole. 

Figure 2: Relationship Between State Economic Freedom Scores
and Residents’ Positive Economic Outlook 

_{Source: Economic Freedom Index 2011, Freedom in the 50 States; Gallup 50-State Poll 2015. Correlation: .44, if outliers like New York, California, and Nevada are excluded, correlation rises to .58.}

Of course, correlation is not causation. But it would also be a mistake not to consider the obvious possibility that economic freedom and economic success are related. There is a reasonable argument to be made that making it easier to start businesses, reducing regulatory barriers, and leaving more money in the private sector can lead to more entrepreneurship, companies creating more jobs, technological innovation, economic growth, and thus more optimistic people.

While these results do not report on actual economic conditions, public perception of economic conditions is also crucially important. Americans’ perception of their state economies can act like a composite score of how residents perceive the multifarious economic forces at work in their states. 

In sum, these results provide some indication that freer markets may provide greater hope for a better economic future.

Check out the Freedom in the 50 State Rankings:

¹ Correlation is a measure of relationship

When the Brookings Institution and Urban Institute claim any tax reform will “lose trillions” they are comparing their static estimates of revenues from those plans (which assume tax rates could double or be cut in half with no effect on growth or tax avoidance) to totally unrealistic “baseline” projections from the Congresional Budget Office. Those CBO projections assume that rapid 2.4% annual increases in real hourly compensation over the next decade will push more people into higher tax brackets every year. As a result, the average tax burden supposedly rises forever — from 17.7% of GDP in 2015 to 19.9% in 2045 and 23.8% by 2090. And, typical of static estimates, this ever-increasing tax burden is imagined to have no bad effects on the economy.

Such a high level of federal taxation never happened in the past (20% was a record set in the tech stock boom of 2000) and it will never happen in the future. In short, this is an entirely bogus basis by which to judge tax reform plans.

A far more sensible question would be this:

Will the Cruz or Rubio tax reforms raise just as much money as the Obama “tax increase” has — namely, 17.5% of GDP from 2013 to 2015. If so, then real tax revenues will grow faster after reform because real GDP growth will surely be at least 1.2% faster — or a middling 3.5% a year, which is all the cautious Tax Foundation estimates suggest.

Ted Cruz says the defense plan he unveiled Tuesday in South Carolina would give the U.S. military “more tooth, less tail.” Actually Cruz’s plan would produce more of everything, especially debt.

Cruz says that as President he’ll spend 4.1 percent of gross domestic product (GDP) on defense for two years, and 4 percent thereafter. As the chart below shows, under standard growth predictions, Cruz’s plan produces a massive increase in military spending: about $1.2 trillion over what would be Cruz’s first term and $2.6 trillion over eight years. Details on the chart are at the end of this post.

The chart also shows how much Cruz’s plan exceeds the Budget Control Act’s caps on defense spending, which remain in force through 2021. Spending bills exceeding those caps trigger sequestration: across-the-board cuts that keep spending at the cap. So Cruz’s plan depends on Congress repealing the law. Experience suggests that Congress will instead trade on dodgy future savings to raise caps by twenty or thirty billion a year—about a tenth of what Cruz needs.

Cruz is relatively clear on the tooth—force structure—he hopes to buy. He’d grow the Army’s end strength to 1.4 million, with at least 525,000 in the active force. Those numbers are scheduled to fall to 980,000 and 450,000 in 2018. Cruz would “reverse the cuts to the manpower of the Marines,” which presumably means going from the current 182,000 active to the 202,000 peak size reached in 2011 for the Iraq and Afghanistan wars. The Navy would grow from 287 to at least 350 ships, and the Air Force would add 1,000 aircraft to reach 6,000. The plan would also modernize each leg of the nuclear triad of intercontinental ballistic missiles, bombers and submarine-launched ballistic missiles. It asserts that the triad is “on the verge of slipping away,” ignoring current plans to modernize each leg, needlessly.

Despite the plan’s “paying for rebuilding” section, Cruz is unclear on how he’ll fund the buildup. The “less tail” option is a red-herring. The implication, standard among those trying to look fiscally responsible while throwing money at the military, is that you cut administration to pay for force structure. But Cruz doesn’t sustain the pretense beyond attacking the Pentagon’s “bloated bureaucracy and social experiments.” He never identifies what bureaucracy—commands, budget line or contracts—he’d axe. He doesn’t explain how to overcome the Pentagon’s tendency to increase overhead during buildups or betray concern about the meager results of past efforts to shift tail to tooth. He complains about “12,000 accountants in the Pentagon,” but between its buildup and push to audit the Pentagon, the Cruz administration would need thousands more. Cruz’s refusal to “bow to political correctness,” evidently does not cover politically-dicey efficiency measures like another Base Realignment and Closure round and reforming military benefit and compensation packages. Neither does Cruz say how his idea of social experiments, like letting gays serve openly or accommodating soldiers allergic to gluten, add costs.

Cruz, of course, will not fund his buildup through taxes. Instead, the plan mentions selling federal assets, unspecified spending cuts, and tax revenue juiced by four or five percent annual growth. Wishful thinking seems a fair summary. Asset sales would only help marginally. The plan lacks a method for abolishing Democrats, who will almost certainly retain enough Senators to keep non-defense discretionary spending pegged to defense, or to make entitlement cuts politically unpalatable. And betting that you can vastly outperform typical growth isn’t sound planning.

That leaves debt as the most likely way President Cruz will fund his buildup, adding to the pile he already plans. And that helps explain why Cruz’s defense plan won’t happen. With CBO’s recent estimate of accelerated deficit growth, the politics constraining Pentagon spending should last. Assuming Democrats and vulnerable Republicans continue to block big entitlement spending cuts and Republicans prevent tax increases, concern about deficits translates into pressure to restrain discretionary spending, of which defense is more than half.

Also in the unclear category: the rationale undergirding the plan. Cruz’s force structure hopes, which he doesn’t price, have little to do with his 4 percent spending goal, beyond a general commitment to more. As Matt Fay explains, spending four percent of GDP on defense is to punt on strategy, which involves prioritizing resources to meet threats. Threats don’t grow with wealth or fade with poverty.

Cruz’s force structure suggestions also lack a strategic basis. Cruz criticizes nation-building wars and worries about China. But rather than distribute his buildup accordingly by focusing it on the Navy and Air Force, he gives equally to the ground forces. Ultimately, Cruz proposes spending a lot more to do what we are now doing. Like Jeb Bush, Marco Rubio, and even Dick Cheney, Cruz’s rhetorical assaults on the Obama administration’s defense policy belie underlying agreement with its premises. I attack those bipartisan beliefs in various other places.

__________________________________________________________________

The chart covers 2018–2025 because those are the first and last fiscal year budgets that the next administration will plan, assuming it wins a second term. For GDP growth, the chart uses recent Congressional Budget Office projections. The current spending plans are in budget authority and come from the Pentagon’s new five year defense spending plan (see figure 1–3 on page 1–5) and Office of Management and Budget estimates for subsequent years (table 28–1). These plans track “national defense” (budget function 050), minus overseas contingency operations funding. That spending track falls under 3 percent of CBO’s GDP prediction in 2018 and slides toward 2.5 percent by the mid 2020s. The caps are on page 13 here. All figures are in nominal dollars. 

Will Wilkinson notes that there is a libertarian argument for Bernie Sanders. I’m not sure I buy the precise point Wilkinson is making. Sanders says he wants to make the United States more like Finland, Sweden, and Denmark. And those countries do indeed rank higher than the United States in the Cato Institute’s Human Freedom Index, compiled by my colleagues Ian Vásquez and Tanja Porčnik. But Sanders wants to emulate those countries in the ways they are less free than the United States (i.e., expanding government transfers), not in the ways they are more free (taxes and regulation). I think this powerful Sanders ad featuring Eric Garner’s daughter Erica is a much better libertarian argument for Sanders.

Sanders’ record here isn’t exactly clean. The police confronted Eric Garner because they believed he was selling untaxed cigarettes. If Sanders indeed penned the below letter in 1972 (I have been unable to verify its authenticity, but it sounds like him), then he is well aware cigarette taxes disproportionately burden the poor. 

Aside from the actual tax burden, cigarette taxes also lead to hostile confrontations between citizens and police. I would like to see Sanders propose repealing the federal cigarette tax. Instead, he has voted to increase it, which increases the likelihood of such confrontations. That is probably swamped, however, by Sanders’ support for decriminalizing marijuana and regulating/​taxing it like alcohol and tobacco. That would probably do even more than repealing the federal cigarette tax to reduce such confrontations between black men and the police.

If that letter is authentic, it provides other libertarian arguments for Sanders. His health care plan is not one.