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Say, Congress, want to reform taxes and regulations? Here’s how to promote efficiency

Put earnings into CDs or bonds to pass to your kids and you will have paid income tax on every dollar they get. Save that money for them in a farm, rental property or stock in a startup corporation, and almost all of it will never be taxed. That’s unfair and should be changed, Ed Lotterman says.
Put earnings into CDs or bonds to pass to your kids and you will have paid income tax on every dollar they get. Save that money for them in a farm, rental property or stock in a startup corporation, and almost all of it will never be taxed. That’s unfair and should be changed, Ed Lotterman says. Pittsburgh Post-Gazette

The GOP majorities in Congress and President Trump talk about cutting federal spending, abolishing regulation and reforming taxes to promote economic efficiency. But the Biblical warning that “by their fruits ye shall know them” applies here.

Will Republicans make legislative changes that actually improve efficiency and fairness? Or will it just be gravy for some companies and households to the detriment of the rest of us?

If they are serious about reform, here are suggestions for tax reform, deregulation and spending cuts that genuinely would benefit U.S. society as a whole.

1. Taxes

Do away with the “step-up basis” provision of the income tax. This tax exempts from income taxes the gains in value of assets held until death. Buy a farm for $100,000, for example, sell it when you retire for $500,000, and you will owe income tax on a capital gain of $400,000. Hold it to your death, and your heirs get a $500,000 asset that has a “cost basis” of the market value on the day you died. If they sell it, the $400,000 gain is never taxed.

This provision is unfair. It benefits only a few households. Put earnings into CDs or bonds to pass to your kids and you will have paid income tax on every dollar they get. But if you can save in a farm, rental property or stock in a startup corporation, then nearly all the wealth the next generation gets will never have been taxed.

This distorts decisions on using capital. Of those who qualify, a benefit of thousands or tens of thousands of dollars accrue to most, while hundreds of millions or even billions go to super-rich families with names like Gates, Buffett, Walton and Soros.

Axing this is particularly important if we abolish the federal estate tax. The estate tax has a high overall economic cost relative to revenue raised, but it catches money that escapes income taxation because of the step-up basis. Eliminate the estate tax while keeping step-up basis and the richest 5 percent of households will get an enormous windfall.

2. Regulation

Kill the ethanol mandate. It improves the environment little and has no benefits not be better achieved with other policies. It distorts commodity prices, skews land values and motivates misallocation of inputs like fertilizer.

Many of the benefits go to nonfarming landowners like me. Young beginning farmers have to pay more for land because of it. And it transfers money from consumers to the handful of large companies producing most ethanol.

Also, get rid of the measures keeping U.S. sugar prices above free-market levels. These don’t involve direct subsidies so are off most public radar.. The income transfer means 330 million people pay more for sugar so that fewer than 6,000 sugar producers can have higher income.

Yes, most of the sugar producers, like those in Idaho, are hard-working farmers. But these farmers are not Ma and Pa Kettle. Nearly all fall into the top 5 percent or so of household incomes and the top 1 percent of net worth.

3. Spending

For a wasteful income-transfer program, end farm subsidies structured as “insurance.” These replaced the “direct payment” subsidies in place for decades.

Insurance was intended to reduce efficiency-robbing distortions created by direct payments. But the primary advantage for farmers and politicians is that it hides, rather than eliminates, perverse incentives, and it camouflages income transferred by government fiat. And insurance reduces diversity of crops produced and tilts things even more toward large operations.

It’s a gravy train for private underwriters who administer it, since federal re-insurance protects them against losses. Fees are ample. And it has created opportunities for farmers to game the system and even engage in outright fraud. Some producers suffer “prevented planting” three years out of five or have crop “disasters” eight years out of 10. There probably is more abuse and fraud in federal crop insurance than in food stamps.

Again, benefits are skewed. Numerous midsized farmers get modest payments. But, despite laws supposedly limiting payments to any individual, loopholes let large payments go to a small cohort of very large producers.

Indemnities are based on self-tabulated “actual production histories.” Planting dates, yields and other data related to losses also comes from producers. Ostensibly, there are provisions to check the accuracy of producer reports, but preventing abuse and fraud is difficult.

Moreover, the private underwriters who administer the program for USDA compete with each other. They find profits in the small cohort of large producers with thousands of acres in one operation. No single underwriter will press any big customer closely on the accuracy of reported losses or that account will go somewhere else.

Economists use the term “scale-neutral” to describe incentives created by some institution or government policy that influence the size of companies. A policy is “scale neutral” if it favors all sizes of operations to the same degree. But federal farm policies have never been neutral and have always created incentives for operations to get bigger. This is no different under the contemporary “insurance” scheme than it was under prior subsidy systems.

Having taxpayers pick up production risks discouraged crop diversification and encouraged growing crops on marginal land where they would not be feasible under market forces.

Will Congress and the president adopt these suggestions? No. Would a Democratic Congress and president be any more likely to do so? No. The power of vested interests and political inertia is too great.

But if all remains as is, please spare us the pious rhetoric about any thirst for reform of taxes, regulation and spending.

St. Paul economist and writer Edward Lotterman can be reached at boise@edlotterman.com.

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