The IRS 501(c)(4) Exposes Broader Flaws at the Heart of the U.S. Tax System

President Obama is shocked and angered that the IRS targeted certain conservative organizations for special scrutiny when they applied for 501(c)(4) tax exemptions as “social welfare” organizations. Republicans are just as shocked. The whole Washington political establishment is shocked, just shocked, that anyone, let alone the IRS, would try to stem the flow of political money that pours through this gaping loophole in the federal tax system.

The campaign finance reform organization Democracy 21 has tirelessly documented abuse of the 504(c)(4) loophole by political organizations. Its president, Fred Wertheimer, is quick to agree that the IRS was wrong to single out Tea Party affiliated organizations for scrutiny. However, Wertheimer does not suggest that the IRS should evenhandedly rubber stamp all 501(c)(4) applications. Instead, he argues that it should aggressively clamp down on loophole abusers of the right, left, and center. His list of targets includes Carl Rove’s Crossroads GPS, the pro-Obama group Priorities USA, and Americans Elect, an organization that sought to run an independent candidate for president in 2012.

There seems to be an informal premise, supported by past practice of the IRS, that a self-proclaimed social welfare organization is abusing its tax status if it spends more than half of its budget on overtly political activities. As Wertheimer points out, the IRS does not enforce even this generous limit.

Many 501(c)(4)s cross the 50 percent line with impunity, and some have even registered as political parties. However, as he recently told the Washington Post’s Dylan Mathews,  the 50 percent limit, even if strictly enforced, is already too generous. According to the relevant statute, it should be zero.
Although I applaud Wertheimer’s efforts to get the IRS to obey the law, I think his focus is far too narrow. The 501(c)(4) “social welfare” designation is only one of many tax exemptions that needs a rethink. The IRS code includes more than two dozen types of 501(c) organizations,  ranging from credit unions to insurance companies, that qualify for various kinds of tax privileges.

The 501(c)(4) social welfare groups that are at the center of the current IRS scandal are sometimes lumped together with their close cousins, 501(c)(3) charitable organizations. They share some tax privileges such as not having to pay tax on income they earn and exemption from gift taxes. In other ways they differ. The big draw of 501(c)(3) status is the right of donors to deduct contributions from their federal income taxes.  The main attraction of 501(c)(4) groups, instead, seems to be their right not to reveal the identity of their donors. For some donors, anonymity is apparently even more valuable than a tax deduction.

In a two part series last year [1] [2], I argued that we should eliminate the tax deductibility of contributions to 501(c)(3)s. These are the main points I made, many of which apply to 501(c)s of all varieties:

• The ostensible justifications for 501(c) tax exemptions are “social welfare” and “charity.” However, these organizations are not exclusively devoted to such goals. Even for 501(c)(3)s, no more than a third of tax-advantaged spending goes to real charity, if we use that term according to its dictionary meaning of “generous actions or donations to aid the poor, ill, or helpless.” For other 501(c)s, charity and social welfare is often even more incidental to their main activities.
• Even the full tax deductiblity of 501(c)(3) contributions does little to increase overall giving. That conclusion finds support both in statistical evidence and in the effects of past tax law changes that have sharply cut the economic value of the deduction with little if any impact on total giving. The idea that we would get insufficient political giving without tax privileges for 501(c)(4)s is even less credible.
• All tax exempions are costly to the federal budget. That is why economists refer to them as “tax expenditures.” Just for 501(c)(3) organizations, each $1 of truly charitable spending induced by the tax exemption costs the budget from $3 to $4.5o, depending on the estimate. If we included tax losses from exemptions for all the 501(c)s, the ratio would look even worse.
• In any event, tax-deductible giving is only a small part of what makes Americans the most generous people in the world. Much of that distinction comes from our willingness to help both neighbors and strangers on a one-to-one basis and to volunteer our time, not our money, to charitable organizations. The same goes for politics. It is unlikely that an end to the tax privileges and anonymity provided by 501(c)(4)s would fatally damage the democratic process or the willingness of people to give time and money to political causes they believe in.

Progressives and conservatives should be able to agree, although for different reasons, that we should eliminate 501(c)s of all kinds.

Progressives tend to have faith in the ability of government to promote social welfare and help the less fortunate. Accordingly, they should be willing to support a reform package that closed tax loopholes, left tax rates unchanged, and spent the resulting increase in revenue on expansion of social welfare programs.

Conservatives tend to think that reducing tax rates is an important policy goal in itself, and to think that the private initiatives do a better job than government in helping the poor and undertaking other civic initiatives. Accordingly, they should be willing to support a package that eliminated tax preferences, used the resulting gain in revenue to reduce marginal tax rates, and left social welfare to the private sector.

In a rational world, progressives, conservatives, and centrists would be able to craft a tax reform compromise that did a little of each of the above and left us all better off.

The bottom line: The scandal over the apparent political bias in the IRS treatment of 501(c)(4) groups is nothing compared to the broader scandal of a tax system that is corrupt and inefficient at every turn. We need to attack the code with an axe. In doing so, we should not to flinch at chopping off the 501(c)s with all their rotten branches.

US CPI Falls at Fastest Rate since 2008, but could it Still be Overstating the Rate of Inflation?

According to data released yesterday by the Bureau of Labor Statistics, the U.S. Consumer Price Index fell in April at an annual rate of -4.35 percent. It was the second consecutive monthly decrease and the fastest rate of decrease since late 2008, when the economy was in free fall.

The April decrease was largely attributable to lower gasoline prices, as have been almost all of the gyrations in the index since the start of the year. The core CPI, which removes its food and energy components, shows much less month-to-month volatility. It rose at an annual rate of 0.6 percent in April, its slowest rate of increase since 2010. The following chart shows that both all-items and core inflation have trended gradually downward over the past two years.



Many people are skeptical of the CPI data published by the BLS. For various reasons, they believe that the true cost of living is rising much faster than the CPI. Given that perceived inflation is generally higher than the CPI indicates, it will come as a surprise to learn that some professional economists think the CPI overstates the rate of inflation, and does so by an increasingly wide margin. >>>Read more

Follow this link to view or download a classroom-ready slideshow with charts of the latest inflation data.

Eurozone woes: France in Recession, Germany on the Skids, but Estonia and Malta are Doing Well

The latest data from Eurostat shows that fewer than half of the eurozone’s economies are now growing. Real GDP in the EZ as a whole was 0.4 percent lower in the first quarter of 2013 than a year earlier. The worst news came from the bloc’s biggest economies: Germany’s growth fell from 0.7 percent Y-o-Y in 2012 to 0.4 percent in Q1 2013. France slipped into negative territory with growth of -0.1 percent.

Prefer to look on the bright side? Tiny Estonia grew by a solid 3 percent, almost enough to offset the headlong dive of Cyprus, which clocked in at -8.7 percent.

Rather let the numbers speak for themselves? Here they are:

 This item was originally posted to Economonitor.com

Why Arguments against Exporting Natural Gas don't Add Up

The energy policy topic of the week is whether to export more of America’s newly abundant natural gas. Like any good card-carrying economist, my instincts favor free trade. Other things being equal, that makes me pro-export. Still, shouldn’t we listen to what the other side has to say? Maybe gas is different. Maybe exporting it is not such a good idea after all. So just how strong is the case against permitting more natural gas exports?

Would low gas prices strengthen the U.S. economy?

Large users of natural gas are among the most vocal opponents of increased exports. Not surprisingly, they argue that today’s gas prices, still only a little above their historic lows, are a boon for the U.S. economy. Speaking recently to Politico, Andrew Liveris, CEO of Dow Chemical, put it this way:

[w]hen natural gas is not solely used as an export, and is used as a building block for manufactured goods, it creates eight times more value across the entire economy. In this way, American’s natural gas bounty is more than a simple commodity. It’s a once-in-a-generation opportunity to export advanced products and not just BTUs.

Unfortunately, pointing out that we could use any exported primary good to make advanced products at home instead does not, by itself, tell us much about whether it should be exported.>>>Read more

US Unemployment Rate Falls to 7.5 Percent, Strong Upward Revisions for Job Growth

The report on the U.S. employment situation for April released today by the Bureau of Labor Statistics contained some good news, with the unemployment rate falling to 7.5 percent, its lowest since late 2008. Payroll jobs rose by a better than expected 165,000, and upward revisions to previous months made job market performance for the late winter look much better than previously reported. Certainly, weak spots remain in the employment situation, but on the whole, the report was stronger than expected.

Although the decrease in the unemployment rate was less than a full percentage point, it was a “good” decrease in that the absolute numbers of unemployed workers fell while both the number of employed workers and the size of the labor force increased. That contrasts with the less favorable situation in March, when the unemployment rate fell only because the labor force decreased faster than the number of workers with jobs. The number of employed workers, as measured by the household survey, increased by 293,000 from March to April. That number differs from the job gain of 165,000 reported in the separate payroll survey partly because of differences in methodology and partly because the payroll survey excludes farm workers and the self-employed. >>>Read more

Follow this link to view or download a classroom-ready slideshow with charts and analysis of the April employment situation

Is the Chained CPI the Right Fix for Social Security?

One of the most controversial elements of President Obama’s 2014 budget is the proposal to reduce future cost-of-living adjustments to Social Security benefits by changing the inflation index. The Social Security Administration now bases inflation adjustments to on the consumer price index for urban wage earners and clerical workers (CPI-W), a close cousin of the more widely publicized CPI for all urban consumers (CPI-U). The administration proposal would instead use a relatively new index called the chained CPI, or C-CPI-U, which, in the past, has increased slightly less rapidly. Predictably, deficit hawks love the idea, while seniors and those who defend their interests hate it. Suppose, though, that we set ideology and interest group politics aside to look at the underlying economics of the issue. On those terms, is the switch to the chained CPI the right fix for Social Security? >>>Read more

US GDP Growth Accelerates from a Crawl to a Walk in Q1

US GDP growth accelerated from a crawl to a walk in the first quarter of 2013, according to the advance estimate issued today by the Bureau of Economic Analysis. The reported annual growth rate of 2.5 percent was just a bit faster than the average rate during the recovery, and much stronger than the 0.4 percent reported for Q4 2012. Compared with yesterday’s news that the British economy had barely escaped a triple-dip recession and that unemployment hit a record high in Spain, the latest numbers position the United States as one of the healthiest of the advanced economies. Behind the headline growth rate, however, some of the details were less encouraging.



Personal consumption expenditure was the most important component of the acceleration. Consumption contributed 2.24 percentage points to the Q1 growth rate, compared to just 1.28 percentage points in Q4. Nearly all of that came from the service sector. Housing services and utilities, recreation, and financial services all showed strong gains. Growth in consumption of goods slowed slightly. >>>Read more

Follow this link to view or download a classroom-ready slideshow with charts and commentary on the latest GDP data