Recessions and the social safety net: The alternative minimum tax as a countercyclical fiscal stabilizer

Stanford Law Review

Volumn 63, Issue 1, 2010, Pages 187-246

  Galle, Brian ^a   Klick, Jonathan ^b  

^a BOSTON COLLEGE   (United States)

^b UNIVERSITY OF PENNSYLVANIA LAW SCHOOL   (United States)

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[No Author keywords available]

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EID: 78650409892     PISSN: 00389765     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Article

References (222)

1. See Yilin Hou, Fiscal Reserves and State Own-Source Expenditure in Downturn Years, 33 PUB. FIN. REV. 117, 123 (2005); David A. Super, Rethinking Fiscal Federalism, 118 HARV. L. REV. 2544, 2609-10 (2005). For a recent empirical demonstration of this point, see Jonathan Rodden & Erik Wibbels, Fiscal Decentralization and the Business Cycle: An Empirical Study of Seven Federations, 22 ECON. & POL. 37 (2010).
2. See, e.g., Michael Cooper, States Face Tough Decisions, N.Y. TIMES, Feb. 19, 2009, at A17; State Budgets in Crisis: Happy New Year, ECONOMIST, July 4, 2009, at 74; Editorial, States in Distress, N.Y. TIMES, Aug. 4, 2009, at A22.
3. Surprisingly, study of the management of the business cycle, known as macroeconomic policy, is almost wholly absent from the legal tax literature. Jeff Strnad's essay discusses the general macroeconomic implications of the tax code. See Jeff Strnad, Some Macroeconomic Interactions with Tax Base Choice, 56 SMU L. REV. 171, 181-99 (2003). Lily Batchelder and her colleagues have analyzed the macroeconomic and other properties of refundable tax credits, but found macroeconomic considerations relatively unimportant. See Lily L. Batchelder et al., Efficiency and Tax Incentives: The Case for Refundable Tax Credits, 59 STAN. L. REV. 23, 61-65 (2006). David Super considers state stabilization efforts as a part of his larger analysis of fiscal ties between the federal government and the states. See Super, supra note 1, at 2610-14. And, in an important recent manuscript, Yair Listokin sets out more comprehensively the significance of federal tax policy for national business cycles. See Yair Listokin, Tax Expenditures and Business Cycle Fluctuations (Yale Law Sch. John M. Olin Ctr. for Studies in Law, Econ., & Pub. Policy, Research Paper No. 378, 2009), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1372782.
4. 26 U.S.C. §§ 55-58 (2006). For an overview of the AMT's complex provisions, see STAFF OF THE JOINT COMM. ON TAXATION, JCX-38-07, PRESENT LAW AND BACKGROUND RELATING TO THE ALTERNATIVE MINIMUM TAX 1-6 (2007), available at http://www.jct.gov/x-38-07.pdf.
5. Our only direct antecedent here is Super, supra note 1, at 2610-14, 2632-37. David Gamage also nicely captures many aspects of states' problems when facing economic hardship, and our analysis follows but expands on his. See David Gamage, Preventing State Budget Crises: Managing the Fiscal Volatility Problem, 98 CALIF. L. REV. 749 (2010).
6. Again, the only other effort we are aware of is a brief passage in Super, supra note 1, at 2650-51, and an unpublished essay by the economist Marianne Vigneault, who studied the stabilization properties of alternative possible versions of Canada's revenue-sharing system. See Marianne Vigneault, The Role of Intergovernmental Transfers in Regional Stabilization and Equalization 10-15 (Feb. 2002) (unpublished manuscript), available at http://www.aucc.ca/pdf/english/programs/cepra/Final%20Paper%20-%20Literature%20 Reviw%20-by%20Vigneault.pdf. Gamage considers a similar but conceptually distinct point: how best to distribute the risk of cyclical changes in the tax system across the population. See Gamage, supra note 5, at 772-91.
7. See WILLIAM J. BAUMOL & ALAN S. BLINDER, ECONOMICS: PRINCIPLES AND POLICY 88-89 (5th ed. 1991). Macroeconomics is the study of whole economies, while microeconomics is the study of individual and group behavior. Id. at 76-77.
8. See id. at 88; DAVID ROMER, ADVANCED MACROECONOMICS 217-59 (2d ed. 2001).
9. See ROMER, supra note 8, at 494-97.
10. We explain this theory in more detail in Part I.
11. See Brian Knight & Arik Levinson, Fiscal Institutions in U.S. States, in INSTITUTIONS, POLITICS AND FISCAL POLICY 167, 176-80 (Rolf R. Strauch & Jürgen von Hagen eds., 2000); Rodden & Wibbels, supra note 1, at 37; Russell S. Sobel & Randall G. Holcombe, The Impact of State Rainy Day Funds in Easing State Fiscal Crises During the 1990-1991 Recession, PUB. BUDGETING & FIN., Fall 1996, at 28; David E. Wildasin, State and Local Government Finance in the Current Crisis: Time for Emergency Federal Relief? 1 (Inst. for Federalism & Intergovernmental Relations, Working Paper No. 2009-07, 2009), available at http://www.ifigr.org/publication/ifir_working_papers/IFIR-WP-2009-07.pdf.
12. We detail the preceding points in Part II.
13. See Hou, supra note 1, at 733 (discussing the procyclicality of state budgeting rules); Rodden & Wibbels, supra note 1, at 37; Teressa Ter-Minassian, Decentralization and Macroeconomic Management 7 (Int'l Monetary Fund, Working Paper No. WP/97/155, 1997), available at http://www.imf.org/external/pubs/ft/wp/wp97155.pdf.
14. See Robert P. Inman, Transfers and Bailouts: Enforcing Local Fiscal Discipline with Lessons from U.S. Federalism, in FISCAL DECENTRALIZATION AND THE CHALLENGE OF HARD BUDGET CONSTRAINTS 35, 45-47 (Jonathan Rodden et al. eds., 2003) (discussing the extraterritorial effects of local fiscal failures).
15. See Wildasin, supra note 11, at 12. Past events demonstrate this relationship as well. See Tamim Bayoumi & Barry Eichengreen, Restraining Yourself: The Implications of Fiscal Rules for Economic Stabilization, 42 IMF STAFF PAPERS 32, 46 (1995) ("[S]tate budgets played a significant role in macroeconomic stabilization in the 1970s and 1980s . . . .").
16. We explain these arguments in depth in Part III.
17. 26 U.S.C. § 164 (2006).
18. See, e.g., Jim Sanders, California Legislature: 1 Month to Battle over Slew of Bills, SACRAMENTO BEE, Aug. 16, 2009, at A1. In earlier recessions, governors pushed for needed tax increases, only to be punished by their electorates. See Super, supra note 1, at 2613 n.267.
19. There is significant disagreement among macroeconomists about the efficacy of using fiscal policy to stimulate economic growth. Some macroeconomists support the view that stimulus is not generally welfare improving. See, e.g., Valerie A. Ramey, Identifying Government Spending Shocks: It's All in the Timing (Nat'l Bureau of Econ. Research, Working Paper No. 15464, 2009), available at http://www.nber.org/papers/w15464 (placing the government spending multiplier, the ratio of resulting consumption per dollar of government spending, somewhere between 0.6 and 1.1). Some macroeconomists also claim that fiscal policy is effective but inferior to using monetary policy to stimulate the economy and improve welfare. E.g., Christina Romer, Changes in Business Cycles: Evidence and Explanations, J. ECON. PERSP., Spring 1999, at 23, 36. Other macroeconomists claim that fiscal policy is the only feasible option to stimulate an economy and improve welfare in a liquidity trap where monetary policy is impotent. See, e.g., Lawrence Christiano et al., When Is the Government Spending Multiplier Large? 1-2 (Nat'l Bureau of Econ. Research, Working Paper No. 15394, 2009), available at http://www.nber.org/papers/w15394.pdf. Even within the last camp, there is disagreement as to whether spending increases or tax cuts are more effecitive as stimulus tools. Compare Gauti B. Eggertsson, What Fiscal Policy Is Effective at Zero Interest Rates? 2 (Fed. Reserve Bank of N.Y., Staff Report No. 402, 2009), available at http://www.ny.frb.org/research/staff_reports/sr402.pdf (concluding that cuts in labor/payroll taxes lead to deflationary pressures, which worsen economic conditions), with Mark Bils & Pete Klenow, Further Discussion of Temporary Payroll Tax Cut During Recession(s) 4 (Dec. 12, 2008) (unpublished manuscript), available at http://klenow.com/Discussion_of_Payroll_ Tax_Cut.pdf (reporting that under their model there are very large gains from cutting payroll taxes). To avoid these very complicated debates, we focus on the social insurance aspects of countercyclical fiscal policy, and we simply note that the AMT's stabilization effects could be important in models that allow for fiscal policy to have a stimulus effect. Even for those readers more interested in macroeconomics per se, our discussion should still be pertinent; since recipients of social insurance may have a higher marginal propensity to consume, they may be important targets of fiscal stimulus. See Strnad, supra note 3, at 195.
20. Sometimes referred to as the "law of diminishing marginal utility," this phenomenon can be modeled using a concave utility function, which is the standard modeling assumption in economics. See ANDREU MAS-COLELL ET AL., MICROECONOMIC THEORY 185 (1995). The assumption that marginal utility is diminishing across the entire population is probably not completely accurate, but it is greatly simplifying. See Joseph Bankman & Thomas Griffith, Social Welfare and the Rate Structure: A New Look at Progressive Taxation, 75 CALIF. L. REV. 1905, 1947 (1987); Richard A. Musgrave, ET, OT, and SBT, 6 J. PUB. ECON. 3, 8-9, 14 (1976).
21. See MAS-COLELL ET AL., supra note 20, at 187-88.
22. It will be useful to distinguish between social insurance and redistribution. Social insurance is aimed at mitigating temporary downturns in an individual's income, whereas redistribution attempts to level the amount of lifetime resources the individual has access to. See Martin Feldstein, Rethinking Social Insurance, 95 AM. ECON. REV. 1, 2-3 (2005). However, at a general level, redistribution can be seen as a form of social insurance. See id. at 2.
23. See, e.g., James M. Poterba & Jürgen von Hagen, Introduction to FISCAL INSTITUTIONS AND FISCAL PERFORMANCE 1, 5 (James M. Poterba & Jürgen von Hagen eds., 1999).
24. See Feldstein, supra note 22, at 4. Note that social insurance necessarily generatescross-subsidization in this context, though under a Rawlsian veil of ignorance individuals may support such cross-subsidies.
25. Beyond private insurance markets, there is evidence that public provision of unemployment insurance crowds out precautionary savings and additional income production in the family. See Julie Berry Cullen & Jonathan Gruber, Does Unemployment Insurance Crowd Out Spousal Labor Supply?, 18 J. LAB. ECON. 546 (2000); Eric M. Engen & Jonathan Gruber, Unemployment Insurance and Precautionary Saving, 47 J. MONETARY ECON. 545 (2001).
26. See, e.g., Jonathan Gruber & Daniel M. Hungerman, Faith-Based Charity and Crowd-Out During the Great Depression, 91 J. PUB. ECON. 1043, 1043 (2007).
27. Although there is evidence of crowd-out here as well. See David M. Cutler & Jonathan Gruber, Does Public Insurance Crowd Out Private Insurance?, 111 Q.J. ECON. 391 (1996).
28. See 7 U.S.C. §§ 2011-2036 (2006) (Supplemental Nutrition Assistance Program); HOME and Low Income Housing Tax Credits (LIHTC), U.S. DEP'T HOUSING & URB. DEV. (June 2, 2010), http://www.hud.gov/offices/cpd/affordablehousing/training/web/lihtc.
29. JAMES M. BUCHANAN & GORDON TULLOCK, THE CALCULUS OF CONSENT 78 (1965).
30. JOHN RAWLS, A THEORY OF JUSTICE 136 (1971).
31. A number of studies find this effect. See, e.g., Richard J. Timpone, Structure, Behavior, and Voter Turnout in the United States, 92 AM. POL. SCI. REV. 145, 149 (1998).
32. See, e.g., Daniel Hewitt, Demand for National Public Goods: Estimates from Surveys, 23 ECON. INQUIRY 487, 503 (1985).
33. Sobel & Holcombe, supra note 11, at 44; Gary A. Wagner & Russell S. Sobel, State Budget Stabilization Fund Adoption: Preparing for the Next Recession or Circumventing Fiscal Restraints?, 126 PUB. CHOICE 177, 180-85 (2006).
34. Rodden & Wibbels, supra note 1, at 56 ("Procyclicality is the rule among provinces and states in federations.").
35. Bayoumi & Eichengreen, supra note 15, at 46; Edward M. Gramlich, Subnational Fiscal Policy, in PERSPECTIVES ON LOCAL PUBLIC FINANCE AND PUBLIC POLICY 3, 4-5 (John M. Quigley ed., 1987); Arik Levinson, Balanced Budgets and Business Cycles: Evidence from the States, 51 NAT'L TAX J. 715, 716 (1998); Rodden & Wibbels, supra note 1, at 42-43 (noting that federal efforts to smooth incomes can be "completely undone by the need for provincial governments to raise taxes or cut expenditures because of flagging revenues").
36. See sources cited supra note 13.
37. Of course, this would only be an attractive strategy if the stimulative effect of the state's spending were greater than the drag on the economy caused by the tax.
38. The normative appeal of rate smoothing derives from the way taxes distort economic behavior. When taxes rise, some productive exchanges do not occur: the equilibrium point shifts to the left on a standard supply/demand curve, leaving a triangular area representing lost welfare gains. RICHARD A. MUSGRAVE & PEGGY B. MUSGRAVE, PUBLIC FINANCE IN THEORY AND PRACTICE 235-36, 279-95 (5th ed. 1989). The welfare losses that result can be calculated by the standard geometric formula for the area of a triangle, (1/2)bh, implying that the loss rises in proportion to the square of the size of the distortion. Id. at 281.
39. See Robert J. Barro, On the Determination of the Public Debt, 87 J. POL. ECON. 940, 943-45 (1979). For instance, instead of hiking rates from 10% to 20% for one year, it might instead borrow, and increase rates to 11% for ten years to pay off the debt. Again, because of the exponential relationship between tax rates and welfare losses, this move would increase the overall welfare of the state.
40. See Torsten Persson & Guido Tabellini, Federal Fiscal Constitutions: Risk Sharing and Redistribution, 104 J. POL. ECON. 979, 988 (1996) (assuming that individuals who are less exposed to risk will prefer lower amounts of social insurance); Rodden & Wibbels, supra note 1, at 42 (arguing that an automatic interpersonal social insurance program would disproportionally favor individuals affected by regional shocks).
41. See, e.g., Joseph P. Kalt & Mark A. Zupan, The Apparent Ideological Behavior of Legislators: Testing for Principal-Agent Slack in Political Institutions, 33 J.L. & ECON. 103, 103-04, 107-08 (1990). Some scholars argue that political conditions in select local governments mitigate this problem. For instance, suburban homeowners in a given jurisdiction may all have relatively similar preferences for the few services their government provides, and their social and geographic proximity may encourage collective action. See WILLIAM A. FISCHEL, THE HOMEVOTER HYPOTHESIS 73-76 (2001). But this is not true of more diverse jurisdictions, such as states, rural counties, suburbs that welcome many new migrants, or large cities. See Richard Briffault, Our Localism: Part II-Localism and Legal Theory, 90 COLUM. L. REV. 346, 400-22 (1990). Even within suburbs, residents may overcome free riding only on issues of special importance to a subset of the whole population, making monitoring haphazard and contingent on the alignment of monitor interests with government performance on that narrow issue. Cf. Jean Tirole, The Internal Organization of Government, 46 OXFORD ECON. PAPERS 1, 3-4 (1994) (describing the difficulties of monitoring an entity that performs variety of services and may succeed at some and fail at others).
42. See Clayton P. Gillette, Can Public Debt Enhance Democracy?, 50 WM. & MARY L. REV. 937, 965-66 (2008).
43. See id. It is well established empirically that taxes affect the location of capital investment. E.g., Michael P. Devereux & Rachel Griffith, Taxes and the Location of Production: Evidence from a Panel of US Multinationals, 68 J. PUB. ECON. 335, 335, 351-58 (1998); Joseph M. Phillips & Ernest P. Goss, The Effect of State and Local Taxes on Economic Development: A Meta-Analysis, 62 S. ECON. J. 320, 320, 323-29 (1995). Evidence that taxes also affect personal choices is less overwhelming, but still substantial. E.g., Richard J. Cebula, Internal Migration Determinants: Recent Evidence, 11 INT'L ADVANCES ECON. RES. 267, 272 (2005) (reporting that the cost of living affects migration patterns); Peter John et al., Residential Mobility in London: A Micro-Level Test of the Behavioural Assumptions of the Tiebout Model, 25 BRIT. J. POL. SCI. 379, 379 (1995) ("Taxes and services are found to be important factors in the moving decision . . . ."); Hui Shan, Property Taxes and Elderly Mobility, 67 J. URB. ECON. 194 (2010) (finding that rising property taxes cause older households to relocate); Donald Bruce et al., Base Mobility and State Personal Income Taxes 18 (Sept. 2008) (unpublished manuscript), available at http://cber.utk.edu/confpapers/Bruc_Fox_Yang.pdf ("[T]axpayers with pension income prefer lower-tax-rate states . . . ."); Elda Pema, Do State Taxes Affect the Migration of Human Capital? (unpublished manuscript), available at https://www.msu.edu/~pemaelda/E_Pema-Taxes%20and%20Human%20Capital.pdf (finding that more educated households are also more responsive to local taxes, affecting migration rates).
44. See Clayton P. Gillette, Local Redistribution, Living Wage Ordinances, and Judicial Intervention, 101 NW. U. L. REV. 1057, 1082-84 (2007); Saul Levmore, Interstate Exploitation and Judicial Intervention, 69 VA. L. REV. 563, 571-72, 601 (1983). Note that this implies that states with larger locational surplus-generally more densely populated and more urban jurisdictions-will be more capable of stabilization spending.
45. See Roberta Romano, Law as a Product: Some Pieces of the Incorporation Puzzle, 1 J.L. ECON. & ORG. 225, 235-36 (1985).
46. In theory states could overcome the exit problem by coordinated action, but both theory and observation suggest that will be rare. If all states face equal need for stabilization spending, and all raise taxes together, the exit dilemma disappears, because no state is more or less of a bargain than it was before the crisis, all else being equal. That is an extreme and implausible scenario, but it may retain a significant grain of truth regionally. See Ravi Kanbur & Michael Keen, Jeux Sans Frontières: Tax Competition and Tax Coordination When Countries Differ in Size, 83 AM. ECON. REV. 877, 879-81 (1993). If neighboring states are affected in relatively similar fashion, and relocating out of the affected region is expensive, then only clusters of states need act together, rather than all fifty at once. Still, most scholars believe that coordinated tax raising will be rare, because the benefits of defection are high. This dynamic produces a prisoner's dilemma in which states must cut taxes to attract mobile taxpayers, even if that strategy loses revenues. See Dan T. Coenen, Business Subsidies and the Dormant Commerce Clause, 107 YALE L.J. 965, 1025-26 (1998); Kelly Edmiston, Strategic Apportionment of the State Corporate Income Tax: An Applied General Equilibrium Analysis, 55 NAT'L TAX J. 239, 251 (2002). These theories have some empirical support. Robert C. Turner & Mark Cassell, Racing to the Bottom at Different Speeds? The Impact of Intra-State Competition on Abatement Generosity in Ohio (2009) (unpublished manuscript), available at http://www.skidmore.edu/~bturner/Racing%20to% 20the%20Bottom%20at%20Different%20Speeds%20Turner%20and%20Cassell.pdf. There is no obvious reason the situation would be different for stabilization spending.
47. See Barry R. Weingast et al., The Political Economy of Benefits and Costs: A Neoclassical Approach to Distributive Politics, 89 J. POL. ECON. 642, 648 (1981) (arguing that legislators award pecuniary gains to discrete individuals and groups in order to "claim credit and exact tribute").
48. See GEOFFREY BRENNAN & JAMES BUCHANAN, THE POWER TO TAX: ANALYTICAL FOUNDATIONS OF A FISCAL CONSTITUTION 178 (1980).
49. See William W. Bratton & Joseph A. McCahery, The New Economics of Jurisdictional Competition: Devolutionary Federalism in a Second-Best World, 86 GEO. L.J. 201, 264-65 (1997); Gillette, supra note 42, at 966; see also Emmanuelle Reulier & Yvon Rocaboy, Regional Tax Competition: Evidence from French Regions, 43 REGIONAL STUD. 915 (2009) (finding that the main source of pressure on individual income tax rates in competing localities is the ability of individuals to compare their own rates against those of their neighbors' and threaten to punish underperforming officials).
50. For an overview of the dynamics of public borrowing, see William W. Bratton & G. Mitu Gulati, Sovereign Debt Reform and the Best Interest of Creditors, 57 VAND. L. REV. 1, 8-25 (2004).
51. For empirical evidence that states face difficulty borrowing, see Douglas Holtz-Eakin et al., Intertemporal Analysis of State and Local Government Spending: Theory and Tests, 35 J. URB. ECON. 159 (1994); and Wildasin, supra note 11, at 13 (summarizing other studies).
52. See Robert J. Barro, Are Government Bonds Net Wealth?, 82 J. POL. ECON. 1095, 1096 (1974).
53. ROMER, supra note 8, at 537; John J. Seater, Ricardian Equivalence, 31 J. ECON. LITERATURE 142, 142 (1993).
54. For discussion of the points in this paragraph, see ROMER, supra note 8, at 537-41; Tamim Bayoumi & Paul R. Masson, Liability-Creating Versus Non-Liability-Creating Fiscal Stabilisation Policies: Ricardian Equivalence, Fiscal Stablisation, and EMU, 108 ECON. J. 1026, 1028 (1998); Robert P. Inman, Public Debts and Fiscal Politics: How to Decide?, 80 AM. ECON. REV. 81, 84 (1990); and Seater, supra note 53, at 144-56.
55. For example, one comprehensive survey claims that equivalence is a close approximation of reality, see Seater, supra note 53, at 156-84 (reviewing dozens of studies), while another survey claims to find "strong evidence against" equivalence, T.D. Stanley, New Wine in Old Bottles: A Meta-Analysis of Ricardian Equivalence, 64 S. ECON. J. 713, 713-14 (1998).
56. See Clayton P. Gillette, Direct Democracy and Debt, 13 J. CONTEMP. LEGAL ISSUES 365, 391 (2004); Inman, supra note 54, at 83.
57. See Gillette, supra note 56, at 391; Inman, supra note 54, at 83. For instance, if my ten-unit condo association borrows $100,000 to replace the roof of my building at a market rate of interest, the loan will reduce the resale price of each unit by about $10,000. Empirical evidence suggests that capitalization is usually incomplete, however. See Gillette, supra note 56, at 392 (summarizing studies).
58. See Inman, supra note 54, at 83.
59. See Gillette, supra note 56, at 392; Inman, supra note 54, at 83-84.
60. See Bayoumi & Masson, supra note 54, at 1028; Inman, supra note 54, at 84 n.4.
61. See Gillette, supra note 42, at 959-60; Inman, supra note 54, at 84 n.4. We claim that renters do not bear the burden of future debt on the assumption that there is a relationship between property values and rents. Over the long term, when housing costs rise, so do rents. Joshua Gallin, The Long-Run Relationship Between House Prices and Rents, 36 REAL EST. ECON. 635, 636 (2008). So lower home values should result in lower rents, which means that public debt actually benefits renters.
62. See Gillette, supra note 42, at 961; Inman, supra note 54, at 84.
63. See Gillette, supra note 42, at 971.
64. See Gillette, supra note 42, at 971.
65. See Gillette, supra note 56, at 976-77; Ehtisham Ahmad et al., Subnational Public Financial Management: Institutions and Macroeconomic Considerations 13 (Int'l Monetary Fund, Working Paper No. 05/108, 2005), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=887977.
66. See David E. Wildasin, Externalities and Bailouts: Hard and Soft Budget Constraints in Intergovernmental Fiscal Relations 1, 20-22 (World Bank Dev. Research Grp., Working Paper No. 1843, 1997), available at http://ideas.repec.org/p/wbk/wbrwps/1843.html (modeling the argument that larger subnational governments are more likely to receive bailouts).
67. Cf. Inman, supra note 14, at 45-53 (describing the intergovernmental impacts of defaults).
68. See, e.g., Wallace E. Oates, On the Theory and Practice of Fiscal Decentralization, in INSTITUTIONAL FOUNDATIONS OF PUBLIC FINANCE: ECONOMIC AND LEGAL PERSPECTIVES 165, 176 (Alan J. Auerbach & Daniel N. Shaviro eds., 2008); Jonathan Rodden, The Dilemma of Fiscal Federalism: Grants and Fiscal Performance Around the World, 46 AM. J. POL. SCI. 670, 671-72 (2002); Andres Velasco, Debts and Deficits with Fragmented Fiscal Policymaking, 76 J. PUB. ECON. 105, 107 (2000). Robert Inman argues, though, that the United States has generally resisted bailouts, although he acknowledges some prominent recent exceptions. Inman, supra note 14, at 59-61.
69. See Rodden, supra note 68, at 671-72; Velasco, supra note 68, at 107; Ahmad et al., supra note 65, at 12-13.
70. See, e.g., BRENNAN & BUCHANAN, supra note 48, at 24-32, 40; Susanne Lohmann & Deborah M. Weiss, Hidden Taxes and Representative Government: The Political Economy of the Ramsey Rule, 30 PUB. FIN. REV. 579, 584-86, 605 (2002) (suggesting that taxation and budgeting may be driven by political manipulation of ignorant voters).
71. See Brian E. Dollery & Andrew C. Worthington, The Empirical Analysis of Fiscal Illusion, 10 J. ECON. SURVS. 261, 293-94 (1996); Wallace E. Oates, On the Nature and Measurement of Fiscal Illusion: A Survey, in TAXATION AND FISCAL FEDERALISM: ESSAYS IN HONOUR OF RUSSELL MATHEWS 65, 76-77 (Geoffrey Brennan et al. eds., 1988).
72. See Sumit Agarwal et al., The Age of Reason: Financial Decisions over the Life Cycle and Implications for Regulation, BROOKINGS PAPERS ON ECON. ACTIVITY, Fall 2009, at 51, 53 (reporting that younger and older individuals pay interest rates that "are not explained by differences in observed risk characteristics"); Paul S. Calem & Loretta J. Mester, Consumer Behavior and the Stickiness of Credit-Card Interest Rates, 85 AM. ECON. REV. 1327, 1327-28, 1333 (1995) (finding evidence that consumers are impatient or misestimate their future borrowing behavior, leading to excessive present costs); David Laibson et al., A Debt Puzzle, in KNOWLEDGE, INFORMATION, AND EXPECTATIONS IN MODERN MACROECONOMICS: IN HONOR OF EDMUND S. PHELPS 228, 228-29 (Philippe Aghion et al. eds., 2003).
73. Compare Jonathan Klick & Gregory Mitchell, Government Regulation of Irrationality: Moral and Cognitive Hazards, 90 MINN. L. REV. 1620, 1626 (2006) (suggesting that government correction of consumer errors may lower welfare in the long run by reducing incentives for consumers to change themselves), with Brian Galle, Federal Fairness to State Taxpayers: Irrationality, Unfunded Mandates, and the "SALT" Deduction, 106 MICH. L. REV. 805, 818-23 (2008) (arguing that Klick and Mitchell assume that consumers would have the power to change their own behavior without government intervention).
74. See Richard Briffault, Foreword: The Disfavored Constitution: State Fiscal Limits and State Constitutional Law, 34 RUTGERS L.J. 907, 917-18 (2003); Clayton Gillette, Fiscal Federalism and the Use of Municipal Bond Proceeds, 58 N.Y.U. L. REV. 1030, 1062-63 (1983); Inman, supra note 54, at 82.
75. Timothy Besley & Anne Case, Political Institutions and Policy Choices: Evidence from the United States, 41 J. ECON. LITERATURE 7, 54-56 (2003); see also James M. Poterba, State Responses to Fiscal Crises: The Effects of Budgetary Institutions and Politics, 102 J. POL. ECON. 799, 818 (1994) (finding that proximity to the next election affected governors' choices of how to balance budget). Creditors are also a potential source of restraint on borrowing, Gillette, supra note 42, at 942, but the goals of creditors rarely match those of constituents, and many creditors have only weak incentives to monitor local governments. See id. at 972, 975-81; see also Ter-Minassian, supra note 13, at 10 (arguing that officials are insensitive to credit market discipline).
76. Timothy Besley & Anne Case, Incumbent Behavior: Vote-Seeking, Tax-Setting, and Yardstick Competition, 85 AM. ECON. REV. 25, 28-30 (1995). But see Gillette, supra note 42, at 958-59 (arguing that government services are too difficult to compare for interjurisdictional competition to be meaningful).
77. See Ahmad et al., supra note 65, at 12. As Inman explains, capitalization likely fails to restrain these exit-driven pressures to borrow, since rational home buyers will each free ride on one another's efforts to verify future debt burdens. See Inman, supra note 14, at 50-51.
78. See Knight & Levinson, supra note 11, at 169-70 tbl.1; Levinson, supra note 35, at 717.
79. Briffault, supra note 74, at 915-16.
80. See James M. Poterba, Budget Institutions and Fiscal Policy in the U.S. States, 86 AM. ECON. REV. 395, 396 (1996) (listing states' usual options for mitigating fiscal restraints, none of which are related to business cycle); see also Levinson, supra note 35, at 717-19 (same, and noting that restraints on state budget rules may in fact "exacerbate" the impact of business cycles on states).
81. See Briffault, supra note 74, at 917-18, 948 (discussing the reasons for state constitutional limits on spending).
82. See id. at 909, 918-25.
83. See id at 919-22.
84. Id. at 918-19.
85. See, e.g., Bayoumi & Eichengreen, supra note 15, at 33, 40-41, 46; see also James Poterba, Do Budget Rules Work?, in FISCAL POLICY: LESSONS FROM ECONOMIC RESEARCH 53, 75-77 (Alan J. Auerbach ed., 1997) (collecting studies). But see Robert Krol & Shirley Svorny, Budget Rules and State Business Cycles, 35 PUB. FIN. REV. 530, 541 (2007). Krol and Svorny reach contrary results by relying on a different definition of what constitutes a strict budget constraint. They employ an index devised by Government Accountability Office (GAO) lawyers, and eschew the state official self-reporting that was the basis for other studies. Id. at 532, 534-35. They do not verify the GAO's work. We find state self-reporting more persuasive, because officials will probably know the reality of their own budget constraints. Research assistants working at the GAO may easily have read what appears in a statute to be a strict state rule as strict, when in reality it has been judicially undermined or is easily circumvented.
86. See Briffault, supra note 74, at 926; James M. Poterba, Balanced Budget Rules and Fiscal Policy: Evidence from the States, 48 NAT'L TAX J. 329, 334-35 (1995); see also Poterba, supra note 75, at 804-18 (finding that even states with strict budget limits are able to adjust to fiscal shocks, but that more binding limits have larger effects on state spending).
87. Sobel & Holcombe, supra note 11, at 28.
88. Sobel & Holcombe, supra note 11 at 29-30.
89. See Martin Browning & Annamaria Lusardi, Household Saving: Micro Theories and Micro Facts, 34 J. ECON. LITERATURE 1797, 1799-812 (1996) (discussing saving and borrowing as alternative tools for income smoothing).
90. See, e.g., Sobel & Holcombe, supra note 11, at 28, 30, 43-45; Super, supra note 1, at 2642-43.
91. See Sobel & Holcombe, supra note 11, at 33; Super, supra note 1, at 2611.
92. See Lars P. Feld & Gebhard Kirchgässner, Does Direct Democracy Reduce Public Debt? Evidence from Swiss Municipalities, 109 PUB. CHOICE 347, 350 (2001); Super, supra note 1, at 2611.
93. Cf. Gillette, supra note 42, at 955 (making this point about monitoring the misuse of public funds).
94. See Super, supra note 1, at 2636, 2648-49 (suggesting a larger federal role in social insurance).
95. For an overview, see George R. Zodrow, Reflections on the Economic Theory of Local Tax Incentives, 28 ST. TAX NOTES 891, 893-94 (2003).
96. See Wallace E. Oates, Fiscal Competition and European Union: Contrasting Perspectives, 31 REGIONAL SCI. & URB. ECON. 133, 133-43 (2001) (discussing the benefits and drawbacks of a tax system with multiple competing sovereigns rather than a single central authority); John Douglas Wilson & David E. Wildasin, Capital Tax Competition: Bane or Boon?, 88 J. PUB. ECON. 1065, 1088 (2004) (same); George R. Zodrow, Tax Competition and Tax Coordination in the European Union, 10 INT'L TAX & PUB. FIN. 651, 651-66 (2003) (same).
97. See MUSGRAVE & MUSGRAVE, supra note 38, at 451; Mariano Tommasi & Frederico Weinschelbaum, Centralization vs. Decentralization: A Principal-Agent Analysis, 9 J. PUB. ECON. THEORY 369, 378, 380 (2007). We think this story is more persuasive as to social insurance than for redistribution generally. There is little direct evidence individuals choose where to live based on their preference for redistribution. However, risk preferences, and hence preferences for insurance, are correlated strongly with wealth. See Lawrence Blume & Daniel L. Rubinfeld, Compensation for Takings: An Economic Analysis, 72 CALIF. L. REV. 569, 603-04 (1984). There is strong evidence that individuals are geographically segregated by wealth. See CHARLES M. HAAR, SUBURBS UNDER SIEGE: RACE, SPACE, AND AUDACIOUS JUDGES 5 (1996); Douglas S. Massey & Mary J. Fischer, The Geography of Inequality in the United States, 1950-2000, in BROOKINGS-WHARTON PAPERS ON URBAN AFFAIRS 1, 6-29 (2003).
98. See Torsten Persson & Guido Tabellini, Federal Fiscal Constitutions: Risk Sharing and Moral Hazard, 64 ECONOMETRICA 623, 629-35 (1996); cf. Pablo Sanguinetti & Mariano Tommasi, Intergovernmental Transfers and Fiscal Behavior: Insurance Versus Aggregate Discipline, 62 J. INT'L ECON. 149, 153-54 (2004) (noting that federal guarantees induce fiscal recklessness by local governments). We note that the possibility of moral hazard assumes asymmetric information between the central and regional governments: that is, if the federal government had perfect information about local finances and policies, it could set a subsidy rule that would eliminate opportunities for self-serving behavior by local officials. But, of course, that is essentially impossible. See Ben Lockwood, Inter-Regional Insurance, 72 J. PUB. ECON. 1, 2 (1999).
99. See Oates, supra note 68, at 176-77; Rodden, supra note 68, at 672.
100. See Sanguinetti & Tomassi, supra note 98, at 151. As Persson and Tabellini note, this incentive can be mitigated by offering additional subsidies to local governments to invest in risk-reducing activity, but this requires that the federal government be able to verify that these risk-reducing grants are used as intended. See Persson & Tabellini, supra note 98, at 642-43. This seems a bleak possibility to us, because the difficulty of verifying local conditions is exactly what leads to moral hazard in the first place. See Timothy J. Goodspeed & Andrew Haughwout, On the Optimal Design of Disaster Insurance in a Federation 14-19 (Ctr. for Econ. Studies Info. & Forschung, Working Paper No. 1888, 2007), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=959998 (arguing that the federal government cannot observe state precautionary efforts closely enough to set the correct subsidy amount and cannot commit politically to withholding aid from areas that fail to invest in disaster prevention). We note that additional incentives to take on risky new policies might be desirable to the extent that such policies are undersupplied by the political market. See Brian Galle & Joseph Leahy, Laboratories of Democracy? Policy Innovation in Decentralized Governments, 58 EMORY L.J. 1333, 1341-98 (2009) (considering whether local governments innovate suboptimally). But calibrating federal social insurance to provide the correct amount of additional risk taking seems a challenging task.
101. See Oates, supra note 68, at 176.
102. For an introduction to federal grant programs, see THOMAS R. DYE, AMERICAN FEDERALISM: COMPETITION AMONG GOVERNMENTS 99-115 (1990).
103. See Lockwood, supra note 98, at 14 (finding that the optimal stabilization grant under asymmetric information provides only partial insurance); cf. WILLARD G. MANNING & M. SUSAN MARQUIS, RAND CORP., HEALTH INSURANCE: THE TRADE-OFF BETWEEN RISK POOLING AND MORAL HAZARD 31 (1989) (arguing that partial personal liability of the insured will counterbalance moral hazard of health insurance policies); Martin S. Feldstein, The Welfare Loss of Excess Health Insurance, 81 J. POL. ECON. 251 (1973) (same).
104. See Bayoumi & Masson, supra note 54, at 1027.
105. See id. at 1030.
106. See Michael C. Dorf & Charles F. Sabel, A Constitution of Democratic Experimentalism, 98 COLUM. L. REV. 267, 313 (1998).
107. See Robert Tannenwald, Fiscal Disparity Among the States Revisited, NEW ENG. ECON. REV., July-Aug. 1999, at 3, 4. "Tax exporting" refers to a local tax system in which the incidence of the tax is borne by outsiders. See generally Charles E. McLure, Jr., The Interstate Exporting of State and Local Taxes: Estimates for 1962, 20 NAT'L TAX J. 49 (1967) (describing the phenomenon of tax exporting and measuring its extent).
108. Cf. Levinson, supra note 35, at 724 (describing unintentional cross-border effects of fiscal stimulus efforts).
109. See Daniel Shaviro, An Economic and Political Look at Federalism in Taxation, 90 MICH. L. REV. 895, 957-58 (1992).
110. See Thomas Aronsson & Magnus Wikstrom, Optimal Taxation and Risk-Sharing Arrangements in an Economic Federation, 55 OXFORD ECON. PAPERS 104, 105 (2003); Gillette, supra note 74, at 1055-56, 1059; Oates, supra note 68, at 175; Michael Smart, Taxation and Deadweight Loss in a System of Intergovernmental Transfers, 31 CANADIAN J. ECON. 189, 205-06 (1998).
111. See Sanguinetti & Tommasi, supra note 98, at 167.
112. See 2 DEP'T OF THE TREASURY, TAX REFORM FOR FAIRNESS, SIMPLICITY, AND ECONOMIC GROWTH 63-64 (1984); Gillette, supra note 74, at 1059; Edward M. Gramlich, Federalism and Federal Deficit Reduction, 40 NAT'L TAX J. 299, 305 (1987).
113. Brian Galle, Federal Grants, State Decisions, 88 B.U. L. REV. 875, 931-34 (2008).
114. See Weingast et al., supra note 47, at 656.
115. Super, supra note 1, at 2587-88; see Hou, supra note 1, at 123. This problem cannot be circumvented by using block grants. Block grants reduce the need for state contributions, but that means there will also be greater moral hazard. See Super, supra note 1, at 2589-90.
116. See Super, supra note 1, at 2610.
117. See, e.g., Strnad, supra note 3, at 179-80; Wildasin, supra note 11, at 9; see also John B. Taylor, The Lack of an Empirical Rationale for a Revival of Discretionary Fiscal Policy, 99 AM. ECON. REV. PAPERS & PROC. 550, 550 (noting the consensus of earlier economists on this point) (2009); Vigneault, supra note 6, at 14.
118. See Strnad, supra note 3, at 180; Super, supra note 1, at 2608; Vigneault, supranote 6, at 14.
119. See, e.g., Strnad, supra note 3, at 180.
120. See Romer, supra note 19, at 37.
121. We are grateful to Jeff Strnad for highlighting this point.
122. In fact, conventional wisdom is that because of delays in tax collection and real estate assessments, budget deficits lag downturns. See Rodden & Wibbels, supra note 1, at 57.
123. Rodden and Wibbels find some data to suggest that central government officials may also deliberately reduce their support for states during downturns in order to avoid bearing the political cost of revenue shortfalls. See id. at 51-52; cf. Jonathan R. Macey, Federal Deference to Local Regulators and the Economic Theory of Regulation: Toward a Public-Choice Explanation of Federalism, 76 VA. L. REV. 265, 284-90 (1990) (suggesting that the federal government delegates power to lower tiers in order to avoid costly political decisions). Some commentators have suggested that grant programs based on formulae, such as a state's unemployment rate, can function as automatic stabilizers. See, e.g., Super, supra note 1, at 2650-51. We favor more traditional stabilizers, on the view that in practice these automatic formulae are also subject to lobbying, interpretation, and inexact targeting. See Ter-Minassian, supra note 13, at 11 (noting that formulae may encourage gaming and manipulation of measurement criteria). However, we do not mean to suggest that the two are mutually incompatible.
124. See Alan J. Auerbach & Daniel Feenberg, The Significance of Federal Taxes as Automatic Stabilizers, J. ECON. PERSP., Summer 2000, at 37.
125. See id.; Strnad, supra note 3, at 180.
126. See Listokin, supra note 3, at 10-22.
127. See id. at 18-20.
128. See STAFF OF THE JOINT COMM. ON TAXATION, supra note 4, at 2.
129. See id. at 19.
130. See id. at 2.
131. See id. at 21.
132. See 26 U.S.C. §§ 63(c)(2), 151 (2006); Rev. Proc. 2009-50 § 3.11, 2009-45 I.R.B. 617, 622.
133. AMT Parameters, 1993-2009, TAX POL'Y CENTER (Dec. 28, 2009), http://www.taxpolicycenter.org/taxfacts/displayafact.cfm?Docid=539.
134. STAFF OF THE JOINT COMM. ON TAXATION, supra note 4, at 7.
135. See AMT Parameters, 1993-2009, supra note 133.
136. See STAFF OF THE JOINT COMM. ON TAXATION, supra note 4, at 7.
137. Our example assumes (counterfactually) that Klick is unmarried.
138. See STAFF OF THE JOINT COMM. ON TAXATION, supra note 4, at 20.
139. See 26 U.S.C. § 56 (2006) (limiting certain other tax preferences under the AMT); id. § 106(a) (employer-provided health insurance premiums); id. § 162(a) (trade or business expenses); id. § 163(h) (home mortgage interest).
140. See Greg Leiserson & Jeffrey Rohaly, The Individual Alternative Minimum Tax: Historical Data and Projections, TAX POL'Y CENTER, 6 (June 2008), http://www.taxpolicycenter.org/uploadedpdf/411703_individual_amt.pdf. The SALT deduction has become somewhat less dominant as incomes have crept up above the AMT's personal exemption amount, owing to the fact that large state tax bills areusually the product of large incomes. See STAFF OF THE JOINT COMM. ON TAXATION, supra note 4, at 17. That is, because the AMT now affects households with lower incomes than it once did, deductions and exemptions that are more common in low-income households have gained significance.
141. See STAFF OF THE JOINT COMM. ON TAXATION, supra note 4, at 18 tbl.4.
142. See Charles E. McClure, Jr. & George R. Zodrow, Treasury I and the Tax Reform Act of 1986: The Economics and Politics of Tax Reform, J. ECON. PERSP., Summer 1987, at 37, 55.
143. Kirk J. Stark, Fiscal Federalism and Tax Progressivity: Should the Federal Income Tax Encourage State Redistribution?, 51 UCLA L. REV. 1389, 1414 (2004).
144. 26 U.S.C. § 164(b)(5) (2006). A use tax is a mirror image of the sales tax, but is imposed on the out-of-state purchase of goods. See Walter Hellerstein, Jurisdiction to Tax Income and Consumption in the New Economy: A Theoretical and Comparative Perspective, 38 GA. L. REV. 1, 20 (2003). For an interesting analysis of the complex interaction between the sales tax election and other choices, see Herwig Schlunk, Why Every State Should Have an Income Tax (and Retail Sales Tax, Too), 78 MISS. L.J. 637, 677-81 (2009).
145. In making this claim, we do not intend also to take a position on whether the SALT deduction can be justified as a matter of the normative definition of the ideal tax base. For further discussion of that issue, see Galle, supra note 73.
146. See Lawrence B. Lindsey, Federal Deductibility of State and Local Taxes: A Test of Public Choice by Representative Government, in FISCAL FEDERALISM: QUANTITATIVE STUDIES 137, 169 (Harvey S. Rosen ed., 1988).
147. Studies finding higher revenues from deductible categories include Douglas Holtz-Eakin & Harvey Rosen, Federal Deductibility and Local Property Tax Rates, 27 J. URB. ECON. 269, 270 (1990); Edward M. Gramlich, The Deductibility of State and Local Taxes, 38 NAT'L TAX J. 447, 453-58 (1985); and those surveyed in Bruce Bartlett, The Case for Eliminating Deductibility of State and Local Taxes, 28 TAX NOTES 1121, 1122-23 (1985). Those pressing the tax-base-shifting argument, albeit without any empirical evidence, include George R. Zodrow, Eliminating State and Local Tax Deductibility: A General Equilibrium Model of Revenue Effects, in FISCAL FEDERALISM: QUANTITATIVE STUDIES 177 (Harvey S. Rosen ed., 1988); and Martin S. Feldstein & Gilbert E. Metcalf, The Effect of Federal Tax Deductibility on State and Local Taxes and Spending, 95 J. POL. ECON. 710 (1987). The AMT was not empirically significant during this period. See Leiserson & Rohaly, supra note 140, at 10 tbl.2 (showing that total number of taxpayers nationwide subject to the AMT was 430,000 in 1985 and 200,000 in 1990, compared to 33.4 million today). A subsequent study purported to find evidence that deductibility led states simply to shift tax bases without also increasing overall tax revenues. See Paul N. Courant & Edward M. Gramlich, The Impact of the Tax Reform Act of 1986 on State and Local Fiscal Behavior, in DO TAXES MATTER? THE IMPACT OF THE TAX REFORM ACT OF 1986, at 243, 244-63 (Joel Slemrod ed., 1990). Kaplow, reviewing the various data, calls the evidence for the shifting theory "conflicting." Louis Kaplow, Fiscal Federalism and the Deductibility of State and Local Taxes Under the Federal Income Tax, 82 VA. L. REV. 413, 487 & n.206 (1996). The Courant and Gramlich study provides unconvincing evidence that deductibility cannot increase revenues because the study could not control for several possible confounding factors. Courant and Gramlich studied the effect of the 1986 repeal of federal deductibility of state and local sales taxes. See Courant & Gramlich, supra, at 244. At the same time, federal marginal rates changed dramatically, greatly altering the value of deductibility. See Stephen H. Pollock, Mechanisms for Exporting the State Sales Tax Burden in the Absence of Federal Deductibility, 44 NAT'L TAX J. 297, 297-99 (1991). And, too, sales taxes are both hard to deduct (such that their prior deductibility may have been more theoretical than real) and uniquely useful as a means for tax exporting. See id. at 297-99, 306. Thus, looking only at the 1986 change offers at best mixed information about the importance of deductibility for other revenue sources. See Gilbert E. Metcalf, Deductibility and Optimal State and Local Fiscal Policy, 39 ECON. LETTERS 217, 221 (1992). So loss of deductibility might well present a much more serious blow to state revenues for other forms of tax.
148. See supra notes 37-39 and accompanying text.
149. The figure simplifies reality somewhat. In actuality, only some taxpayers will benefit from the SALT deduction even in severe downturns, so that effective rates for other earners will increase if the jurisdiction raises rates across the board. Normatively, then, the jurisdiction in crisis should aim to limit tax rate increases for those who remain subject to the AMT, unless those earners exhibit little elasticity in their response to a higher rate. As a practical matter, however, it will likely be difficult to change rates selectively only for those spared the AMT, which is one reason we write that the AMT/SALT pairing only mitigates state tax constraints.
150. AMT Preference Items 2002, 2004-2007, TAX POL'Y CENTER (July 27, 2010), http://www.taxpolicycenter.org/taxfacts/displayafact.cfm?Docid=468. For a complete listing and explanation of each provision, see STAFF OF THE JOINT COMM. ON TAXATION, supra note 4, at 2-4.
151. See STAFF OF THE JOINT COMM. ON TAXATION, supra note 4, at 17-18 & tbl.4 (reporting that in 2007, 42.7% of AMT payers lost personal exemptions they could have claimed under the standard income tax).
152. See id. at 18 tbl.3 (stating that in 2007, under two million taxpayers lost "other preferences and adjustments," including the home equity interest deduction).
153. See id. at 18 tbl.4.
154. See 26 U.S.C. § 151(d)(1), (4) (2006) (setting amount at $2000 in 1989 dollars, adjusted for inflation).
155. Leonard E. Burman, The Alternative Minimum Tax: Assault on the Middle Class, MILKEN INST. REV., Fourth Quarter 2007, at 12, 14, available at http://www.urban.org/UploadedPDF/1001113_Burman_AMT.pdf.
156. See David S. Johnson et al., Household Expenditure and the Income Tax Rebates of 2001, 96 AM. ECON. REV. 1589, 1597 tbl.2 (2006). Families with dependent children may also have increased demand for local government services, such as schools and public safe
157. 26 U.S.C. § 163(h)(3)(C) (2006).
158. 26 U.S.C. § 56(b)(1)(C) (2006).
159. See STAFF OF THE JOINT COMM. ON TAXATION, supra note 4, at 18 tbl.4. However, the total dollar value of the miscellaneous lost deduction in 2007 was more than eight billion dollars. Id. at tbl.3.
160. See Listokin, supra note 3, at 16.
161. See Wallace E. Oates, The Effects of Property Taxes and Local Public Spending on Property Values: An Empirical Study of Tax Capitalization and the Tiebout Hypothesis, 77 J. POL. ECON. 957, 966-67 (1969).
162. See Julie Roin, The Consequences of Undoing the Federal Income Tax, 70 U. CHI. L. REV. 319, 331 (2003).
163. STAFF OF THE JOINT COMM. ON TAXATION, supra note 4, at 12.
164. See id.
165. Public SOI data include the AMT data beginning only in 2004. State-level individual income tax data are collected at SOI Tax Stats-Historic Table 2, IRS.GOV, http://www.irs.gov/taxstats/article/0,id=171535,00.html (last updated Sept. 2, 2010).
166. Note that for the graphs that follow, a similar picture emerges if one conditions on average state tax rates, suggesting that this correlation is not simply the result of high income states having higher tax rates.
167. Note that the cluster of observations with very low AMT shares, but high per capita GDP, represent Delaware, which has a relatively low tax burden despite the relatively high state income levels. See Delaware's State and Local Tax Burden, 1977-2008, TAX FOUND. (Aug. 27, 2008), http://www.taxfoundation.org/taxdata/show/446.html.
168. That is, for two states with identical income, the one with a higher total AMT liability spends less on social insurance.
169. These data come from the Survey of State Government Finances, U.S. CENSUS BUREAU, http://www.census.gov/govs/state (last updated July 15, 2010). We view education as social insurance because, among other reasons, retraining (for adults) and investing in a child's future income are both household responses to the loss of employment for one of its current earners.
170. For a discussion of the relationship between sample size and statistical power, see MICHAEL O. FINKELSTEIN & BRUCE LEVIN, STATISTICS FOR LAWYERS 182 (2d ed. 2001).
171. CPI data are available at Consumer Price Index, BUREAU LAB. STAT., http://www.bls.gov/cpi/data.htm (last visited Sept. 6, 2010). Prices from 1982-1984 provide the base year for price comparisons.
172. See JOSHUA D. ANGRIST & JÖRN-STEFFEN PISCHKE, MOSTLY HARMLESS ECONOMETRICS: AN EMPIRICIST'S COMPANION 92 (2009).
173. For a discussion of this problem, see Marianne Bertrand et al., How Much Should We Trust Differences-in-Differences Estimates?, 119 Q.J. ECON. 249 (2004).
174. These problems and their solution are discussed in A. Colin Cameron, Jonah B. Gelbach, & Douglas L. Miller, Robust Inference with Multi-way Clustering (UC Davis Dep't of Econ., Working Paper No. 09-9, 2009), available at http://www.econ.ucdavis.edu/working_papers/09-9.pdf.
175. See infra text accompanying notes 183-193.
176. Additionally, at very low income levels AMT payers pay little in state tax, see supra note 140, and therefore the AMT is unlikely to affect their views of state tax levels.
177. Thus, states in roughly the top one-sixth of the national distribution of AMT liability would spend 8% less on social insurance annually than the median state-tens of millions of dollars each year. One might assume that some of this effect will be countered by the income effect, which implies that as more individuals fall under the AMT, incomes are rising, leading to increased support for public spending. While this is possible, this counteracting income effect need not be present because the income effect is based on real income and the AMT is not indexed for inflation.
178. State & Local Government Finance, U.S. CENSUS BUREAU, http://www.census.gov/govs/estimate/ (last visited Oct. 11, 2010).
179. See JEFFREY M. WOOLDRIDGE, INTRODUCTORY ECONOMETRICS: A MODERN APPROACH 518 (4th ed. 2009).
180. In general, we think spending is the best measure of a state's capacity to undertake countercyclical spending, since it includes both taxing and borrowing capacity. The AMT affects both: higher effective tax rates may impact borrowing by implying future liquidity problems for the state, leading rational voters to prefer to avoid taking on too much current government debt. We examine effects on revenues as well, however, because there might be political obstacles to cutting spending independent of cutting taxes. For instance, voters might doubt that officials will save excess revenues against future liquidity crunches, rather than just spending them at a politically useful later time. We thank Michael Knoll for raising this last point as a reason to be interested in the AMT's effect on annual revenues.
181. Data for 2004 to 2007 are available at State Government Tax Collections-Historical Data, U.S. CENSUS BUREAU, http://www.census.gov/govs/statetax/historical_data.html (last visited Oct. 11, 2010).
182. Results are qualitatively similar for total tax revenue. We present only the personal income tax results because many components of total tax revenue would be unaffected by our causal mechanism (e.g., revenue from user fees).
183. See Kaplow, supra note 147, at 486-87.
184. See The Individual Alternative Minimum Tax: Hearing Before the S. Comm. on Finance, 110th Cong. 12 (2007) (statement of Leonard E. Burman, Director, Tax Policy Center); Kaplow, supra note 147, at 487.
185. See Linda M. Beale, Congress Fiddles While Middle America Burns: Amending the AMT (and Regular Tax), 6 FLA. TAX REV. 811, 824-25 (2004); Leonard E. Burman et al., The AMT: Projections and Problems, TAX NOTES, July 7, 2003, at 105, 115-16.
186. See Deborah Schenk, Exploiting the Salience Bias in Designing Taxes 27-28 (NYU Ctr. for Law, Econ. & Org., Working Paper No. 10-37, 2010), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1661322. In laboratory studies, subjects had difficulty integrating in their heads the combined effects of two overlapping tax systems. See Edward J. McCaffery & Jonathan Baron, The Political Psychology of Redistribution, 52 UCLA L. REV. 1745, 1765-68 (2005). It is unclear to what extent these laboratory studies capture real world behavior. See Brian Galle, Hidden Taxes, 87 WASH. U. L. REV. 59, 84 (2009).
187. See Gillette, supra note 42, at 958 (arguing that political free riding diminishes when costs of acquiring information decline).
188. See MANCUR OLSON, JR., THE LOGIC OF COLLECTIVE ACTION: PUBLIC GOODS AND THE THEORY OF GROUPS 21-22, 31, 35 (rev. ed. 1971); Gillette, supra note 56, at 389. Of course, in many cases this story will be much more complex. See id.
189. Cf. Alexander Volokh, Privatization and the Law and Economics of Political Advocacy, 60 STAN. L. REV. 1197, 1207-15 (2008) (modeling argument that removing a likeminded political actor will increase others' lobbying efforts).
190. We note that this result is dependent on the existence of the AMT, which prevents some taxpayers ever from receiving the benefit of the SALT deduction. In the absence of the AMT, the SALT deduction would actually be more politically appealing to wealthier taxpayers, because the dollar value of a deduction increases as marginal tax rates increase.
191. In many circumstances, these kinds of information deficits can be overcome by policy entrepreneurs. Entrepreneurs invest their own effort in gathering and sharing information, in exchange for rents and political support for their own cause from the beneficiaries. See Christopher H. Schroeder, Rational Choice Versus Republican Moment-Explanations for Environmental Laws, 1969-73, 9 DUKE ENVTL. L. & POL'Y F. 29, 49-56 (1998); Richard E. Wagner, Pressure Groups and Political Entrepreneurs: A Review Article, 1 PUB. CHOICE 161, 164-67 (1966) (reviewing MANCUR OLSON, JR., THE LOGIC OF COLLECTIVE ACTION (1965)). The entrepreneur story is implausible in our scenario because most of the important information is privately held by other taxpayers and perhaps by government insiders. Indeed, those who hold this information have incentives to keep it secret. See Galle, supra note 186, at 95 n.171. Therefore gathering the information is not simply a matter of investing time and effort-the data is literally inaccessible. Entrepreneur claims about hidden taxes may also have fairly low credibility. See id. at 91-92.
192. See Filing Season Weekly Reports, IRS.GOV, http://www.irs.gov/taxstats/article/0,id=184855,00.html (last visited Oct. 15, 2010).
193. See Taukir Hussain, Projections of Federal Tax Return Filings: Calendar Years 2005-2012, IRS STAT. INCOME BULL., Winter 2005-2006, at 147, 147-49.
194. See STAFF OF THE JOINT COMM. ON TAXATION, supra note 4, at 22.
195. See Elizabeth Garrett, Comment, Accounting for the Federal Budget and Its Reform, 41 HARV. J. ON LEGIS. 187, 195-96 (2004); Rebecca M. Kysar, The Sun Also Rises: The Political Economy of Sunset Provisions in the Tax Code, 40 GA. L. REV. 335, 359-70 (2006).
196. See Jacob E. Gersen & Eric A. Posner, Timing Rules and Legal Institutions, 121 HARV. L. REV. 543, 561 (2007).
197. Cf. BUCHANAN & TULLOCK, supra note 29, at 283-95 (arguing that political dynamics allow incumbents to ratchet tax payments upwards).
198. For an ingenious (but in our view pie-in-the-sky) proposed solution to this problem, see Gamage, supra note 5, at 123-43.
199. See supra text accompanying notes 117-123.
200. See INTERNAL REVENUE SERV., PUBLICATION 919: HOW DO I ADJUST MY TAX WITHHOLDING?, at 4-5, 11 (2010), available at http://www.irs.gov/pub/irs-pdf/p919.pdf (advising taxpayers to match liabilities with ithholding, taking into account factors such as state taxes, hence in effect advising taxpayers with higher expected state taxes to reduce their federal withholding).
201. See INTERNAL REVENUE SERV., PUBLICATION 505: TAX WITHHOLDING AND ESTIMATED TAX, at 19-22, 36 (2010), available at http://www.irs.gov/pub/irs-pdf/p505.pdf (explaining the obligation to make estimated quarterly payments for self-employed taxpayers, and noting that payers should estimate the amount of deductions they will be allowed when making payments).
202. For more information on refund anticipation loans, see Michael S. Barr, Banking the Poor, 21 YALE J. ON REG. 121, 166-77 (2004).
203. The opposite strategy of taxing only the wealthy faces an uphill battle, because in that case free riding among wealthy voters is even lower than in the AMT scenario.
204. For our illustration of how this targeting can minimize the impact of tax increases on state residents, see supra Figures 1, 2.
205. For example, the state could award a credit against state tax liability for the lesser of the dollar value of the federal SALT deduction and the amount of federal AMT liability in excess of the standard tax. Such a credit would approximate the value of the federal deduction lost to the AMT. If the state calibrates its tax hike to roughly the value of the federal match, this credit would ensure that state taxpayers subject to the AMT would not experience any tax increase.
206. See supra text accompanying notes 149-150.
207. See Steven A. Bank, Origins of a Flat Tax, 73 DENV. U. L. REV. 329, 336-37 (1996).
208. The exception is junk food. See Jonah B. Gelbach, Jonathan Klick & Thomas Stratmann, Cheap Donuts and Expensive Broccoli: The Effect of Relative Prices on Obesity (Dec. 15, 2009) (unpublished manuscript), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=976484.
209. See David Shakow & Reed Shuldiner, A Comprehensive Wealth Tax, 53 TAX L. REV. 499, 501-02 (2000).
210. See JOSEPH M. DODGE, THE LOGIC OF TAX: FEDERAL INCOME TAX THEORY AND POLICY 88 (1989).
211. An important disclaimer here is that federal tax reductions in April of Year Two may not fully compensate a taxpayer for her higher state-tax expenses in Year One, even if the two are of equal present discounted value. Timing effects matter, and may be especially important for households that do not budget rationally or are highly liquidity constrained. See Brian Galle & Manuel Utset, Is Cap-and-Trade Fair to the Poor? Shortsighted Households and the Timing of Consumption Taxes, 79 GEO. WASH. L. REV. 33 (2010).
212. See Batchelder et al., supra note 3, at 58.
213. Kelly Sims Gallagher & Erich Muehlegger, Giving Green to Get Green: Incentives and Consumer Adoption of Hybrid Vehicle Technology 22-24, 28 (Harvard Univ. John F. Kennedy Sch. of Gov't, Working Paper No. RWP08-009, 2008), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1083716 (finding increased efficacy of income tax incentives in the second quarter, and suggesting that this effect cannot easily be explained except as connected to tax filing season). It is not clear, however, that the study in fact establishes that there is a salience effect during tax filing season. See Galle, supra note 186, at 76-77.
214. See 26 U.S.C. § 219(f)(3) (2006).
215. 26 U.S.C. § 164(a) (2006).
216. One technical point perhaps worth mentioning about this proposal is that we would recommend slightly disfavoring retroactive deductions relative to taxes incurred during the tax year. For example, we would reduce the amount of retroactive deductions by about onethird of the annual risk-free rate of return, to account for the time value of the taxpayer's holding onto her money between December of Year One and April of Year Two. The reason is that we would want fully informed taxpayers to be indifferent between purchasing sooner rather than later: we would not want retroactive deductibility to be a reason for consumers to delay consumption. The reduction would also mitigate the federal revenue lost by accelerating some deductions.
217. For example, Klick would receive a check from Pennsylvania for $600 in June of Year One, on the effective date of a new Pennsylvania tax increase that will cost him $600 over the course of the year. In April of Year Two, when he files his state tax return, he would repay the $600 advance. At the same time, he would receive a $600 refund from the federal government. On net, Klick comes out even both in Year One and Year Two. We assume here that the state charges Klick no interest; that benefit is offset (from Klick's perspective) by the fact that the federal government pays Klick no interest on the money he overpaid in Year One.
218. Taxpayers who were fully informed about their taxes and who had an unlimited ability to borrow would not face this timing challenge, since they could simply borrow against their expected rebate. But evidence suggests that borrowing even against fully expected tax rebates is incomplete. See, e.g., Matthew D. Shapiro & Joel Slemrod, Consumer Response to Tax Rebates, 93 AM. ECON. REV. 381, 392-93 (2003).
219. See, e.g., 26 U.S.C. § 6049 (2006) (requiring payors of interest to file information return with IRS and furnish payment information to payee).
220. See Paul Kane, Democrats Finishing Up Stimulus Proposal, WASH. POST, Jan. 15, 2009, at A4 ("I'm not aware of the AMT having any stimulative effect." (quoting U.S. Representative Jim Cooper)).
221. Among repeal proponents are the leading tax-lawyer organizations, along with many former high-ranking tax officials. See Allen Kenney, Former Commissioners Say It's Time to Scrap AMT, 103 TAX NOTES 1466 (2004); ABA Section of Taxation et al., Tax Simplification Recommendations from ABA, AICPA, and TEI, TAX NOTES TODAY, Feb. 25, 2000, available at LEXIS 2000 TNT 39-82. One of the few in agreement with us on the future of the AMT is Deborah Schenk, who offers it as a second-best solution to political failures in other tax-setting mechanisms. Schenk, supra note 186, at 50-51.
222. For a description of the controversy and summary of the existing data, see supra note 147.