A critique–and, if you read far enough, a partial defense–of the President’s rhetoric about the definition of a tax.
Be sure to read my follow-up post: “Answer: When It’s a Fine“
President Obama has walked into a rhetorical box on taxes. On the one hand, he campaigned on a promise not to raise taxes on Americans who earn less than $250,000 per year. On the other hand, he has endorsed policies that look a lot like taxes on those people. They include:
- A $0.62 per pack increase in the federal cigarette tax. President Obama signed this into law to help finance an expansion in health programs for children; the increase went into effect on April 1.
- Proposals to tax insurers who offer “Cadillac health insurance plans.” As many commentators have noted – and as I taught my students on Monday – some of that tax (perhaps much of it) would ultimately be passed on to consumers in higher insurance premiums. So insurers may be the ones writing checks to the government, but, in reality, consumers will be paying higher taxes.
- Penalties to enforce an individual mandate in the health bills now pending in Congress. For example, the draft Baucus bill (from a few days ago; it may have since changed) would impose a penalty of up to $3,800 per year for families that could afford health insurance but do not purchase it.
The President’s supporters have argued that the first two tax increases are consistent with his pledge. The increased cigarette tax, for example, isn’t an increase in income taxes. And the tax on insurance companies isn’t a direct tax on individuals and, even if it’s partially passed through, it would not increase individual income taxes.
Such hairsplitting has no economic content – some of both tax increases really would fall on families that earn less than $250,000 – but may provide enough political cover to defend what I presume the President actually meant on the campaign trail: “I will not raise income taxes directly on American families who earn less than $250,000.”
Unfortunately for the President, that hairsplitting apparently won’t work with the third proposal which involves a direct tax on individuals who don’t get qualifying health insurance. Those individuals would have to write a check to the government as a penalty for this lack of coverage.
There would seem to be no wiggle room to enable the President to call this anything but a tax (albeit not an income tax). Yet, when asked about this by George Stephanopoulos on Sunday, the President tried to deny that such penalties are taxes. Stephanopoulos and Merriam-Webster, however, were having none of it:
The President’s argument fails, on its face, if you take the view that a tax is any money that the government takes from you through exercise of its sovereign power. Purchasing a souvenir at a National Park? Not a tax since it’s a voluntary, market-like transaction. But paying a penalty because you haven’t purchased government-approved health insurance? That’s a tax. And, indeed, it is treated as such by the Congressional Budget Office in its evaluation of health proposals.
I think CBO is correct: for federal budget purposes, the penalty on the uninsured would indeed be a tax, since it reflects the exercise of the government’s sovereign power.
However, and this may surprise you, I also think the President has an important point which he tried, with only limited success, to articulate. I would describe it as follows: A well-meaning government levies taxes for two different reasons:
- First, it levies taxes to finance the government. National defense, the court system, the social safety net, etc. all require financing. Taxes allow the government to provide those services.
- Second, taxes are a tool to discourage behavior that is harmful to others. For example, a government may levy a tax on emissions of carbon dioxide if it worries about potential damage from climate change. In economics-speak, that’s using a tax to internalize an externality. Such taxes are often known as Pigouvian taxes – a concept made famous by Greg Mankiw’s Pigou Club which advocates for greater use of them.
From a budget / government sovereignty perspective, Pigouvian taxes are indeed taxes. The government is using its power to collect money from people and companies that engage in the taxed activity. But revenues are not the primary purpose of the policy. Instead, the goal is to solve another problem such as pollution.
The President is viewing the tax on the uninsured as a Pigouvian tax. And he’s right, at least up to a point. If an individual can afford insurance but chooses to go without it, that person may impose significant costs on other people. Why? Because they will still get health care if, for example, they are in an auto accident. Those costs will then be paid by others (e.g., by the hospital). In that sense, the uninsured individual imposes an externality on others.
And that externality only gets larger if insurance companies are forbidden to exclude new beneficiaries because of pre-existing conditions. If that regulation goes into effect (as proposed in the health bills now pending in Congress), then an uninsured person can potentially impose substantial costs on everyone else by waiting until they have an expensive chronic disease before they purchase insurance. Because they can’t be charged more for waiting to getting coverage, they would be able to pass a substantial cost burden onto other people.
The purpose of a tax on the uninsured is to prevent such cost-shifting. The tax is thus a policy tool, not primarily a way to raise new revenue. That’s the distinction that the President was trying to articulate. And it’s an important one.
Which brings us back to the rhetorical box the President has put himself in. I think the President is wrong to claim that, in essence, a Pigouvian tax isn’t a tax. It is a tax. But he’s right to draw a distinction taxes as a tool of policy and taxes as a way to raise revenue.
Just for fun, I’ve been trying to figure out whether the President can salvage his rhetoric without making the transparently-implausible claim that a tax isn’t a tax. One option would be to just say “yes it’s a tax, but it’s not an income tax.” However, the President’s remarks didn’t go in that direction.
A second approach would be to dust off an old idea from the Reagan era, and say that the tax is really a “user fee” not a tax. But I doubt that would work any better today than it did back then.
The best I could come up with is the following: “Our government needs more tax revenue. I will not raise that revenue by raising taxes on Americans earning less than $250,000.” Something along those lines (as polished by White House communicators) might be able to give the President rhetorical wiggle room for taxes that have other purposes. (Of course, the taxes also raise revenue, so this isn’t perfect.) Other ideas?
P.S. The distinction between the two types of taxes come with caveats. If the purpose of the tax is solely to avoid cost-shifting, then the magnitude of the tax should be calibrated to match that goal. If it’s higher, then the extra portion is just a revenue-raising, unqualified tax.