Obama – Donald Marron

What’s the Mix of Spending and Revenue in the President’s Deficit Reduction Proposal?

President Obama’s budget identifies a group of policies as a $1.8 trillion deficit reduction proposal. I found the budget presentation of this proposal somewhat confusing; in particular, it is difficult to see how much deficit reduction the president wants to do through spending cuts versus revenue increases.

After some digging into the weeds, I pulled together the following summary to answer that question:

The proposal would increase revenue by $750 billion over the next decade. Much media coverage has been incorrectly suggesting an increase of either $580 billion (revenue from limiting tax breaks for high-income taxpayers and implementing a “Buffett Rule”) or $680 billion (adding in the revenue that would come from using chained CPI to index parameters in the tax code).

But there’s another $67 billion in additional revenue. Almost $47 billion would come from greater funding for IRS enforcement efforts that lead to higher collections. To get that funding, Congress must raise something known as a “program integrity cap.” The administration thus lists this as a spending policy, but the budget impact shows up as higher revenues (assuming it works—such spend-money-to-make-money proposals don’t always go as well as claimed, although there is evidence that IRS ones can). Several similar administrative changes in Social Security and unemployment insurance add almost $1 billion more.

Another $20 billion would come from increasing federal employee contributions to pension plans. That sounds like a compensation cut to me and, I bet, to affected workers, and would be implemented through spending legislation. Under official budget accounting rules, however, it shows up as extra revenue as well.

In total, then, “spending” policies would generate more than $67 billion in new revenue.

Taken as a whole, the president’s deficit reduction proposal includes $750 billion in revenue increases, $808 billion in programmatic spending cuts, and $202 billion in associated debt service savings. The proposal thus involves about $1.1 in programmatic spending cuts for every $1 of additional revenue.

At least according to traditional budget accounting. If you believe (as I do) that many tax breaks are effectively spending in disguise, the ratio of spending cuts to tax increases looks much higher. From that perspective, much of the $529 billion that the president would raise by limiting deductions, exemptions, and exclusions for high-income taxpayers should really be viewed as a broadly-defined spending cut. I haven’t had a chance to estimate how much of that really is cutting hidden spending, but even if only three-quarters is, the ratio of broadly-defined spending cuts to tax increases would be 3.5-to-1.

Understanding President Obama’s Revenue Targets

President Obama and administration officials have offered two different revenue targets for the fiscal cliff debate: $1 trillion and $1.6 trillion (sometimes reported as $1.5 trillion). You might be wondering (I was) where those numbers come from.

The $1 Trillion

President Obama wants to extend the majority of the Bush-era individual income tax cuts—enacted in 2001 and 2003 and extended in 2010—except for those that affect only households with incomes more than $200,000 (single) or $250,000 (joint). In addition, he wants to return the estate tax to its 2009 structure, rather than the one that applies today. Together, those changes would increase revenue by $968 billion over the next decade, according to Treasury estimates, relative to a current policy baseline (i.e., a baseline that has income and estate taxes in their 2012 form).

That $968 billion, which rounds to $1 trillion, has the following components, all applying only to taxpayers with incomes above the president’s thresholds:

All of the provisions in this list are part of the fiscal cliff, which is why the President has emphasized them—and the trillion-dollar figure—in his comments about dealing with the cliff. The larger number—the $1.6 trillion—arises in discussions about the larger fiscal deal that might accompany the cliff negotiations.

The $1.6 Trillion

In his budget last February, President Obama proposed $1.56 trillion in tax increases. In round numbers: $1.6 trillion, sometimes misreported as $1.5 trillion.

That figure includes the $968 billion noted above plus another $593 billion in tax increases.

The largest of those, by far, is the president’s proposal to limit the value of itemized deductions and certain exclusions for upper-income taxpayers. Under that proposal, upper-income taxpayers would benefit only 28 cents on the dollar for their charitable deductions, mortgage interest, employer-provided health insurance, etc., even if they are in the 36% or 39.6% tax brackets.

That provision would raise $584 billion. The rest of his tax provisions, including both cuts and increases, then net out to just $9 billion.

As rough justice, therefore, you can think of the president’s $1.6 trillion target as being almost entirely composed of his proposed tax increases on high-income households: $968 billion + $584 billion = $1.552 trillion. That ignores dozens of his other proposals, of course, but gives a good sense of what’s in his overall revenue aspiration.

P.S. For details on any of these proposals, please see TPC’s comprehensive analysis of the president’s tax proposals.

P.P.S. The President’s budget actually proposed $1.69 trillion in revenue increases. That’s the figure reported in Treasury’s summary of the proposals (known as the Green Book) and in TPC’s analysis of the president budget. The difference between that and the budget’s $1.56 trillion figure reflects some arcane budget presentation decisions. For example, the president proposed a $61 billion fee on banks that the Treasury reports as revenue, but the budget does not include in its tax section.

P.P.P.S. 2010’s health reform included new taxes on upper incomes that go into effect on January 1. Including those taxes, the top capital gains rate under the president’s proposal would rise to 23.8% and the top dividend rate to 43.4% (not including the effects of Pease).

Playing Favorites in the Corporate Tax Code

The President’s new Framework for Business Tax Reform is two documents in one. The first diagnoses the many flaws in America’s business tax system, and the second offers a framework for fixing them.

Much of the resulting commentary has focused on the policy recommendations. But I’d like to give a shout out to the diagnosis. The White House and Treasury have done an outstanding job of documenting the problems in our business tax system.

As the Framework notes, our corporate tax system pairs a high statutory tax rate with numerous tax subsidies, loopholes, and tax planning opportunities. Our 39.2 percent corporate tax rate (including state and local taxes) is the second-highest in the developed world, and will take over the lead in April when Japan cuts its rate. But our tax breaks are more generous than the norm.

That leaves us with the worst possible system – one that maximizes the degree to which corporate managers have to worry about taxes when making business decisions but limits the revenue that the government actually collects. It’s a great system for tax lawyers, accountants, and creative financial engineers, and a lousy system for business leaders and ordinary Americans. Far better would be to fill in the Swiss cheese of the tax base and move to a lower statutory rate, just as the President proposes (albeit with much more clarity about the rate-cutting than the cheese-filling and with proposals that would make some of the holes bigger).

A related problem is that our corporate tax system plays favorites among different businesses and activities, often with no good reason. To illustrate, Treasury’s Office of Tax Analysis calculated the average tax rates faced by corporations in different industries. As you can see, the corporate tax really tilts the playing field:

I am at a loss to understand why the tax system should favor utilities, mining (which includes energy extraction), and leasing, while hitting services, construction, and wholesale and retail trade so hard. Why should the average retailer pay 31%, while the average utility pays only 14%?

These disparities are unfair and economically costly. Investors recognize these differences and allocate their capital accordingly. More capital flows to industries on the left side of the chart and less to those on the right. Far better would be a system in which investors deployed their capital based on economic fundamentals, not the distortions of the tax system.

The chart highlights one of the key battlegrounds in corporate tax reform. Leveling the playing field (while maintaining revenues) will require that some companies pay more so others can pay less. The U.S. Chamber of Commerce announced Wednesday that it “will be forced to vigorously oppose pay-fors that pit one industry against another.” But such pitting is exactly what will be necessary to enact comprehensive corporate tax reform.

P.S. The full names of the sector names I abbreviated in the chart are: Transportation and Warehousing; Agriculture, Forestry, Fishing, and Hunting; Finance and Holding Companies; and Wholesale and Retail Trade.