Tag: Politics

Why Do Half of Americans Pay No Federal Income Tax?

You may have heard the claim that about half of Americans pay no federal income tax. That’s a true fact. My Tax Policy Center colleagues estimate, for example, that 46% of households either will pay no federal income tax in 2011 or will receive more from the IRS than they pay in.

Today, TPC released a new study that examines why these people end up paying no federal income tax.

The number one reason should come as no surprise. It’s because they have low incomes. As my colleague Bob Williams notes:

A couple with two children earning less than $26,400 will pay no federal income tax this year because their $11,600 standard deduction and four exemptions of $3,700 each reduce their taxable income to zero. The basic structure of the income tax simply exempts subsistence levels of income from tax.

Low incomes (or, if you prefer, the standard deduction and personal exemptions) account for fully half of the people who pay no federal income tax.

The second reason is that for many senior citizens, Social Security benefits are exempt from federal income taxes. That accounts for about 22% of the people who pay no federal income tax.

The third reason is that America uses the tax code to provide benefits to low-income families, particularly those with children. Taken together, the earned income tax credit, the child credit, and the childcare credit account for about 15% of the people who pay no federal income tax.

Taken together, those three factors — incomes that fall below the standard deduction and personal exemptions; the exemption for most Social Security benefits; and tax benefits aimed at low-income families and children — account for almost 90% of the Americans who pay no federal income tax.

For further details and info about the other 10%, please see the study.

P.S.: The true fact — about half of Americans do not pay federal income taxes — often gets transmogrified in public discourse into the decidedly untrue claim that half of Americans pay no taxes. That simply isn’t so. There are many other taxes in our fair land, including payroll taxes, excise taxes, sales taxes, state income taxes, and property taxes. Most people who don’t pay federal income taxes still encounter some of these other taxes.

A Big Error in the Senate Republicans’ Balanced Budget Amendment

Senate Republicans made a striking error in the balanced budget amendment they introduced last week. As written, the amendment would limit federal spending far more than those senators realize or, I suspect, desire.

The Republicans want the budget to be balanced by keeping spending down rather than by raising tax revenues. They thus propose limiting spending to no more than 18% of gross domestic product (GDP). That’s in line with average tax revenues over the past four decades, but well below average spending, which has been just short of 21% of GDP.

So what’s the problem? The way the amendment would implement the spending limit:

Total outlays for any fiscal year shall not exceed 18 percent of the gross domestic product of the United States for the calendar year ending before the beginning of such fiscal year, unless two-thirds of the duly chosen and sworn Members of each House of Congress shall provide by law for a specific amount in excess of such 18 percent by a roll call vote.

The amendment compares spending in one period (the upcoming fiscal year) to the size of the economy in an earlier period (the last complete calendar year). If the amendment were in force today, for example, spending in fiscal 2012, which starts in October, would be limited to 18 percent of GDP in calendar 2010. That’s a gap of 21 months.

As Bruce Bartlett pointed out in analyzing an earlier version of this amendment, that time lag can add up to big money. Why? Because both real economic growth and inflation will expand the economy during those 21 months.

The Congressional Budget Office projects, for example, that nominal GDP will grow about 4.5% annually in the latter part of this decade (the earliest the amendment could go into effect). Over 21 months, that works out to roughly 8% growth. The amendment would thus limit federal spending in those years to about 16.7% of each year’s GDP (16.7% = 18% / 1.08) not the advertised 18%. In 2020 alone that amounts to a difference of more than $300 billion in spending.

That’s a big error.

I doubt that Senate Republicans really want to limit spending to only 18% of GDP. Even the House Republican budget calls for spending of more than 20% of GDP for at least two decades. But if the Senate Republicans are serious, their first step should be to fix the drafting error in their amendment.

The Cost of Sunshine: Hugo Chavez Edition

Campaign systems often rely on disclosure (e.g., of campaign contributions and petition signing) to limit corruption and inform the voting public. Such sunshine provides important benefits, but, as I’ve noted before (here and here), it can also have costs. For example, disclosure makes it easier for politicians to identify their supporters and opponents and, if they are so inclined, to mete out rewards and punishments accordingly.

A recent paper in the American Economic Journal: Applied Economics reports a striking example of this in Venezuela. Chang-Tai Hsieh, Edward Miguel, Daniel Ortega, and Francisco Rodriguez document (here; ungated version here) what happened to Venezuelans who signed at least one of three petitions in 2002-03 calling for a recall vote against President Hugo Chavez. The third petition was successful, but Chavez survived the vote.

He then got his hands on the list of Venezuelans who signed the third petition. Using household survey data, the authors were able to track what happened to those signers, Here’s their abstract:

In 2004, the Hugo Chávez regime in Venezuela distributed the list of several million voters who had attempted to remove him from office throughout the government bureaucracy, allegedly to identify and punish these voters. We match the list of petition signers distributed by the government to household survey respondents to measure the economic effects of being identified as a Chávez political opponent. We find that voters who were identified as Chávez opponents experienced a 5 percent drop in earnings and a 1.3 percentage point drop in employment rates after the voter list was released.

In short, a notable fraction of the opponents lost their jobs, were unable to get new jobs, or had their pay cut.

Individuals who signed the first or second petition, but not the third, did not experience any decline in earnings or employment.

Why the difference? Because only information about the third petition appeared in the computerized data sets that Chavez distributed.

So it wasn’t disclosure alone that allowed the punishment, but disclosure coupled with easy-to-access dissemination.

Spending in Disguise

Republicans are demanding a deficit-reduction package that’s entirely spending cuts. Democrats insist that revenues must also be included.

Are these positions completely irreconcilable? Not if both sides are willing to attack the spending hidden in our tax code.

I explore this idea for finding common ground in a new essay in National Affairs, “Spending in Disguise”:

A great deal of government spending is hidden in the federal tax code in the form of deductions, credits, and other preferences that seem like they let taxpayers keep their own money but are actually spending in disguise. Those preferences complicate the code and often needlessly distort family and business decisions. Their magnitude raises the possibility of a dramatic reform of the tax code—making it simpler, fairer, and more pro-growth—that would amount to both cutting spending and increasing government revenue at once, and without raising tax rates. 

Such a reform would not eliminate the need for serious spending cuts, of course, nor would it take tax increases off the table. But it could dramatically improve the government’s fiscal outlook and make the task of budget negotiators far easier. It will only be possible, however, if we clearly understand how spending is hidden in the tax code and what reformers might do about it—if we see that tax policy and spending policy are not always as distinct as we might think.

In short, there is a deal to be done in which revenues go up solely because spending in the tax code goes down.

The trillion-dollar question is whether President Obama, Speaker Boehner, and Leader Reid can cut that deal by August 2nd. If not, one side will have to cave on a core principle (no prize for guessing which party that’s likely to be), or we will find out just how painful it really is to run out of fresh borrowing room.

Don’t Fall for a Repatriation Holiday

Recent weeks has brought much chatter — from both Republicans and Democrats — about offering companies a temporary tax holiday for repatriating foreign earnings. A typical proposal would effectively tax any repatriated earnings at 5.25% this year, rather than the usual rates which can be as a high as 35%.

Proponents tout this as a form of economic stimulus. But, as my Tax Policy Center colleagues Bill Gale and Ben Harris point out, that’s doubtful. In “Don’t Fall for Repatriation” at Politico, they say:

In addition, firms are unlikely to invest the repatriated funds. Congress passed a similar repatriation tax holiday in 2004 and required firms to create domestic jobs or make new domestic investments to get the tax break. Nonetheless, the firms, on average, used the tax break to repurchase shares or pay dividends — not to increase investment.

The holiday, instead, turned into a massive tax break for shareholders — resulting in little or no economic gain or job market expansion. Why? Because money is fungible, to satisfy the requirements of the law, corporations reported repatriated funds as the source of money for investments or jobs they would have created anyway — and used other funds to increase shareholder wealth.

Today, domestic firms are sitting on near-record levels of liquid assets. The reason they’re not investing or creating more jobs is not a cash shortage. 

 Bill and Ben also note the costs of a repatriation holiday:

First, allowing repatriation today means less taxable corporate profits in the future — which would translate into less government revenue.

Second, and perhaps even more costly than the lost revenue, would be the dangerous precedent that firms would expect regular repatriation holidays. This expectation may persuade firms to hoard profits overseas and perhaps even move production abroad, betting that Congress will eventually grant another “one-time” tax break.

Indeed, the prior tax holiday was supposed to discourage firms from holding profits overseas. But instead, firms stockpiled new reserves, presumably in anticipation of another holiday. The Joint Committee on Taxation estimates that these two factors would contribute to the $79 billion 10-year price tag on a second repatriation.

Playing with Fire with the Debt Limit

My latest column in the Christian Science Monitor:

America sometimes takes its exceptionalism too far.

Case in point: We are the only major economy that talks openly of default.

Government debt has ballooned throughout the developed world in the aftermath of the Great Recession. France and Britain are as deep in debt as the United States, for example, and Japan is much further in the hole.

But their leaders never mention the possibility of default. Why would they? If you have the ability to pay your bills, there’s no reason to scare your creditors.

But that’s exactly what we do in America. Treasury Secretary Timothy Geithner has been warning about the risks of default since January.

If we don’t increase the debt limit by early August, he tells us, default becomes a real possibility. And that could pose grievous risks to our already weak economy.

Many Republicans play down that risk. Echoing famed investor Stanley Druckenmiller, some argue that a temporary default would be acceptable if it’s part of a larger political strategy that brings future deficits under control.

But that is a dangerous game.

Large swaths of America’s financial infrastructure have been built on the assumption that US Treasuries pay on time. And financial markets would likely punish the US with higher interest rates if we defaulted. That’s what happened in 1979, for example, when back office snafus caused Treasury to unintentionally miss payments to some investors.

This time, Fitch, Moody’s, and Standard & Poors are threatening to cut the US credit rating if we choose to default. Given the risks, most observers recognize that default is not, and should not be, an option. The US is not a deadbeat nation.

But does that mean the debt limit has to go up in early August? Some Republicans say no because of a simple fact: Every month, the federal government collects more in taxes than it pays in interest. With careful cash management (which would likely have to start before the August deadline), Mr. Geithner should be able to prioritize debt payments and thus avoid debt default.

As best as I can tell, that argument is correct, but it’s hardly a reason for complacency. America is currently spending about $100 billion more each month than it collects in revenues. If we hit the debt limit, we won’t be able to pay everyone who is rightly expecting to be paid.

Geithner can and should ensure that our debtholders get paid.

But someone – perhaps millions of someones – won’t be paid on time. Contractors, federal workers, program beneficiaries, or state and local governments will suddenly find themselves short on their cash flow.

That won’t be good for the economy. Even though it’s not as bad as debt default, it still would paint the US as a deadbeat.

The US faces severe fiscal challenges in the years ahead. It’s perfectly reasonable that lawmakers want to combine an increase in the debt limit with efforts to rein in future deficits.

But that worthy goal should not weaken our commitment to paying – on time and in full – the obligations that we have already incurred.

As the debt limit draws near, our leaders should stop playing with fire and craft instead a plan to rein in future deficits without threatening our struggling recovery.

That’s a difficult balancing act, requiring tough compromises across the political spectrum. But as everybody knows on Capitol Hill and beyond, it would be the best step for the nation and our fragile economy.

It would also be exceptional.

How Ambitious is Pawlenty’s Growth Goal?

Plenty.

In his economic speech on Tuesday, presidential candidate Tim Pawlenty set out an ambitious goal for economic growth:

Let’s grow the economy by 5%, instead of the anemic 2% currently envisioned.  Such a national economic growth target will set our sights on a positive future.  And inspire the actions needed to reach it. By the way, 5% growth is not some pie-in-the-sky number. We’ve done it before. And with the right policies, we can do it again.

Between 1983 and 1987, the Reagan recovery grew at 4.9%.  Between 1996 and 1999, under President Bill Clinton and a Republican Congress the economy grew at more than 4.7%. In each case millions of new jobs were created, incomes rose and unemployment fell to historic lows. The same can happen again.

In the aftermath of the Great Recession, it wouldn’t be surprising to see a couple years of strong growth at some point. Let’s hope it’s soon.

But could we have remarkably strong growth for a full decade, as Pawlenty hopes? His two examples don’t inspire confidence. In each case, strong growth ended in four years or less.

So when was the last time the United States grew at 5% for a full decade?

Mid-1958 through Mid-1968. Over that span, U.S. growth averaged exactly 5.0% per year.

But that’s the only instance since World War II. Economic growth was lower than 5%, usually much lower, in every other decade since 1947:

Growth hasn’t reached even 4% over any decade since the late 60s and early 70s.

Getting up to 5% over the next decade thus seems not merely ambitious, but almost unthinkable.

Of course, a few years back many would have said the same thing about getting the U.S. growth rate down to 2%. Until the Great Recession, there was only one ten-year stretch in the post-war period, ending in early 1983, in which growth averaged as low as 2%.

Sadly, we’ve broken that record handily. Over the past ten years, growth has averaged a meager 1.8%.

So maybe T-Paw’s right, and the economy can break out to the upside just as we’ve done to the down.

But I wouldn’t bet on it, regardless of who is president.

P.S. The quarterly data I use here are available since 1947. Annual data go back to 1929. Perhaps not surprisingly, every ten-year period ending in 1941 through 1951 had an average growth rate of 5% or more, thanks to World War II and the rebound from the Great Depression.   

The Cost of Sunshine: The Downside of Disclosing Campaign Donors

Campaign finance rules emphasize sunlight. For example, all campaign donations above a modest amount (e.g., $200) must be publicly disclosed. That allows everyone to see who is providing financial support to which candidates.

That sounds good if you are worried about campaign contributions buying undue access to our elected leaders.

As I noted last year, however, that sunshine comes with costs. For example, it makes quid pro quo’s easier. Why? Because candidates know who is financing them. A completely anonymous system — in which no one, including candidates, knows the identity of donors — would make explicit quid pro quo’s much more difficult.

Full disclosure also discourages individuals from making donations that would be unpopular with their relatives, friends, neighbors, and employers. You can make anonymous donations to unpopular causes to your heart’s content without anyone knowing. But if you make even a modest donation to an unpopular political candidate that’s a matter of easily-Googleable public record. That can be a real deterrent.

Writing in today’s Wall Street Journal, James L. Huffman raises a related concern: that disclosure stacks the deck in favor of incumbent politicians:

[P]ublic disclosure serves the interests of incumbents running for re-election by discouraging support for challengers. Here’s how it works.

A challenger seeks a contribution from a person known to support candidates of the challenger’s party. The potential supporter responds: “I’m glad you’re running. I agree with you on almost everything. But I can’t support you because I cannot risk getting my business crosswise with the incumbent who is likely to be re-elected.”

…

Disclosure makes threats possible, and fears of retribution plausible. Within weeks of a contribution of $200 or more, the contributor’s name appears on the public record. Contributors know this, and they know that supporting the challenger can, should the challenger lose, have consequences in terms of future attention to their interests. Of course no incumbent will admit to issuing threats or seeking retribution, but the perception that both exist is widespread.

Huffman was the unsuccessful Republican nominee in Oregon’s Senate race in 2010. Depending on your view, that might mean that he speaks from experience or that he suffers from sour grapes. Without evidence, there’s no way to know how much, if at all, such concerns arose in his race.

But the broader issue he raises is worth pondering. Sunshine is sometimes the best disinfectant. But it also lets bad actors see what’s going on.

Time Management and the Budget Debate

What features tiger blood, March madness, federal deficits, and Stephen Covey’s time-management advice? My latest column at CNN Money:

America faces trillions of dollars in deficits in coming years. But Congress has been reduced to funding the government three weeks at a time so it can fight over mere billions.

Why is Congress spending so much time and effort on so little money? Are those billions bigger than they appear because cuts today will carry forward into further cuts tomorrow? Is today’s skirmishing part of a larger political strategy to rein in our deficits?

Maybe.

But I think good old-fashioned human psychology is a bigger factor. Congress faces the same time-management challenge that plagues me and, I suspect, you. The urgent crowds out the important.

Productivity guru Stephen Covey popularized the “important versus urgent” distinction, showing how we should spend our time versus how we do.

People spend too much time on “waste” and “distraction,” immersed in unimportant issues. Waste and distraction can be fun, of course, and are welcome in small doses. Charlie Sheen’s rantings about his “tiger blood” are entertaining. And no one should berate President Obama for filling out his NCAA bracket. But let’s hope he didn’t spend too much time on it.

Today Congress faces a different problem. It seems stuck in the realm of “crisis and necessity,” to use Covey’s terms. Unless lawmakers pass yet another spending bill, many agencies will run out of money on April 8. Unless Congress increases the debt limit, America will be unable to pay some of its bills.

Urgent and important, these issues demand congressional attention. As Samuel Johnson might have said, nothing focuses the mind like the prospect of a government shutdown and subsequent hanging by the voters.

And therein lies the problem. America faces much larger fiscal challenges — a broken tax code and an unsustainable build-up of debt. But these exceptionally important challenges aren’t urgent. Neither has a deadline. And so they languish, prompting commission reports and congressional hearings but little action.

Budget watchers often lament that we won’t fix our budget until struck by an actual fiscal crisis — skyrocketing interest rates or a failed Treasury auction. Indeed, some experts sometimes seem to be wishing for such a crisis so that long-run budget issues finally become urgent.

Let’s hope it doesn’t come to that. Rather than wait for (or cheer on) an actual crisis, we have a better option: leadership. The art of leadership is getting people to pay heed to what’s important, even when it isn’t urgent. President Obama, for example, enacted his health reform legislation one year ago because he pushed for it, not because it was politically urgent.

We need the same leadership on budget issues and tax reform. Our elected leaders must make time to address our long-run challenges, even as they address the urgent problems of the day. The Senate’s bipartisan “Gang of Six” has taken an important first step, working together to turn the recommendations of the president’s fiscal commission into draft legislation.

But more leadership is needed. That’s why 64 senators — 32 Democrats and 32 Republicans — wrote to Obama last week urging him to take the lead in deficit-reduction discussions in which everything would be on the table: discretionary spending, entitlement programs and tax reform.

Let’s hope the president takes the senators up on this request. He is in a unique position to elevate the budget debate from day-to-day urgency mode to the realm of leadership, where it belongs.

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