Taxes – Page 10 – Donald Marron

Bowles-Simpson, Health Insurance, Social Security, and Payroll Taxes

The other day I discussed the Tax Policy Center’s distributional analysis of the Bowles-Simpson tax proposal. As you may recall, a key feature of the proposal we considered (“Option 1”) is that it eliminates almost all existing tax breaks and reduces tax rates on most types of income (but raises them on capital gains and dividends).

We subsequently learned that we misinterpreted one aspect of the Bowles-Simpson proposal. As a result, we posted an updated distributional analysis yesterday. Let me turn the mike over to Howard Gleckman at TaxVox:

One of the most dramatic elements of the tax reform plan offered by the chairs of President Obama’s deficit commission, Erskine Bowles and Alan Simpson, was their proposal to eliminate tax breaks for employer-sponsored health insurance, contributions to retirement plans, and other employee benefits. When the Tax Policy Center did its first analysis of that proposal on November 16, our modelers assumed (perfectly reasonably) that if these benefits were now subject to income tax, workers would have to pay Social Security and Medicare payroll taxes on them as well.

Because these tax subsidies are so generous, a payroll tax on their value would generate a lot of money—more than $100 billion a year. And that extra levy would have a noticeable impact on the how taxes would be distributed among various earners under the plan. But after we published our analysis, the Bowles-Simpson staff told us they did not intend to hit workers with payroll tax on this income as well.

So TPC has run a new distributional analysis for the Bowles-Simpson plan without those extra payroll taxes. It turns out that everyone still pays more tax on average, but less, of course, than if they were hit with bigger payroll taxes. The lowest 20 percent of earners (who will make an average of about $12,000 in 2015 and who pay far more in payroll tax than in income tax) would pay about $200 more than they do today, instead of an average of $400 if they took a payroll tax hit as well. Their typical after-tax income would be cut by 2 percent, instead of 3.4 percent if they had to pay that extra payroll tax.

Middle-income earners (who’ll make about $60,000) will pay about $1,000 more instead of $1,900. Their after-tax income would be cut by about 2.2 percent instead of 4 percent. People at the top 0.1 percent of the economic food chain would also save about $1,000. But when you’re making an average of $9 million, and paying a half a million in new taxes, an additional thousand bucks is easily lost in the sofa cushions.

You can also see the importance of the payroll tax effect in the debt reduction proposal released on Wednesday by a Bipartisan Policy Center task force on which I served. In that proposal, the rollback affects both payroll taxes and income taxes. The extra Social Security revenues from phasing out the tax exemption for employer-sponsored health insurance account for about one-third of the plan’s overall improvement in Social Security solvency.

Bottom line: When you are cutting tax breaks, it’s a big deal whether you do that for payroll taxes as well as income taxes.

The Distributional Effects of the Bowles-Simpson Tax Proposal

Today Eric Toder and Daniel Baneman of the Tax Policy Center released a preliminary analysis of the tax proposal put forward by the fiscal commission’s co-chairs Erskine Bowles and Alan Simpson. The centerpiece of their proposal is to eliminate almost all tax expenditures* except the earned income tax credit and the child tax credit and use the resulting revenues for a mix of deficit reduction and tax rate cuts (they also consider other options that would retain more tax expenditures). The proposal would also increase the fraction of wages subject to the Social Security tax, increase the gasoline tax by 15 cents per gallon, and make a few other changes.

The distributional impacts of the proposal depend greatly on what baseline you compare against. As my TPC colleague Howard Gleckman notes, if you use current policy (in which the 2001 and 2003 tax cuts remain in place and the alternative minimum tax is patched), then the Bowles-Simpson plan raises taxes on everybody:

The Bowles-Simpson proposal is indeed an across-the-board tax increase– and a fairly progressive one at that. In 2015, the lowest earners would face an average cut in their after-tax income of 3.4 percent or about $400. Middle-income households (those earning an average of about $60,000) would see their after-tax incomes fall by 4 percent or about $1,900. On the other end of the economic food chain, the top one percent of earners (who earn an average of about $2 million) would lose about $77,000 (5.3 percent) while the top 0.1 percent would see their after-tax incomes cut by nearly 8 percent, or close to $500,000.

Things look different if your baseline is current law–in which all the 2001 and 2003 tax cuts expire and the AMT remains unpatched. In that case:

[T]he distributional impact of the Bowles-Simpson plan would be quite different: While low-income households and the top one percent of earners would be hit with a tax increase, the upper middle class would enjoy a small tax cut averaging about 1 percent.

You can find all the details here.

* Added 11/17: As noted in a previous post, the concept of tax expenditures officially includes the lower tax rates paid on capital gains and dividends. So whenever you hear the phrase “eliminate tax expenditures”, that means not only eliminating deductions, credits, etc., but also taxing capital gains and dividends as ordinary income.

Cleaning Up the Tax Code and 15 Other Ways to Cut the Deficit

In conjunction with its new deficit option game, the New York Times asked 16 budgeteers to write-up ideas for reducing the deficit. My assignment was to explain the rationale for reducing tax expenditures–the exclusions, exemptions, deductions, and credits that complicate the code and dramatically reduce the revenue that it raises:

The Office of Management and Budget has identified more than 170 such tax expenditures (these provisions are called “expenditures” because they essentially run spending programs through the tax code). The deductibility of state and local taxes, for example, runs almost $70 billion each year. Favorable tax treatment for life insurance savings is about $23 billion. Credits for alcohol-based fuels total almost $9 billion. And dozens of rifle-shot provisions benefit narrow interests, such as special tax rules for NASCAR venues.

In total, individual and corporate tax expenditures reduce revenues by more than $1 trillion each year. Congress should revisit each tax break to see if it produces sufficient economic and social benefits to justify its budgetary cost. Some provisions should make the grade (the earned income tax credit, for example). But many others should be restructured or cast into the dustbin of history.

Such housecleaning would help close the deficit, reduce wasteful spending disguised as tax cuts, simplify tax preparation for millions of households, and potentially make the tax code more progressive (since many tax expenditures are worth most to households in high tax brackets) – all without raising rates.

You may have noticed that the co-chairs of the President’s fiscal commission recently made tax expenditures a centerpiece of their proposal for both deficit reduction and tax reform. Tax expenditures are so expansive that the co-chairs decided an aggressive roll-back could both raise more revenue and finance substantial reductions in tax rates on wages, salaries, and other ordinary income (tax rates on capital gains and dividends would increase since their lower rates are counted as tax expenditures, a topic I will return to at a later date).

For the other 15 ideas for deficit reduction, see here.

NYT: You Fix the Budget

Over at the New York Times, David Leonhardt, Bill Marsh, Shan Carter, Matthew Ericson, and Kevin Quealy have prepared a great online tool for analyzing federal budget options.

Your charge, if you choose to accept it, is to assemble a combination of spending cuts and tax increases that will adequately reduce the budget deficit ~~balance the budget~~ in 2030. To do so, you will need to find $1.355 trillion in budget adjustments.

I particularly like their decision to list cutting foreign aid in half ($17 billion) and eliminating earmarks ($14 billion) as the first two items. These are popular options in many circles, but they are small potatoes when it comes to the overall budget. Choose both options and you still have $1.324 btrillion to go.

Good luck.

* As Vivian Darkbloom notes in the first comment, I originally misread the goal for this exercise. The graphic refers to closing the budget gap, which I mistook as budget balance. David Leonhardt’s accompanying blog post makes clear that the goal is essentially getting down to a sustainable deficit level, which is an easier target.

The Biggest Tax Policy Mistake of the Year

The fine folks over at the New York Times Freakonomics blog recently asked me to identify the “biggest potential tax policy mistake that might be made this year.” Here’s my answer:

With little time left on the legislative clock, policymakers will be hard-pressed to top the tax policy blunders they’ve already made this year. Most notable is their failure to decide what this year’s tax law should be. While politicians, analysts and the media endlessly debate how expiring tax cuts might affect taxpayers in 2011, the real disgrace is that we still don’t know what the tax law is in 2010.

Will our leaders really allow the alternative minimum tax to hit 27 million taxpayers this year, a whopping 23 million more than in 2009? Did the estate tax really expire back in January, making 2010 the year without an estate tax? Will companies really receive no tax credits for their investments in research and development?

Under existing law, the answer to each of these questions is yes. Unless Congress acts, the AMT will expand its reach almost 500 percent, George Steinbrenner’s estate will pay no estate tax, and America’s most innovative companies will go without the R&E tax credit. But in today’s world, existing law doesn’t mean much until Congress throws in the legislative towel. The upcoming lame-duck session will thus feature healthy debate about patching the AMT, retroactively resuscitating the estate tax and extending a host of expired business tax credits — all policies that would determine 2010 taxes.

Such retroactive policymaking is an embarrassment. In a well-functioning democracy, policymakers should establish the laws of the land in advance so that families and businesses can knowledgeably plan their activities. Surprises may sometimes necessitate mid-course corrections. An economic downturn may justify mid-year tax cuts, or a sudden crisis may require mid-year tax increases. But persistent retroactive lawmaking undermines the core idea that ours is a nation of law.

Needless uncertainty also creates real costs. Uncertainty about the R&E tax credit, for example, limits its usefulness as an incentive. If businesses think that it might expire, they have less reason to take it into account when planning their research efforts. That can turn a helpful incentive into a pointless giveaway.

Needless delay also undermines the IRS’s ability to implement the tax system. In 2007, for example, Congress fiddled until just before Christmas before deciding to enact that year’s AMT patch. Because of that delay, affected taxpayers couldn’t begin filing their returns until February 15, when IRS computers finally reflected the new law.

Congress has made a huge mistake by leaving taxpayers in limbo for more than 10 months. Let’s hope they resolve that quickly when they return for what promises to be a frantic lame-duck session.

Joel Slemrod, Bill Gale, and Clint Stretch also contributed to the discussion.

Will Budget Concerns Ever Influence Carbon Policy?

Climate change legislation died an ignominious death in the Senate earlier this year. If you’d like to understand why, check out Ryan Lizza’s autopsy of the effort in the latest New Yorker. Lizza documents how the “tripartisan” trio of John Kerry, Joe Lieberman, and Lindsey Graham came up short in their effort to craft a 60-vote coalition in the Senate. Among the bumps along the way:

On March 31, President Obama announced a dramatic expansion in offshore waters open for oil and natural gas drilling. In so doing, he gave away one of the sweeteners that the trio was hoping to use to attract pro-drilling senators.

On April 15, Fox News reported that, according to “senior administration officials”, the White House was opposing efforts by Senator Graham to increase gasoline taxes. That claim was perverse–the bill didn’t include higher gasoline taxes and Graham certainly wasn’t pushing them–but not surprisingly it created problems for Graham back home.

Lizza’s article is rich with such anecdotes, but it’s the larger picture I’d like to emphasize. Kerry, Lieberman, and Graham adopted a traditional approach to building a Senate coalition. They identified their main goal–comprehensive climate change limits–and then started negotiating with individual Senators and special interests to see how they could get to 60 votes. Nuclear power, electric utilities, oil refiners, home heating oil, even cod fisherman all make an appearance at the bargaining table. But it’s not clear that such horse-trading could ever yield 60 votes.

This failure makes me wonder whether the traditional approach will ever generate a substantive climate bill. I suppose that’s still possible, particularly if the EPA begins to implement a burdensome regulatory approach to limiting carbon emissions. That might bring affected industries running back to the table.

But I would like to suggest another strategy: Perhaps the environmental community should make common cause with the budget worrywarts. In principle, a carbon tax is a powerful two-birds-with-one-stone policy: it cuts carbon emissions and raises money to finance the government. (This is equally true of a cap-and-trade approach in which the government auctions allowances and keeps the proceeds.) Perhaps there’s a future 60-vote coalition that would favor those outcomes even if various energy interests would be opposed?

Such a coalition is unthinkable today. Opposition to energy taxes runs deep, as Senator Graham experienced. But fiscal concerns will continue to grow in coming years, and spending reductions may not be enough to get rising debts under control. If so, maybe we’ll see a day in which a partnership of the greens and the green eyeshades will take a stab at a carbon tax.

Nickels Matter: Pigou and the Plastic Bag

On January 1, Washington DC introduced a 5-cent tax on disposable shopping bags at grocery, drug, convenience, and liquor stores. The fee had two goals: to reduce the number of bags, in particular plastic ones, that end up blighting the landscape and to raise funds for cleaning up the Anacostia River.

The fee appears to be succeeding on both counts, but not equally so. As Sara Murray and Sudeep Reddy report over at the Wall Street Journal, shoppers have cut back on bag use more than anticipated; as a result revenues are running below expectations:

[T]he city estimated that [bag use] would decline by 50% in the first year after the tax was imposed. …. [A]n informal survey of corporate headquarters for grocery stores and pharmacies with dozens of locations in the city estimated a reduction of 60% or more in the number of bags handed out. … Through the end of July, the city collected more than $1.1 million from the bag fee and small donations. At that rate, receipts are likely to fall short of the expected $3.6 million in the first year.

I’ve witnessed the sharp decline in bag use during my daily lunch run. Last year, the Subway folks would automatically put your sandwich and a napkin in a plastic bag. Now they ask if you want one. I always decline, as do most other customers.

Why has there been such a strong reaction to a nickel fee? I think it’s a combination of two factors.

The first is a traditional microeconomic explanation: there are often good substitutes for a disposable shopping bag. For example, I find it just as easy to carry the wrapped sandwich as to carry the old Subway bag. And if I buy some dental floss at CVS, I can just pop it in my pocket for the trip home. So even a relatively small fee can get results.

The second is a behavioral explanation: people act weird when things are free–they acquire things without really thinking about it. If you start charging a price–and thus change the default from “here’s your bag” to “do you want a bag?”–you can witness large responses.

P.S. As noted in a previous post on the bag fee, Arthur Cecil Pigou is the father of environmental taxes.

TPC’s New Tax Calculator

Over at the Tax Policy Center, we just unveiled a nifty new tool for understanding how the ongoing tax debate might affect real households. The Tax Calculator allows taxpayers, analysts, and the media to analyze how much an individual or family would pay in taxes under three scenarios:

2010 law, in which the 2001-2003 tax cuts are all in effect;

The law scheduled to take effect in 2011, in which essentially all of the 2001-2003 tax cuts have expired; and

The proposals that would take effect in 2011 under President Obama’s Budget. The budget includes numerous features, of which the most prominent is that the tax cuts would continue for incomes up to $200,000 (individual) or $250,000 (joint), but almost all of the tax cuts at higher income levels would expire.

Users can create their own taxpayer profiles or can select from any of six sample households.

If you are interested, please try it out.

Testimony on the 2001 and 2003 Tax Cuts

As you may have heard, the tax cuts that were originally enacted back in 2001 and 2003 are scheduled to expire at the end of the year.

In the good old pre-crisis days, many members of the budget community (myself included) used to say things like “maybe the looming expiration of the tax cuts will finally provide enough pressure to get Congress to enact fundamental tax reform.”

That notion seems rather quaint today. Congress can’t even figure out what to do with the tax code for 2010, which is already more than half over.

For example, we still don’t know whether millions of Americans will be newly subject to the alternative minimum tax. We don’t know what will happen to all the “tax extenders.” And we don’t know whether Congress will really allow all estates of people who die in 2010–including George Steinbrenner–to completely avoid the estate tax (which will then return in full force at midnight on New Year’s morning).

Given that record, most hope for fundamental tax reform is now focused on the President’s fiscal commission. Congress, meanwhile, is now gearing up to figure out what to do about the expiring tax cuts. On Wednesday the Senate Finance Committee held a hearing to discuss the distributional and economic growth effects of extending the tax cuts. I appeared as a witness.

You can read my written testimony here.

You can find the opening statements of Chairman Baucus and Ranking Member Grassley and testimony of the other witnesses here.

You can see video of the hearing here.

As you might imagine, the five witnesses didn’t always agree. There was a strong consensus, however, that our tax system needs fundamental reform. The challenge is figuring out how to do it … and do it well. During the Q&A, Doug Holtz-Eakin had one suggestion: lock the business community out of the discussion entirely. Why? Because a basic principle of tax reform will be eliminating special interest provisions and that will be easiest if business interests aren’t in the mix protecting their favorite provisions.

Why Taxes Are Going Up

It’s hard to imagine that spending restraint alone can solve America’s long-run fiscal woes. Facing an aging population and rising health care costs, the federal government will continue to expand even if policymakers take serious steps to trim spending. That’s why policy wonks are working so hard to evaluate ways to raise more revenue. Cutting back on loopholes and other tax expenditures, taxing carbon emissions, introducing a value-added tax – all of these deserve attention in case America decides that it wants to finance a substantially larger federal government.

However, that focus sometimes overshadows a key fact about our tax system: Revenues are already on track to rise substantially in coming years. And not just because of an economic rebound and expiring tax cuts. There are structural reasons why tax revenues will grow faster than the economy.

The Congressional Budget Office estimates that tax revenues will rise from 14.9% of GDP in 2010 to 20.7% in 2020 and 23.3% in 2035 if current law remains in place (the “extended baseline” scenario in pink):

To put those figures in context, note that federal revenues have averaged about 18.2% of GDP over the past forty years. Tax revenues today are thus remarkably low. Indeed, they are the lowest they’ve been since 1950. But that will quickly reverse under existing law. By 2020, revenues would near their all-time record (20.9% of GDP in 1944) and by 2035, revenues would be more than 25% higher than historical levels.

That rapid growth reflects six factors. First, the economy will recover, lifting revenues from currently depressed levels. Second, the 2001 and 2003 tax cuts will expire, as will tax cuts enacted in the 2009 stimulus. Third, the Alternative Minimum Tax, which is not indexed for inflation, will boost taxes for millions more taxpayers. Fourth, the new taxes that helped pay for the recent health legislation will go into effect. Fifth, retiring baby boomers will make more taxable withdrawals from tax-deferred retirement accounts. Finally, in a phenomenon known as bracket creep, growing incomes will push taxpayers into higher brackets and reduce their eligibility for various credits.

Together, those six factors will increase tax revenues by 8.4 percentage points of GDP over the next 25 years, according to CBO. About a third of that increase (2.7 percentage points) comes from expiring individual income tax provisions and the expansion of the AMT. Another third (2.6 percentage points) is due to real bracket creep and reduced credits. And about one-seventh (1.2 percentage points) results from the tax increases in the health legislation. The other factors account for the remainder.

We clearly have sizeable tax increases built into our revenue system. The trillion-dollar question, however, is whether policymakers will allow them to happen. That’s why CBO considers a second scenario in which Congress gives in to the temptation to cut taxes. Under that “alternative fiscal” scenario (blue), Congress would permanently extend most of the 2001 and 2003 tax cuts and would limit the growth of the AMT. That would slow the growth of tax revenues but they would still reach 19.3% of GDP by the end of the decade, well above the forty-year average. CBO assumes that policymakers would then enact a series of unspecified future tax cuts to hold revenues at that level rather than letting structural factors lift them higher.

CBO’s bottom line is thus simple: tax revenues will rise faster than the economy even if Congress does nothing new. Indeed, revenues may rise faster than the economy even if Congress enacts substantial tax cuts. Our long-run fiscal dilemma exists because the scheduled growth in future spending is even larger than the scheduled growth in future revenues.

This post first appeared on TaxVox, the blog of the Urban-Brookings Tax Policy Center.