Tag: Taxes

How Bad is the Budget Outlook?

The Congressional Budget Office offers two visions of the future in its new long-run budget outlook.

The first imagines a world in which lawmakers take pay-as-you-go budgeting really seriously. The budget baseline assumes that existing laws execute exactly as written: all the 2001 and 2003 tax cuts expire, the alternative minimum tax hits millions more families, real bracket creep drives taxes far above historical norms, Medicare payments to doctors are cut by more than 20%, discretionary spending grows only with inflation, and all the offsets in the recent health legislation – taxes on “Cadillac” health plans, cuts in provider payments, etc. – happen as scheduled. If Congress tries to avoid any of those changes, it would have to pay for them through offsetting spending cuts or tax increases.

In that strict—and unrealistic—PAYGO world, our debt would continue to increase faster than the economy, rising from about 60% of gross domestic product today to about 80% in 2035. That’s far above where we want to be. PAYGO policymaking cannot fix the budget pressures of an aging population and rising health costs. But you have to give PAYGO some credit. If Congress really acted that way on every future budget decision, it’s unlikely that we would have a fiscal crisis in the next decade or more.

Of course, no one believes that Congress will really be that disciplined. That’s why CBO offers a second vision, in which lawmakers give in to temptation. They extend most of the tax cuts, patch the AMT, limit bracket creep, increase payments to Medicare docs, allow discretionary spending to rise with GDP, and turn off some of the health legislation offsets after 2020.

If policymakers give in to all those temptations, the debt skyrockets, rising from about 60% of GDP today to 185% by 2035. And that’s assuming no negative effects on the economy. As my colleagues Len Burman, Jeff Rohaly, Joe Rosenberg, and Katie Lim have pointed out, out-of-control deficits would weaken the economy by crowding out investment and driving up interest rates, so the debt-to-GDP ratio would actually grow even faster.

CBO doesn’t include those economic effects in its official long-run projections. However, it does separately examine what would happen to the economy because of reduced investment. The results aren’t pretty. When CBO runs the giving-in-to-temptation world through its model, it discovers that the U.S. economy ceases to exist after 2027.

OK, maybe that’s a bit strong. What happens is that crowding out gets so severe that CBO’s model breaks down, overwhelmed by the debt explosion.

These findings provide ammunition to both sides of the great deficit debate. Budget hawks will point to the temptation scenario as further evidence that we are on a reckless fiscal path that threatens our economic well-being. Budget doves will emphasize the PAYGO scenario as evidence that we can muddle along for years without needing to fear an economic backlash.

I think the hawks have the better of this argument. Even under perfect PAYGO, our fiscal condition would deteriorate in coming years. Moreover, the odds that lawmakers will show that much discipline in the near term are nil. For example, the PAYGO law enacted earlier this year allows Congress to extend most of the 2001 and 2003 tax cuts and to avoid cuts to Medicare doctor payments without finding any offsets. Real life PAYGO doesn’t come close to the rigorous standards of CBO’s PAYGO scenario.

Nevertheless, I don’t really think that the U.S. economy will blink out of existence in 2027. We will find a way a muddle through. But to do so, we need to face up to CBO’s bleak vision of our fiscal future and the temptations that lawmakers will face. Now is not the time for sudden austerity—the G-20 bandwagon non-withstanding—but it is the time to develop a plausible plan to bring taxes and spending into long-run balance.

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

Edited (7/6/10): Added “most of” in fourth paragraph (CBO’s alternative fiscal scenario extends most of the 2001 and 2003 tax cuts, but it allows the rates reductions for high-income taxpayers to expire).

Gaming the Budget Window

Faced with continuing gridlock over a soup-to-nuts extenders bill, congressional leaders have gotten creative in their legislative strategy. Exhibit A is a stripped-down bill that passed the Senate by unanimous consent on Friday. This bill would temporarily reverse the 21% cut in Medicare physician payment rates that took effect earlier this month. The price tag for this six-month “doc fix” is a bit more than $6 billion over the next ten years.

To appear fiscally prudent, lawmakers want to pay for that spending by raising new revenues or reducing other spending. About $4 billion would come from changes to Medicare. The other $2 billion would come from allowing businesses to postpone contributions to their underfunded pension plans.

Yes, you read that correctly. In the strange world of Washington budgeting, lawmakers can pay for new spending by making it easier for corporations to underfund employee pensions.

You might think this move would worsen the budget situation since the government insures pensions through the Pension Benefit Guarantee Corporation. And you would be right. If firms put off needed contributions to their plans, the PBGC will be exposed to more losses, and future government spending will be higher (even if PBGC collects somewhat higher premiums because of the underfunding). Many of those losses won’t occur for years, however, and thus fall outside the 10-year window that Congress uses to evaluate the budgetary impacts of legislation.

And that’s not all. When companies make pension contributions, they get to deduct that money from their income. Lowering pension contributions for a few years would thus temporarily raise taxable corporate income and boost corporate tax revenues. But those tax gains would reverse once firms have to fund their pension plans. That’s why the pension provision would increase corporate tax revenues by about $6 billion through 2016 and then would lower revenues by about $4 billion in 2017 through 2020.

Over ten years, the net revenue gain would total about $2 billion, enough to cover the remaining costs of the six-month doc fix. But that’s only because we’d also lose about $2 billion in revenue outside the budget window. Taking those losses into account, the bill would generate essentially no net revenues.

The doc fix/pension underfunding bill would be “paid for” only because Congress would have managed to push both future spending increases and future revenue losses outside the budget window. Let’s hope such budget gaming isn’t the norm when Congress finally confronts our larger budget challenges.

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

A Small Step toward Tax Equality for Same-Sex Couples

A trio of recent IRS rulings (here, here, and here) has rekindled debate on how our tax system should treat same-sex couples.

Under the Defense of Marriage Act, the federal government does not recognize same-sex marriages. As one consequence, same-sex couples must file individual tax returns even if they are married or registered as domestic partners under state law.

The new rulings were prompted by a 2007 California law that requires registered domestic partners to treat their earnings and some investment returns as common property for state tax purposes. Under this approach, the partners share equally in their combined income, regardless of which partner earned it. If one partner earned $50,000 and the other nothing, for example, they would each be viewed as having $25,000 of income.

Because “federal tax law generally respects state property law characterizations and definitions,” the IRS decided to apply that approach to federal taxes. As a result, domestic partners in California (most of whom are same-sex couples) will each report half their combined income from earnings or community property on their individual federal tax returns.

That approach will lower the tax burden for many eligible same-sex couples. For example, if one partner earns $50,000 per year and the other has no earnings, the couple’s combined federal tax bill would fall from about $6,000 to $3,000 (assuming they have no children). That decline is identical to the “marriage bonus” that the federal tax code currently provides to heterosexual married couples at that income level.

For that reason, some commentators have characterized the rulings as tax equality for same-sex couples (e.g., the Wall Street Journal ran the headline “Gay Couples Get Equal Tax Treatment”). But that interpretation exaggerates the impact of the rulings and understates the differences in taxation between same-sex and heterosexual couples.

First, the rulings apply only in states with these community property rules for same-sex partners. According to the WSJ, besides California, only Nevada and Washington might currently be affected.

Second, same-sex partners still can’t file joint returns. As a result, their tax burdens can differ from those of otherwise identical heterosexual couples. For example, one domestic partner might have investment income from assets that are not community property and thus are not shared with the other partner. Depending on their income, that can result in the same-sex couple paying more or less than a heterosexual couple.

Dividing income under the community property approach may also allow same-sex couples with high incomes to pay less in federal taxes than heterosexual couples. For example, a same-sex couple that earns $300,000 would pay about $66,000 in tax under the new ruling, while a heterosexual married couple would pay about $78,000.

Finally, the rulings don’t address a host of other ways in which same-sex couples face less-favorable tax treatment. At a recent TPC event, for example, Michael Steinberger of Pomona College noted that same-sex couples can face significantly higher estate taxes because they aren’t eligible for tax-free bequests to spouses.

For all these reasons, same-sex couples and heterosexual couples still aren’t treated the same under the tax code. The recent IRS rulings narrow the gap in some cases, but create new gaps in others. Given the complexities of our tax code, separate treatment will inevitably mean that some same-sex couples will pay more or less in taxes than comparable heterosexual couples do. If policymakers ever want same-sex couples to be taxed the same as heterosexual couples, the only practical way to do so would be to allow same-sex couples to file their tax returns as married couples.

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

The Looming Budget Battle over the Bank Tax

Treasury Secretary Tim Geithner appeared before the Senate Finance Committee today to push the Administration’s proposal for a Financial Crisis Responsibility Fee, more commonly known as the Bank Tax. The purpose of the fee is to

[M]ake sure that the direct costs of TARP are paid for by the major financial institutions, not by the taxpayer.  Assessments on these institutions will be determined by the risks they pose to the financial system.  These risks, the combination of high levels of riskier assets and less stable sources of funding, were key contributors to the financial crisis.

The fee would be applied over a period of at least ten years, and set at a level to ensure that the costs of TARP do not add to our national debt.  One year ago we estimated those costs could exceed half a trillion dollars.  However, we have been successful in repairing the financial system at a fraction of those initial estimates. The estimated impact on the deficit varies from $109 billion according to CBO to $117 billion according to the Administration.  We anticipate that our fee would raise about $90 billion over 10 years, and believe it should stay in place longer, if necessary, to ensure that the cost of TARP is fully recouped.

As noted by other participants in today’s hearing, the bank tax raises a host of questions: Is it possible to design the tax so that it is ultimately paid by major financial institutions (by which I presume Geithner means their shareholders and top management), or will it get passed through to their customers? How much, if at all, would the tax reduce bank lending? Is it fair to target the banks even though the bank part of TARP actually made money for taxpayers? Would the tax reduce risks in the financial system?

Those are all interesting questions, but today I’d like to highlight another one: Can Congress embrace the idea of a bank tax that would be used to “ensure the costs of TARP do not add to our national debt”?

As described by the Administration, the bank tax would be used to reduce the deficit, thus offsetting budget costs of TARP. Congress, however, is hungry for revenues that it can use to offset the budget costs of new legislation, e.g., extending the ever popular research-and-experimentation tax credit or limiting the upcoming increase in dividend taxes. With PAYGO now the law of the land (for many legislative proposals), some members are looking at the $90 billion of potential bank tax revenues as the answer to their PAYGO prayers.

All of which points to a looming budget battle: Will the bank tax be used to pay off the costs of TARP, as the President has proposed, or will it be used to pay for other initiatives?

America in the Red, AOL Version

Responding to all the recent talk of a value-added tax, AOL News poses the following question today: “Do we need a new way to tax citizens?”

In response, AOL posts several pieces about the pros and cons of a VAT (by Henry Aaron and Isabel Sawhill, Ira Stoll, and Veronique de Rugy). In addition, it also includes an abridged version of my National Affairs piece, “America in the Red,” which they titled “Don’t Take Anything Off the Table.”

If you haven’t found time for the full length version, with charts, you might want to try AOL’s abridged one. (Please note that they did the abridging.)

Three Principles for New Tax Policy

The folks over at Our Fiscal Future asked me to write a short piece to commemorate tax week. Here’s an excerpt:

Let me offer three basic principles that our leaders—and our fellow citizens—should keep in mind in evaluating new revenue options:

  1. It is usually better to broaden the tax base rather than increase tax rates. Why? Because high tax rates create disproportionately large economic distortions and invite widespread evasion. Any effort to increase revenues should therefore focus first on the many special credits, exemptions, and exclusions that undermine our current tax base. Such “tax expenditures” cost more than $1 trillion each year but receive surprisingly little oversight. Some of these provisions generate economic or social benefits, but many are simply hidden ways to help special interests. Reducing or eliminating those tax expenditures could bring in new revenues, improve economic efficiency, and avoid the economic damage that would result from higher tax rates.
  2. Income taxes are usually worse for the economy than consumption taxes. Why? Because income taxes discourage saving and investment, while consumption taxes do not. That is why a rising chorus of experts is recommending that the United States consider a value-added tax, rather than higher income taxes, if it decides it wants to finance substantially higher government spending.
  3. Taxes usually discourage whatever activity is being taxed; as a result, it is better to tax bads rather than goods. Taxes on pollution, for instance, should be preferred over taxes on working, saving, or investing.

My New Gig

I am happy to announce that I will become the director of the Urban-Brookings Tax Policy Center on May 17. TPC has established a remarkable record of nonpartisan research on tax and fiscal policy issues over the past eight years, and I am honored to be joining their team.

Here’s the press release from the Urban Institute announcing the appointment:

WASHINGTON, D.C., April 13, 2010 — Donald Marron, who served as a member of the President’s Council of Economic Advisers and as acting director of the Congressional Budget Office, will become the director of the Urban-Brookings Tax Policy Center May 17.

Marron was a council member in 2008 and 2009. Earlier, he was the deputy director (2005–2007) and acting director (2006) of the nonpartisan Congressional Budget Office.

Marron’s White House experience includes stints as a senior economic adviser and consultant to the Council of Economic Advisers (2007–08) and as its chief economist (2004–05). He was with Congress’s Joint Economic Committee from 2002 to 2004, first as the Senate minority’s principal economist and later as the committee’s executive director and chief economist.

Marron succeeds Rosanne Altshuler, who will be returning to Rutgers University after nearly two years with the Tax Policy Center. The eight-year-old center, a joint venture of the Urban Institute and Brookings Institution, is the nation’s leading nonpartisan resource providing objective analyses, estimates, distributional tables, and facts about the federal tax system and proposals to modify it. Last year, Tax Policy Center researchers produced more than 50 reports and used their state-of-the-art tax model to generate over 500 sets of detailed tax estimates.

“Understanding and helping address the nation’s revenue problems require imaginative scholarship, crisp communication skills, and an insider’s knowledge about how good public policy can be made. Donald brings that and much more to the Tax Policy Center,” said Robert Reischauer, president of the Urban Institute.

Since leaving his White House post, Marron has been a visiting professor of public policy at Georgetown University and an economic consultant.

Marron, who holds a doctorate in economics from the Massachusetts Institute of Technology, was an assistant professor of economics at the University of Chicago’s Graduate School of Business from 1994 to 1998. He is a member of the Bipartisan Policy Center Debt Reduction Task Force and served as a member of the Federal Accounting Standards Advisory Board.

The Tax Policy Center’s leadership also includes two co-directors, William Gale, the Arjay and Frances Miller Chair in Federal Economic Policy at the Brookings Institution, and Eric Toder, an Institute fellow at the Urban Institute.

The Urban Institute is a nonprofit, nonpartisan policy research and educational organization that examines the social, economic, and governance challenges facing the nation. It provides information, analyses, and perspectives to public and private decisionmakers to help them address these problems and strives to deepen citizens’ understanding of the issues and trade-offs that policymakers face.

The Brookings Institution is a private nonprofit organization devoted to independent research and innovative policy solutions. For more than 90 years, Brookings has analyzed current and emerging issues and produced new ideas that matter—for the nation and the world.

P.S. I am also happy to report that I will continue my teaching at the Georgetown Public Policy Institute next year. Should be a fun and busy year.

Ultra Trouble for the Ultra Low Cost Airline?

Last week Spirit Airlines announced that it would start charging fees for carry-on bags this summer. Spirit described the benefits of this move as follows:

“In addition to lowering fares even further, this will reduce the number of carry-on bags, which will improve inflight safety and efficiency by speeding up the boarding and deplaning process, all of which ultimately improve the overall customer experience,” says Spirit’s Chief Operating Officer Ken McKenzie.  “Bring less; pay less.  It’s simple.”

As I’ve noted in previous posts, carry-on bags have become a problem on many flights. With advances in roll-aboard technology and in the face of new fees for checked luggage, more passengers are bringing baggage on board, sometimes overwhelming the capacity of the overheads. Airlines need to find a solution to that problem. Spirit’s fees are one possible answer.

I’m sure Spirit expected that some passengers and passenger advocates would object to these fees. I wonder, however, whether the airline ever suspected that it would incur the wrath of Washington?

Over the weekend, New York Senator Chuck Schumer denounced the proposed fees and sent a letter to Treasury Secretary Tim Geithner asking that he stop them. He’s also threatening legislation to prohibit them.

If you are like me, your first reaction should be to wonder why the Treasury Secretary–rather than, say, the Transportation Secretary–is the lucky recipient of Schumer’s letter. This being the middle of April, however, the answer shouldn’t surprise you: taxes,  specifically the taxes that are levied on airline tickets (but not on some other fees associated with flying). The narrow issue is whether the carry-on fees should be subject to the tax. The broader issue is whether carry-on fees should be allowed separate from the ticket price.

Meanwhile, the Transportation Secretary, Ray LaHood, wasted no time in denouncing the proposed fees as well, saying:

I think it’s a bit outrageous that an airline is going to charge someone to carry on a bag and put it in the overhead. And I’ve told our people to try and figure out a way to mitigate that. I think it’s ridiculous.

So watch out Spirit Airlines; your experiment in pricing scarce overhead capacity may not be welcome in Washington, even if it does lead to lower fares and faster boarding.

P.S. The tempest over the baggage fees is temporarily overshadowing a much more interesting and important issue: the transparency and intelligibility of airline fees. Secretary LaHood touches on this in the interview linked to above, as does this article over at Philly.com’s Philadelphia Business Today. Given the panoply of fees and taxes on air travel–thanks both to the government and to the airlines–there’s a real question about whether consumers understand the full costs of flying when they make their purchasing decisions. And some airlines–most notably Spirit with its “penny” and “$9” fares–seem to be playing on that.

Pigou and the Plastic Bag

The big news in Washington today are the early returns for the new DC bag tax. As of January 1, DC shoppers have to pay a 5 cent tax for each disposable plastic or paper bag that they get at grocery, drug, convenience, and liquor stores.

The Washington Post reports that the DC government has released results for January, the program’s first month. It appears to have had a big effect on behavior:

In its first assessment of how the new law is working, the D.C. Office of Tax and Revenue estimated that food and grocery establishments gave out about 3 million bags in January. Before the bag tax took effect Jan. 1, the Office of the Chief Financial Officer had said that about 22.5 million bags were being issued each month in 2009.

In other words, 87% fewer disposable bags were handed out in January than the average month last year.

Of course, one implication of a big behavioral response is that the tax might collect less revenue than anticipated:

District officials had estimated that the tax would generate $10 million over the next four years for environmental initiatives [note: that’s $208,000 per month]. The money will go to the newly created Anacostia River Cleanup Fund, which will spend it on various projects. But in January, the tax generated only $149,432, suggesting that it might fall short of revenue projections.

One shouldn’t make too much of a single month of results–particularly when it’s the first month of the program.

But I suspect that Arthur Cecil Pigou (the father of environmental taxes) is smiling somewhere.

Tax Loopholes, Wealth Destruction, and Health Reform

AT&T, Caterpillar, Deere, and Verizon garnered headlines last week (and an unwelcome summons to Capitol Hill) for announcing that a provision in the recent health care legislation would result in substantial accounting write downs. AT&T, for example, told the SEC that it expects to take a $1 billion charge in the first quarter because the law eliminates a tax subsidy for providing prescription drug coverage to retirees. According to the Wall Street Journal, Credit Suisse estimates that the total accounting hit for corporate America will total $4.5 billion.

Citing these impacts, a Wall Street Journal editorial denounced the provision as “a wholesale destruction of wealth and capital.” White House Press Secretary Robert Gibbs, in contrast, praised it as “closing a loophole.”

Who’s right?

To figure that out, I spent a lovely Saturday afternoon tracking through the intersection of health policy, tax policy, and financial accounting and emerged with a clear verdict: Gibbs is right. The provision does indeed close a tax loophole.

But the WSJ isn’t completely wrong. The first law of loopholes is that every loophole benefits someone. If you close a loophole, someone will be hurt. That’s what’s happening here. The extra subsidy for retiree prescription drug coverage provided an extra financial boost for AT&T, Caterpillar, et al. Eliminating the loophole will thus reduce the value of the companies and the wealth of their shareholders, just as the WSJ alleges. But it’s hard to get too teary-eyed since that value and wealth were created by the loophole in the first place.

And now to the details:

Continue reading “Tax Loopholes, Wealth Destruction, and Health Reform”