Taxes – Page 8 – Donald Marron

More Budget Foxes, Fewer Hedgehogs

My latest column at the Christian Science Monitor:

America’s fiscal challenges are often portrayed as a conflict between hawks and doves. The real battle, however, is between foxes and hedgehogs.

hedgehog_fox — Unfortunately, fiscal hedgehogs still have the upper paw.

“The fox knows many things, but the hedgehog knows one big thing,” wrote the ancient Greek poet Archilochus. Both foxes and hedgehogs play important roles in the policy ecosystem in normal times. In times of great change, however, society needs more foxes and fewer hedgehogs. More citizens and leaders who can adapt to new conditions, and fewer who want to preserve the status quo.

That’s where we find ourselves today. Despite all the anguish over a debt limit deal, America’s fiscal outlook remains daunting. Little progress has been made on our largest budget challenges. Despite bipartisan efforts, prospects for a grand fiscal bargain remain dim.

One reason is that fiscal hedgehogs still have the upper paw on key issues.

Consider entitlements. Everyone knows that entitlement spending is our No. 1 long-term budget challenge. Because of an aging population and rising health-care costs, spending on Social Security and federal health programs will explode. The Congressional Budget Office estimates that over the next 25 years spending on these programs will rise from roughly 10 percent of the economy to almost 17 percent. Accommodating that growth would require substantial cuts in other government programs, much higher tax revenues, or unsustainable deficits and debt.

The challenge is to find ways to keep the core benefits of these programs while reining in costs. This is where entitlement hedgehogs and foxes part company.

The hedgehogs know one big thing: These programs provide major benefits. Social Security, for example, has dramatically reduced poverty among seniors and provides essential income to millions of retirees.

Inspired by that one big thing, hedgehogs oppose any benefit reductions, such as increasing the eligibility age or trimming benefits to reflect increased longevity.

Entitlement foxes have a more nuanced view. They recognize, like the hedgehogs, the value of the guaranteed retirement income that Social Security provides. But they also know that the number of retirees receiving benefits is growing faster than the number of workers paying payroll taxes. They know that Americans are living longer but retiring earlier. They know, in short, that the future will be different from the past and that the program needs to evolve to remain sustainable. Foxes are thus open to ideas like raising the eligibility age or changing the benefit formula.

A similar dichotomy exists with taxes. Revenue hedgehogs know one big thing: Taxes place a burden on taxpayers and the economy. Thus, they oppose all tax increases, even efforts to reduce the many tax breaks that complicate our tax code.

Revenue foxes see things differently. They recognize the burden that taxes place on taxpayers and the economy. But they also know that tax increases are not all created equal. Higher tax rates, for example, are usually worse for the economy than cutting back on tax breaks. Indeed, cutting tax breaks sometimes frees taxpayers to make decisions based on real economic considerations rather than taxes, thus strengthening the economy. That’s why revenue foxes support eliminating many tax breaks.

Fiscal hedgehogs will never embrace such changes. To make progress, we need more fiscal foxes.

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.

Does the Gang of Six Cut Taxes or Raise Them?

Here’s a quick multiple choice quiz about the Gang of Six’s new budget proposal.

Over the next ten years, would the proposal:

a. Cut taxes by $1.5 trillion

b. Increase taxes by $2.0 trillion

c. Increase taxes by $1.2 trillion

d. All of the above.

If you answered (d), you have a fine future as a budget watcher (or you peeked at the answer from the last time we played this game).

The answer depends on the yard stick you use to measure changes in tax revenues. Unfortunately, people now use at least three different yard sticks.

The first, known as the current law baseline, assumes that Congress doesn’t change the tax laws on the books today. That means every temporary tax cut expires in the next two years, including the individual tax cuts enacted in 2001/2003 and extended in 2010, the “patch” that limits the growth of the alternative minimum tax, and the current estate tax.

The second, known as the current policy baseline, assumes those three temporary tax cuts all get permanently extended.

The third, known variously as the Fiscal Commission’s plausible baseline or the alternative fiscal scenario of 2010, assumes that those three temporary tax cuts all get extended with one big exception: the tax cuts that benefit “high-income” taxpayers expire.

With three different yard sticks, we get three different measures of the impact of the Go6 proposal.

Relative to the current law baseline, the Go6 plan would be a $1.5 trillion tax cut. In other words, the Go6 plan would raise $1.5 trillion less in revenue over the next ten years than if Congress did nothing, and all the temporary tax cuts expired. That’s an important number because the Joint Committee on Taxation and the Congressional Budget Office are required to use current law in preparing official budget scores.

Relative to the Fiscal Commission’s baseline, the Go6 plan is a $1.2 trillion tax increase. That includes three pieces: $1.0 trillion from reducing tax preferences (some of which may be the moral equivalent of cutting spending), $133 billion in new revenues for the highway trust fund (but not from higher gas taxes), and about $60 billion from using a lower measure of inflation – the chain CPI – to index the tax code.

Relative to current policy, finally, the Go6 plan is roughly a $2 trillion tax increase. In addition to the $1.2 trillion in tax increases noted above, it assumes an additional $800 billion in revenue – equivalent to what would be raised by allowing the “high-income” tax cuts to expire.* The Go6 plan would thus raise about $2 trillion more in revenue over the next ten years than if Congress simply kept in place the tax policies that apply in 2011 (except the payroll tax holiday, which everyone assumes will eventually expire).

Bottom line: You should expect to hear the plan characterized as anything from a $1.5 trillion tax cut to a $2 trillion tax hike.

P.S. For a similar discussion comparing two of the three baselines, see this nice piece by David Wessel of the Wall Street Journal.

P.P.S. What really matters, of course, is the plan itself, not how it scores against some possibly arbitrary baselines. Bob Williams makes that point here.

* I revised this sentence to emphasize that the plan includes revenue equivalent to letting the “high-income” tax cuts expire; it doesn’t actually let the rates expire – instead, it includes a wholesale reform that includes lowering the top rate to no more than 29 percent.

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 2^nd. 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.

Cut Spending by Raising Taxes

My latest column at the Christian Science Monitor argues that we can cut spending by raising taxes:

Here’s a shocker: America can cut government spending by eliminating tax breaks.

I know that sounds crazy. Everyone usually talks as if spending and tax breaks are distinct. Spending is what the government gives out or uses for purchases; tax breaks reduce how much revenue it collects.

Reality, however, is a lot blurrier. Hundreds of billions of dollars of spending are disguised as tax cuts.

It’s not hard to see why. Voters like tax cuts more than spending increases. Politicians understand that, so they convert spending into tax breaks.

The ethanol tax credit is a perfect example. Fuel producers qualify for a 45-cent tax credit for each gallon of ethanol they blend into gasoline. Blenders calculate their income taxes like other businesses, then deduct the value of the credit before they send their check to the Internal Revenue Service (IRS).

The ethanol subsidy thus looks like a tax cut, but it’s really government spending in disguise. The Department of Energy could accomplish the same thing by sending out subsidy checks. The same is true for dozens of other tax provisions, such as the business credit for research and development and personal tax breaks for mortgage interest, health insurance, and charitable giving.

Politicians act as if those provisions are tax cuts. That seems plausible. Businesses and families send less money to the IRS because of them.

But think about it. These tax breaks don’t let you keep your money. They pay you for doing what government wants, whether that’s taking out a mortgage, giving to charity, or investing in R&D. What you pay the IRS equals the taxes you owe minus the payments for which you’ve qualified. Those payments are no different from spending; they just happen to be netted against your tax bill.

That doesn’t mean all tax preferences are bad policy. Some support important goals, and the tax system is sometimes the best way to administer a program. The income tax, for example, provides a natural structure for benefits like the earned income tax credit that should vary with income.

It does mean, however, that these provisions should get the same scrutiny as traditional spending programs. Social Security, health care, defense, and domestic spending must all go under the budget knife if we want to avoid unsustainable debts. The middle-class entitlements, business incentives, and social programs embedded in the tax code shouldn’t escape that surgery just because they’re designed as tax breaks.

That’s why many budget hawks believe that cutting these preferences is essential to deficit reduction. The president’s fiscal commission, for example, proposed dramatic cuts to “spending-like” tax preferences as a way to reduce future deficits while lowering – not raising – income tax rates.

That approach has great merit, but has not yet been universally embraced. When Sen. Tom Coburn, a conservative Republican and budget hawk from Oklahoma, recently introduced legislation to eliminate the ethanol tax credit, he drew fierce opposition from some advocacy groups that favor lower taxes. Both Senator Coburn and the advocates favor smaller government. Where they differ is that Coburn recognizes that spending can hide in the tax code.

Trimming tax preferences won’t be painless – many businesses and families would send more to the IRS. But the result would be a fairer, more honest tax code and a broader, more solid base of revenue to pay for government services.

Congestion Pricing Saves Time and Money

The Highway Trust Fund will soon be broke. Gasoline tax revenues haven’t kept up with spending, and it’s likely that demands for new highway infrastructure will grow in the future.

Joseph Kile, head of the microeconomics studies division at the Congressional Budget Office, discussed various policy options to deal with this funding gap in his testimony to the Senate Finance Committee on Tuesday. Most news coverage of Joe’s testimony emphasized his suggestion that taxes based on miles traveled, rather than gasoline consumption, might be a better way to finance America’s highways. After all, miles traveled is, along with weight, the primary driver of wear and tear on the roads. And it’s a decent proxy for the benefit that drivers get from having functioning roads.

That’s an interesting idea, but I’d like to highlight another important point that Joe made: the amount of infrastructure America should build depends very much on how we price it.

If a six-lane highway gets congested, that doesn’t necessarily mean that we need to build new lanes or lay out parallel roads.

We could charge congestion fees instead. That would discourage driving at peak times and thus speed traffic without new construction. That’s what London and Singapore famously do to limit traffic in their downtowns. And it’s something we should more here in the United States.

Joe reports estimates from the Federal Highway Administration (FHWA) that congestion pricing could decrease highway spending needs by 25 to 33 percent:

The federal government spent about $43 billion on highway investment in 2010. To maintain the same quality of highway performance would require an average of $57 billion in annual federal spending in coming years, according to the FHWA. That price tag drops to only $38 billion, however, if we make good use of congestion pricing. Congestion pricing would thus save federal taxpayers almost $20 billion per year; state and local governments would save even more, since they pay for more than half the costs of these projects.

Congestion pricing can make our roadways work better, save Americans precious time, and reduce federal, state, and local budget pressures. That a great combination in this time of growing infrastructure needs and tightening budgets.

Chain, Chain, Chain, Chain CPI

Over at the Moment of Truth project (a continuation of the president’s fiscal commission), Adam Rosenberg and Marc Goldwein make a compelling case that the government should use a different inflation measure when calculating cost of living increases and indexing the tax code:

Maintaining purchasing power in spending programs and indexing various parts of the tax code is an important policy goal. However, policymakers should ensure that the most accurate measure of inflation is being used.

To correct the problem of over-indexation, many have proposed switching to the chained CPI [consumer price index] to provide a more accurate measure of inflation for indexed provisions in the federal budget. This switch was recommended by the National Commission on Fiscal Responsibility and Reform (“Fiscal Commission”) and the Bipartisan Policy Center ‘s Debt Reduction Task Force (“Domenici-Rivlin”). It has been incorporated into a large number of other plans, including from the Heritage Foundation on the right and the Center for American Progress on the left. An overwhelming majority of economists from both parties agree that the chained CPI is far more accurate measure of inflation than the CPI measurements currently in use.

In addition to improving technical accuracy, switching to chained CPI would have the secondary benefit of reducing the deficit – by about $300 billion over the next decade alone.

For the reasons they mention, I endorse this change and predict it will be part of any “grand bargain” on America’s budget.

With apologies to Aretha Franklin (and any of you with sensitive music sensibiities), let me suggest a theme song for the effort:

Chain, Chain, Chain, Chain CPI

Chain, chain, chain, chain, chain, chain

Chain, chain, chain, chain CPI

For these long years, we have indexed all wrong

We pay too much, that leads to fiscal pain

And now money’s getting tight

But we have no need to cry

We know what to do, oh a better measure we can try

Chain, chain, chain, chain CPI

P.S. To my readers who believe that the regular CPI understates inflation, rather than overstating it: Yes, Aretha’s song is “Chain of Fools”. And yes, that makes it easy for you to make up lyrics that mock the chain CPI rather than endorse it. Have fun.

Fiscal Policy Highlights Around the Net

1. Over at Third Way, Bill Rapp used my data on debt limit votes to make a great graphic showing that those votes are about politics, not principle.

2. Over at the Tax Policy Center, Eric Toder pushes back against the idea that tax expenditures — spending in the tax code — are loopholes and earmarks:

The House Budget resolution promises an individual tax reform that “simplifies the broken tax code, lowering rates and clearing out the burdensome tangle of loopholes that distort economic activity.” The Fact sheet describing President Obama’s new budget framework calls for “individual tax reform that closes loopholes and produces a system which is simpler, fairer, and not rigged in favor of those who can afford lawyers and accountants to game it.” The bipartisan National Commission on Fiscal Responsibility and Reform notes that the tax system is riddled with tax expenditures and adds, “These earmarks not only increase the deficit, but cause tax rates to be too high.”

…

But the largest tax expenditures are not loopholes or earmarks snuck into the law in the dead of night to benefit a shadowy handful of super-wealthy individuals or well-connected corporations. Rather, they benefit tens of millions of taxpayers. Among the biggest: itemized deductions for home mortgage interest, charitable contributions, and state and local taxes, exemption of income accrued within tax-preferred retirement saving accounts, and the exemption from tax of employer contributions to health insurance plans. IRS data show that 39 million taxpayers claimed deductions for home mortgage interest and charitable contributions in 2008, and 35 million deducted state and local income taxes.

3. The Committee for a Responsible Federal Budget offers a helpful side-by-side comparison of four leading budget plans: