The Bottom Line
Senator Tom Coburn (R-OK) yesterday released his "Wastebook" for 2012, a laundry list of government waste and inefficiency. Coburn finds 100 examples of government spending clearly not serving its designed purpose.
Wastebook's examples include:
- Professional sports leagues mischaracterized as non-profits – $91 million
- Improper food stamp payments including payments going to 2000 deceased individuals and food stamps being used for non-nutritious food like Starbucks coffee – $4.5 billion
- Moroccan pottery classes as part of USAID – $27 million
- NASA food research for an unplanned Mars mission – $947,000
- Payments from USDA to promote caviar – $300,000
- Producing the penny at a cost of twice its value – $70 million
- Free cellphones from the FCC – $1.5 billion
- A "prom video game" funded by the National Science Foundation – $516,000
- College tax credits for those not attending college – $3.2 billion
- State Department sends comedy tour to India – $100,000
- Study that finds that fruit flies are less attracted to older flies compared to younger flies – $939,771
- A library vending machine for books – $35,000
- A study investigating whether World of Warcraft would improve cognitive abilities of seniors – $1.2 million
We noticed that not only did Coburn list examples of spending waste, he also listed tax expenditures that were being abused – like paper companies claiming a wood byproduct as an "alternative fuel." At the end of the day, lawmakers may decide that some tax expenditures may be worth keeping, but we need to ensure we pay for the provisions we believe are important and make sure they are being used as intended. Eliminating wasteful programs in the spending and tax sides of the ledger is a great opportunity to take up fundamental tax reform to make our tax code much more efficient and pro-growth.
Eliminating waste, fraud, and abuse will not solve our debt problem. The extent of our fiscal challenges is too great to avoid making the difficult decisions on tax reform and entitlement reforms. Even so, we should take all opportunities to root out waste in government.
The full report can be found here.
Tonight at 9 PM on the grounds of Hofstra University is the second presidential debate and the only debate with a town hall format. This will allow questions from audience members, and with such a broad consensus that something needs to be done about the national debt, we expect at least a few questions on fiscal policy in tonight's debate. As before, we will be live fact checking from Twitter (@BudgetHawks) and our live feed will appear below.
With the final debate to focus specifically on foreign policy, this may be the last chance for the candidates to clearly lay out how they are going to deal with our unsustainable debt problem. The previous presidential and vice presidential debates both featured an interesting back and forth on fiscal policy, although the candidates did stray from the facts at times. If you haven't already, check out our fact checking from the first and second debates to know what to watch out for.
Check back tonight to see our fact checking of the debate as it unfolds.
Former Congressman and CRFB Board Member Tim Penny (D-MN) writes in today's The Hill that even with both parties laying out different plans this election, they need to come together and agree on doing something about our unsustainable fiscal path. Both the Simpson-Bowles and Domenici-Rivlin plans have shown that it is possible to replace the fiscal cliff with a comprehensive debt deal, and if Congress is willing to make the tough decisions, they can get this done.
Over the long-term, our national debt – now at $16 trillion – is simply unsustainable. Indeed, our rising debt threatens our standard of living and the resources we will have in the future. Simply servicing the bloated debt will soon lead to annual trillion-dollar interest payments and will eventually result in interest rate hikes that will make it harder for average people to borrow money to buy a home or a car.
Many politicians talk about cutting "domestic discretionary spending" and "waste, fraud and abuse" as an answer to our deficit challenge. But those items are too small a portion of our federal budget to offer a solution. Instead, we need a balanced, comprehensive approach that will look to both sides of the ledger – spending and revenue. And, more importantly, on the spending side we need to focus on the drivers of our debt, entitlement programs. While raising revenue, it is best to also reform our tax code to eliminate or reduce economy-distorting deductions and loopholes. Lastly, the right kind of long-term debt deal must make sure to protect our fragile economic recovery – meaning these large-scale spending and revenue measures must be phased-in over time.
Getting politicians of both parties to agree to a debt-reduction program that accomplishes all of these goals may seem like a herculean task. But my experience tells me it can be done. There is much consensus already in place for what we need to do. The Simpson-Bowles Commission report and the Rivlin-Domenici plan both prove that there can be bipartisan support for a comprehensive approach to this fiscal challenge. With the “fiscal cliff” looming, I truly believe that the petty politics of the moment will soon give way to the urgency of action.
As the Presidential debates continue, I certainly hope that President Obama and Governor Romney lay out concrete plans to address the debt and avert both the near-term “fiscal cliff” and the long-term debt crisis. But if they don’t, voters need to let them – and Congress – know that the time is now for serious action. You can do this by adding your name to the 225,000 who have already signed the petition at FixTheDebt.org, which urges passage of a comprehensive deal to create a short- and long-term fiscal fix.
My own experience in Congress makes me confident that we can get this done.
The full article can be found here.
"My Views" are works published by members of the Committee for a Responsible Federal Budget, but they do not necessarily reflect the views of all members of the committee.
Our colleagues Jason Delisle and Alex Holt of the New America Foundation's Federal Education Budget Project have released a new paper "Safety Net or Windfall?" on the 2010 changes to federal student loan program's Income-Based Repayment (IBR) plan. The IBR plan was designed to help with student's loan repayment by limiting payments to 15 percent of their income and forgiving the remaining balance after 25 years. In 2010, the administration proposed changes to limit payments to only 10 percent of student's incomes and forgive any balance after 20 years.
While the proposal was intended to help middle class families with student loan debt, the changes actually benefit higher-income earners with graduate or professonal degrees the most. Because IBR is based on Adjusted Gross Income (AGI) and not an individual's entire gross income, it benefits those who have significant contributions to retirement plans or employer-sponsored health insurance, which is more typical of higher-income earners rather than lower income earners. Also, the maximum repayment caps limit monthly payments even for those with incomes that no longer qualify for reduced payments in the IBR program, leaving windfall benefits for those whose student loan repayments may no longer be a significant burden.
To address these issues, the authors list a few recommendations to scale back repayment limits for high-income and high-debt borrowers. These include maintaining the 10 percent cap only for those at or below 300 percent of the poverty line, instituting the loan forgiveness after twenty years only for those with $40,000 or less in loans (those with greater loans would be eligible after 25 years), and eliminating the maximum payment cap for those whose incomes no longer qualify.
You should also check out their IBR calculator that will show the direct impact of the proposed changes for monthly payments and loan forgiveness. Both the paper and calculator are an interesting insight into how the student loan program currently works and how it can be changed to better serve its intended purpose.
With the release of September inflation numbers from the Bureau of Labor Statistics, the Social Security Administration also announced its cost-of-living adjustments (COLA) and change to the maximum amount of income to which the payroll tax is applied. The COLA for Social Security benefits next year will be a 1.7 percent increase, while the taxable maximum will rise from $110,100 to $113,700.
The COLA is calculated based on the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). The SSA calculates the difference between the third quarter estimates (July, August, September) from this year compared to last year's third quarter, yielding the 1.7 percent change.
However, in recent years, there have been suggestions to change the way the CPI is calculated throughout programs in the federal budget (whether the CPI-W or the more widely used CPI-U). We have suggested, along with many other experts and organizations, that using the chained CPI for all calculations would be much more accurate and could help reduce future deficits. Considering the financial state of Social Security and the federal budget on the whole, this could be a useful reform option.
The chained CPI is generally believed to be a more accurate barometer of inflation since it takes account consumers responding to uneven price changes by switching to relatively cheaper substitutable goods in different categories. The chained CPI would fix a problem known as "upper-level substitution bias" in the current CPIs that actually overstate inflation. By our calculation, had COLAs been linked to the chained CPI, the adjustment would have been closer to 1.5 percent.
The Mercatus Center has released a new paper by Social Security Trustee Charles Blahous entitled "The End of Social Security Self-Financing." In the paper and an accompanying article, Blahous writes of the challenges faced by Social Security in continuing to finance its benefits with revenues from the payroll tax. Blahous argues that the transfer of general revenues to the Social Security Trust Fund in the payroll tax cut that's been in place for the last two years is a break from the self-financing precedent.
The Social Security Trust Funds will be exhausted by 2033, at which point the program faces an abrupt across-the-board cut in benefits to cover the gap. However, recent transfers from general revenues could blurr the lines between the program's finances and the Treasury's, possibly spelling harm, according to Blahous, for both the program and the federal budget by making reforms more difficult to enact.
Blahous writes about the long history of Social Security self-financing, how it is unlike other elements of the safety net, and how Social Security was intended to be a pension program with funds linked to lifetime contributions. By linking benefits to contributions from the payroll tax, Social Security was never to compete with other spending programs.
Social Security solvency can still be achieved, however, but only if lawmakers are willing to make the program's future a priority. We have talked before about some possible combinations of changes, including raising the retirement age, raising the payroll tax cap, or changing benefits to grow by the index of "chained CPI." These might be politically difficult choices, but it is important to recognize that shifting the burden of Social Security to the general budget will force equally difficult choices in other areas.
Whatever combination of policies lawmakers believe is the solution, they need to make the tough choices in a bipartisan way while working to protect the people who rely on the program the most. General fund transfers that are not paid for should be avoided. Social Security can certainly continue to be self-financing, but lawmakers are going to need to put everything on the table.
Today, CRFB released a paper on individual income tax reform, showing how comprehensive reforms could lower both deficits and tax rates. The paper explains why a recent Joint Committee on Taxation experiment showing a top rate of 38 percent is not comparable to the Simpson-Bowles plan, the Domenici-Rivlin plan, or any other tax reform plan out there.
This paper comes on the heels of a previous piece we wrote showing how policymakers could broaden the tax base in order to lower the corporate tax rate or raise revenue. Along with that paper we included an interactive tax reform calculator that allows users to design their own tax plan.
Individual and corporate tax reform will both require making hard choices and dealing with a number of trade-offs. Hopefully, our recent papers on tax reform will serve to enlighten the discussion.
Click here to read the full paper on individual tax reform.
- Defense: We said last Thursday that Gov. Romney's proposal to increase base defense spending to four percent of GDP would cost $1.6 trillion. This estimate comes from our "Primary Numbers" report on the budget plans on the Republican presidential candidates. It calculates the increase relative to a baseline that excludes the automatic sequester but includes the initial discretionary spending caps from the Budget Control Act.
- Taxes: Last Thursday, we said Vice President Biden's claim that the extension of the 2001/2003/2010 tax cuts for people making over $1 million would cost $800 billion was wrong. There are a few different ways to look at what he said. The cost of the tax cuts specifically targeted at people making over $1 million is $463 billion, according to the Joint Committee on Taxation (as reported by the Center on Budget and Policy Priorities). But people making over $1 million also benefit from tax provisions that are not targeted towards them--for example, the rate reductions below the top rate. If he meant this, by our best estimate he may have actually been understating the total benefit of the tax cuts to millionaires. Either way, he would have been correct to say that the extension for people making over $250,000 would cost about $800 billion (excluding an extension of the estate tax provision).
- Stimulus: We said last week that total stimulus in response to the Great Recession totaled well over $1 trillion. This counts the $831 billion stimulus in 2009 plus extensions of various policies like unemployment insurance benefits, state fiscal relief, and the homebuyer tax credit. There has also been new stimulus such as the 2010 tax credit for newly hired workers and the 2010 tax cut. If you exclude the extension of the 2001/2003 tax cuts, there has been about $1.6 to $1.7 trillion of stimulus since 2009, according to data on Stimulus.org.
- Insurance Coverage: During the debate, Congressman Ryan said "Look at all the string of broken promises. If you like your health care plan, you can keep it. Try telling that to the 20 million people who are projected to lose their health insurance if Obamacare goes through." We assumed he was referring to the number of people on net projected to lose employer-provided health insurance and said that the number was actually 4 million. Our number comes from CBO's most recent estimate of changed in insurance coverage due to the Affordable Care Act in 2022. Most likely, Congressman Ryan got his number from a March 2012 CBO document showing four alternate coverage estimates based on different behavioral responses. These scenarios show employer coverage dropping by 10, 12 and 20 million people and 3 million people gaining coverage in one scenario. Using the worst alternate scenario instead of CBO's official estimate is misleading at best.
- Medicare Trust Fund: Congressman Ryan said with regards to the health care reform law "Obamacare takes $716 billion from Medicare to spend on Obamacare. Even their own chief actuary at Medicare backs this up. He says you can't spend the same dollar twice. You can't claim that this money goes to Medicare and Obamacare." This is correct. We have said before that it is incorrect to claim that the Medicare savings can both extend the life of the Medicare Part A trust fund and offset the costs in the legislation. CBO assumes that Medicare Part A is fully funded with general revenue, so their analysis implicitly assumes that the former does not happen (since Part A does not go insolvent). Also, Medicare chief actuary Richard Foster has said that claiming credit for both is double-counting at least once. In March 2011 testimony, he said "In practice, the improved HI financing cannot be simultaneously used to finance other Federal outlays (such as the coverage expansions) and to extend the trust fund, despite the appearance of this result from the respective accounting conventions." Finally, we'd note that Foster is not the White House's "own" actuary; in fact, he has been in that position since 1995.
- Medicare Drug Prices: Vice President Biden said that the Administration proposed to save $156 billion by "allow[ing] Medicare to bargain for the cost of drugs like Medicaid can." This is an incomplete description of the policy. The actual Administration policy (page 12 here) is to require drug manufacturers to provide rebates to Medicare for beneficiaries who receive Medicaid or the Low Income Subsidy in Part D--rebates that are currently only required in the Medicaid program. CBO has scored allowing Medicare as a whole--rather than individual prescription drug plans--to negotiate drug prices as saving a negligible amount (see here, here, and here), since they figure the negotiations would not bring drug prices below what they already are. By contrast, the Administration policy includes an explicit rebate (essentially bypassing negotiations), so cost savings materialize to the tune of $156 billion as estimated by OMB and $137 billion as estimated by CBO. Vice President Biden got the number right, but the description of the policy was slightly off.
- Small Businesses: Vice President Biden claimed last night that 97 percent of small businesses have income below $250,000, which we said was true. That statistic comes from a JCT report here.
There wasn't as much discussion of fiscal issues in last night's debate compared to the first debate, probably due to both foreign policy and domestic policy needing to be covered. We hope this next Presidential debate, with its town hall format, allows Romney and Obama to give more details about their fiscal plans and how they are going to take on our debt problem.
Today, a report from the Joint Committee on Taxation was released that some claim to show the near-impossibility of deficit-reducing, rate-reducing tax reform. The JCT report shows an exercise in which the elimination of itemized deductions allows for a top rate of only 38 percent. Comparisons between this report and the various tax reform plans out there are highly misleading. As Erskine Bowles, Al Simpson, Alice Rivlin, and Pete Domenici said in a recent statement:
A new study by the Joint Committee on Taxation (JCT) assumes a less drastic reduction in tax expenditures and a different baseline that allocates more savings to deficit reduction, and therefore is able to achieve much less rate reduction. The fact that rates cannot be lowered as much if large tax expenditures are left unaddressed and if most of the savings from those that are eliminated are put towards deficit reduction illustrates a tradeoff, but does not surprise anyone who has worked with tax estimation.
The JCT study looks at only a subset of the tax expenditures we reformed or eliminated, thereby leaving out a substantial amount of savings that were included in our proposals. Most notably, the JCT study does not address the employer health exclusion, the largest tax expenditure in the code, as our plans would. In addition, the JCT study assumes tax reform is revenue neutral relative to a "current law" baseline - a baseline that includes the expiration of all parts of the 2001, 2003 and 2010 tax cuts, a position neither party is advocating. This assumption effectively required the JCT to find $4.5 trillion of deficit reduction through base broadening - far more than is included in our plans or any other plan - and use only roughly $700 billion for rate reduction.
There are at least three major distinctions between this study and the bipartisan tax reform plans out there:
- The study is revenue-neutral relative to a baseline in which all the tax cuts from the last decade expire -- a policy which neither party supports or measures against. Relative to the more commonly-used baseline, this plan raises taxes by $4.5 trillion over a decade.
- The study only repeals itemized deductions and the preference for newly-issues state and local bonds. It therefore does not account for dozens of additional tax expenditures worth trillions of dollars -- including the largest tax expenditure in the code which excludes employer health insurance from taxation.
- The study taxes capital gains at 38 percent, which according to JCT would actually lose revenue. JCT tends to estimate the revenue-maximizing level at about 28 percent.
Ultimately, the plan is only able to reduce the top rate from 39.6 percent to 38 percent because only about $700 billion is being used for rate reduction (compared to the $4.5 trillion for deficit reduction and the trillions more that remain as tax expenditures). This is not to say that tax reform is easy, but a number of partisan and bipartisan plans proposed by current lawmakers and experts show that it is possible to lower rates and deficits if policymakers are willing to make the hard choices.
* * * * *
What Does the JCT Exercise Show?
The JCT thought experiment begins with the premise that we let all the 2001/2003/2010 tax cuts and AMT patches expire. That in itself would raise $4.5 trillion in new revenue; all rate reduction comes later. From that starting point, the plan would then eliminate all itemized deductions and the preference for newly-issued state & local bonds. However, as you can see below the experiment then would spend most of that money on repealing the Alternative Minimum Tax (AMT), repealing PEP and Pease, and extending the current child tax credit and EITC expansion. It would also tax capital gains as ordinary income, which JCT believes would actually lose revenue.
So what's left? About $700 billion. JCT uses that $700 billion to reduce all the rates by 4 percent, so that the top rate would fall from 39.6 percent to 38 percent and the others fall in kind.
|10-Year Fiscal Impact|
|Eliminate All Itemized Deductions||$2,455 billion|
|Eliminate Exclusion of Interest on State and Local Bonds||$124 billion|
|Slight Increase in Deficits from Reforms||$37 billion|
|Sub-Total, Broadening||$2,616 billion|
|Eliminate the Alternative Minimum Tax||-$986 billion|
|Eliminate PEP and Pease||-$379 billion|
|Maintain EITC and Child Tax Credit at Current Levels||-$402 billion|
|Tax Capital Gains as Ordinary Income*||-$150 billion*|
|Sub-Total, Narrowing||-$1,916 billion|
|Resources Available for Tax Rate Reductions||$700 billion|
Note: All estimates are relative to current law. Numbers may not add exactly to totals due to rounding.
*Capital Gains numbers not provided by JCT separately, though according to JCT methodology a 38 percent cap gains rate would lose money relative to current law. We assume 10-year cost of $150 billion.
If instead of using $700 billion for rate reduction and $4.5 trillion for deficit reduction the report did the reverse, rates could be reduced substantially. In fact, that switch alone would likely be sufficient to push the top rate to 30 percent or below.
What the JCT Exercise Doesn't Show
The JCT study shows how much revenue could be raised by repealing itemized deductions and the interest exclusion for certain bonds. It does not show what would happen if other tax expenditures were eliminated -- including the largest tax expenditure in the code for employer provided health care. By contrast, the tax plans put forward by the Simpson-Bowles Fiscal Commission and the Domenici-Rivlin Task Force -- which would reduce the top rate to 28 percent or lower -- go after trillions of dollars of tax preferences not included in the JCT study.
So how much could rates be reduced in total? As we discussed in a blog post the other day, the Treasury Department found in 2005 that eliminating all tax expenditures would allow the top rate to fall to 23 percent, while still dedicating about $1 trillion in revenue to deficit reduction this decade. This is consistent with the findings of the Simpson-Bowles Commission.
The difference between the 38 percent from the JCT study and the 23 percent cited by Treasury and the Fiscal Commission is due both to the lower revenue target and the additional base broadening. Below we have drawn a rough bridge to illustrate the point:
Of course, this doesn't mean that tax reform will get the top rate down to 23 percent. There are some tax expenditures for which it is administratively difficult, economically unwise, or politically challenging to remove. That's why the Simpson-Bowles illustrative plan, the Domenici-Rivlin tax reform plan, the 2005 tax panel plan, and others have proposed top rates between 28 percent and 33 percent. Even these reforms will require making some very hard choices. But they can also offer real economic and fiscal benefits.
Vice President Joe Biden and Representive Paul Ryan (R-WI) will take the stage in Kentucky tonight at 9:00 PM E.T. in the Vice Presidential Debate. In the last debate, President Obama and Governor Romney spent a good deal of time in the last debate discussing fiscal policy -- though we hope each candidate gets more into the details tonight.
As in the last debate, our fiscal fact checkers will be tweeting live from @BudgetHawks, checking on the accuracy of fiscal policy claims from the two candidates. Check back to this blog tonight to see our Twitter feed below. If you missed our coverage of the first debate, you can find it here.
With a deficit hawk in Ryan and a veteran of budget negotiations in Biden, we expect tonight's debate to further reveal what each campaign will bring to solve our fiscal problems. Hopefully they follow our 12 Principles of Fiscal Responsiblity. Don't miss it!
Check back tonight to see our fact checkers live tweet the debate.
The CBO has released its newest estimate of the Troubled Asset Relief Program (TARP), showing that it would cost taxpayers a total of $24 billion. This is $8 billion lower than their last estimate done in March.
As you can see in the table below, the decrease in the subsidy cost estimate was driven by a lower estimated cost for AIG assistance. Treasury has sold a large chunk of its holdings of AIG common stock since March, and the increase in share prices since March has led to the declining cost, as we speculated might happen last month.
|Subsidy Cost Estimate (billions)|
|Area||December 2011||March 2012||October 2012||Maximum Amount Disbursed|
|Capital Purchase Program||-17||-17||-18||205|
|Citigroup and Bank of America||-8||-8||-8||40|
|Community Development Capital Initiative||0||0||0||1|
|Assistance to AIG||25||22||14||68|
|Subtotal, Financial Institutions||1||-3||-11||313|
|Auto Company Assistance||20||19||20||80|
Note: Numbers may not add up due to rounding
Most of the other categories in the TARP estimate remained constant. Any further movement will likely come from either the auto companies, the mortgage programs, or AIG, since the other programs have mostly wound down. This report showed the good news that AIG's bailout will cost significantly less than anticipated, driving down the overall cost of TARP.
Follow continuing developments on the economic recovery measures that have been enacted since the financial crisis at Stimulus.org.
Tonight at 9 PM in Kentucky will be the first and only vice presidential debate between Vice President Joe Biden and candidate Paul Ryan. If this debate is anything like the first presidential debate, fiscal policy should be given a solid amount of attention, especially given Congressman Ryan's position as chairman of the House Budget Committee and Vice President Biden's involvement in debt ceiling negotiations last year.
As chairman of the House Budget Committee, Congressman Ryan's budgets have received plenty of attention in the past two years, but his plans predate his position as chairman. There are two versions of his Roadmap for America's Future, originally put out in 2008 and revised in 2010. When he became Budget Committee chairman, there were two versions of the Path to Prosperity, put out last year and this year.
To see how his plans have evolved over the past five or so years, CRFB put together a comparison of all four plans. Below is a sample of what is contained in the table.
For his part, Vice President Biden was involved in budget negotiations during the debt ceiling debate and should be able to speak at length tonight on fiscal policy and the President's plan. Like the Ryan plan, the President's budget has evolved over the past couple years. Under the President's FY 2012 budget, debt was projected to keep growing relative to the economy, while the FY 2013 budget would stabilize the debt, albeit at relatively high level of 76 percent of the economy. Finally, the recent Mid-Session Review of the FY 2013 budget showed debt on a slight downward path as a share of the economy later in the decade but not over the long-term. The main differences between this year's budget and last year's budget are additional health care savings and revenues.
If anything, it should be an interesting conversation between two individuals who have been heavily involved with fiscal policy. Check out our live fact checking or follow us on Twitter at @BudgetHawks to get our reactions and fact checking from tonight's debate.
Over the past few years, bipartisan agreement has begun to form around approaches to tax reform that take a broad approach to reducing or eliminating many tax expenditures and using those savings to both reduce tax rates and the deficit. Proposals from the Domenici-Rivlin Task Force and the Simpson-Bowles Commission were able to bridge the gap between both sides of the aisle on tax reform by following this approach. While everyone may have their own ideal way to solve our fiscal challenges, it's also important to consider what can actually generate bipartisan support and become law.
In recent weeks, however, there have been a few statements about how substantial deficit reduction cannot occur with reductions in actual tax rates. In a speech yesterday, which we summarized in a quick blog post, Senator Charles Schumer (D-NY) argued that since there is a need to reduce deficits and debt, reducing rates cannot be the focus, drawing a contrast with the revenue-neutral tax reforms enacted in 1986 that reduced rates.
So can policymakers actually reduce the deficit and marginal tax rates by a significant amount? Let's take a look.
In 2005, Department of Treasury estimates for the President's Advisory Panel on Federal Tax Reform found that eliminating all tax expenditures, which now total more than $1 trillion in lost revenue for the federal government (according to OMB), could reduce marginal tax rates by over one-third. That would mean the bottom rate could fall from 10 percent down to 6.6 percent and the top rate could fall from 35 percent down to 23 percent. The Simpson-Bowles Fiscal Commission also showed in their zero plan, which wiped away all tax expenditures, that the top tax rate could get down to 23 percent.
But the Treasury data above isn't all about reducing tax rates -- it also assumed that some of the revenue raised would pay for the elimination of the AMT, which in today's terms would translate into offsetting the costs of AMT patches for the next decade. By our calculation, doing so would raise over $1 trillion in revenue through 2022, showing that both rate reduction and deficit reduction can go hand in hand.
In addition to the Treasury analysis, the Joint Committee on Taxation has also studied the impact of broad-based tax reforms that reduce rates. The study from 2006 finds that the broad-based reforms JCT looked at were sufficient to reduce the top tax rate down to 27 percent while also raising significant new amounts of revenues. While the overall findings are similar, the assumptions JCT's analysis used were not the same in that it preserved several tax preferences (including preferential rates for capital gains and dividends, the Earned Income Tax Credit, retirement provisions, and other smaller measures) and also raised much more revenue than the tax reform scenario the Treasury Department analyzed.
Lastly, two bipartisan proposals put forward over the last two years would both raise at least $1 trillion in new revenues by reducing tax expenditures and reducing tax rates. The Domenici-Rivlin Task Force raised $2.3 trillion through 2020 through comprehensive reforms combined with a reduction in tax rates to 15 and 29 percent. The Simpson-Bowles Illustrative plan called for $1 trillion in new revenues by 2020 through base-broadening combined with consolidated and reduced tax rates of 12, 22, and 28 percent.
From a review of the past studies and budget proposals, it is certainly possible to reform the tax code to lower tax rates and the deficit. Even though it is technically very feasible, there is no guarantee that we will make the tough choices needed to make these kinds of reforms a reality. But given the interest among so many policymakers to reform the tax code, enact at least $4 trillion in deficit reduction, and reach bipartisan agreement, CRFB is optimistic about the ability of our elected leaders to make the tough decisions. Tax reform that follows approaches already adopted by bipartisan groups of current lawmakers and experts is a very promising route to receiving broader support.
The use of dynamic scoring is one of the most contested issues in the budget world. We highlighted the pros and cons of using it and the issues associated with incorporating it into the budget process in a paper earlier this year.
Proponents say that it would help quantify the impact of pro-growth policies, while opponents say that it may deliver false promises of higher growth rates and lead to more debt. But the debate on dynamic scoring is much more than a disagreement on the effect of lower income tax rates. In a Wall Street Journal article today, David Wessel identifies three points that usually get lost in the dynamic scoring debate.
One, this is hard.
Even without incorporating macroeconomic effects, putting a price tag on a sprawling piece of legislation is tough. Gauging the likely long-run impact on the huge U.S. economy is even tougher. It is time-consuming. It is incomplete. It requires lots of judgment calls. It depends on economic models that give different answers. It requires number-crunchers to make assumptions about how farsighted consumers are, how worker and business behavior will change, how the Federal Reserve will react. A single number is misleading; multiple scenarios are confusing.
Two, both JCT and CBO do it already.
Since 2003, the House Ways and Means Committee has required JCT to provide an analysis of all tax bills....
CBO also has done this for alternative ways to reduce the deficit, and for projecting consequences of going over the fiscal cliff—the tax increases and spending cuts set for year-end. It surely would do it for a Romney tax-reform or Obama deficit-reduction proposal.
Because these analyses aren't factored into official price tags, they are largely ignored by Congress and the press. They don't have to be.
Three, economists find growth effects smaller than politicians expect....
Big deficit-reduction bills or comprehensive tax reform might add a few tenths of a percentage point to annual economic growth.
Over a generation, that is hugely important. In added tax revenue over the 10-year period that Congress uses, not so much.
Whether or not dynamic scoring is used, lawmakers should be promoting pro-growth policies, not depending on overly optimistic assumptions of higher growth to bring in more revenue. Fixing our fiscal problem will require hard choices. While growth will lessen the pain of these decisions, it is not a panacea. For more on dynamic scoring, check out our paper.
Over at TaxVox, Roberton Williams writes about what will happen to tax rates under the fiscal cliff. Many economists believe that marginal tax rates (the tax rate on the next dollar earned) matter more than average tax rates (total taxes paid as a percent of income) in terms of the effect on economic growth. And under the fiscal cliff, marginal rates are due to rise.
While we tend to focus on ordinary income tax rates (the rates going up to 35 percent), Williams notes that there are many different tax rates that are due to rise under the fiscal cliff. While tax increases will be needed, the combination of expiring tax policies in addition to spending cut policies would have a devastating effect on the economy.
A helpful chart from the Tax Policy Center shows the different types of income that are due for an increase in marginal rates on January 1st. From left to right, the chart shows the increase in the individual income tax rate; the combined income and payroll tax rate; the capital gains tax rate; the dividends tax rate; and the rate on taxable interest.
While the fiscal cliff's marginal rate increases may be harmful for growth, it will be very difficult to fix our fiscal problems without more revenue. One option is to increase marginal income tax rates, but a better option is to broaden the base by reducing tax expenditures and making targeted changes to better define income. Plans like Simpson-Bowles allowed marginal rates to decrease while average tax rates (and thus revenue) increased.
Ultimately, tax reform will be a difficult balancing act in trying to raise more revenue, promote an efficient code, and at least maintain progressivity. Some tax provisions may make sense to keep in the code, but lawmakers should put everything on the table and have a thoughtful plan on taxes. Smart tax reform would certainly be better than the fiscal cliff.
In a speech at the National Press Club (video here), Sen. Charles Schumer (D-NY) outlined his vision of how to change the tax code. During the question-and-answer session that followed, he also discussed how his tax plan would fit into a deal to avert the fiscal cliff.
In general, Sen. Schumer said that 1986-style tax reform that broadened the tax base and lowered rates would not be appropriate at this point in time, given that the 1986 reform did not raise revenue and did not increase the progressivity of the tax system. Although recent plans such as Simpson-Bowles have included lowered rates, a broadened base, and higher revenue, Sen. Schumer indicated his opposition to using a portion of the revenue raised via reducing tax expenditures to bring down rates on individuals, saying that it would require middle-class tax increases to raise sufficient revenues. The Simpson-Bowles plan, though, was able to make the tax code substantially more progressive, even if it did not insulate all middle-class taxpayers.
In terms of reforming the corporate tax code, Sen. Schumer declared his support for a revenue-neutral corporate rate reduction as a way to maintain global competitiveness and that such changes should be made outside a deficit reduction deal. CRFB recently took a closer look at why the corporate code is in need of reform and the many policies lawmakers could choose from to design a fiscally responsible reform plan.
In detailing his policy preferences, Sen. Schumer reiterated his support for his party's position to allow the upper-income tax cuts to expire at the end of the year. He also said that although he would not tax capital gains at the ordinary income rate of up to 39.6 percent, the current differential between capital gains and ordinary income rates should be narrowed from its current 20 percentage points (between top rates). He also declared his support for eliminating the carried interest loophole. Beyond these specifics, Sen. Schumer said he would go further to reduce tax expenditures in order to raise revenue.
Responding to a reporter's question, Sen. Schumer targeted $4 trillion of savings over ten years as an appropriate target for a deal with $1.5 trillion of that coming from revenue (roughly the same as the President's budget). In terms of entitlement reform, he said that although he opposes raising the Social Security retirement age, this position, among others, remained negotiable. He did not specify which proposals to reform entitlements he would support.
Sen. Schumer's speech at the National Press Club was notable, if for nothing else, than to see what is going through the mind of one of the top Democrats in the Senate when it comes to taxes. Click here to see the full video.
One of the criticisms of raising the retirement age is the belief that older workers delaying retirement may "crowd out" younger workers and cause higher youth unemployment. This theory, also known as the "lump of labor theory," is challenged in a new paper by Alicia Munnell and April Wu of the Center for Retirement Research at Boston College.
Munnell and Wu study data from 1977 to 2011 and find no evidence of crowding out. In fact, the data suggest the opposite: there was a positive relationship between elderly employment and youth employment. This relationship was found after controlling for the strength of the economy (which would have youth and elderly employment rising and falling together in many cases).
Past studies have shown similar evidence seeming to disprove the "lump of labor theory," but none have studied the effect on youth wages. Similar to their findings on employment, the two economists also find a positive relationship between elderly labor participation and youth wages.
Even during the Great Recession, Munnell and Wu find that the positive association between elderly employment and young employment did not fade. This is critical because one might think that the large shock of the recession and the relative scarcity of job oepnings would in theory make the crowding out effect much stronger.
While this study does not specifically address raising retirement ages, it should help quell fears of crowding out effects for young workers if the ages are raised. Changes to the retirement age need to be phased in slowly and protect the most vulnerable, but there is enough to gain that the option should be considered. We have shown previously that it would improve both the economy and the budget.
The full paper can be found here.
Former Super Committee member and House Budget Committee Ranking Member Chris Van Hollen (D-MD) indicated in a recent Bloomberg interview that the Simpson-Bowles plan may be a the basis of a debt deal that avoids the fiscal cliff. Appearing on Bloomberg Government's Capital Gains, he said that while he didn't agree with every detail of the plan, he thought the general framework of phased-in spending cuts with additional revenue would become the basis of a bipartisan plan.
In addition, Van Hollen was hopeful that Democrats and Republicans would be able to come to an agreement on a deal that would find enough savings to put off the sequester until a grand bargin could be reached. On the expiration of the 2001/2003/2010 tax cuts, Van Hollen was less confident a deal could be reached in the lame duck session, especially since a part-of-the-year extension of tax changes would be administratively difficult.
It is good to hear members of Congress like Van Hollen agree with the general principles of Simpson-Bowles. Ultimately, a bipartisan comprehensive debt deal will require additional revenues but also entitlement reform and gradual spending cuts. Only with sacrifices from both parties will we be able to come up with a plan that can put our debt on a downward path.
The full interview can be found here.
Much of the focus of broadening the tax base in tax reform is on tax expenditures. However, as both our corporate tax paper and our corporate tax calculator showed, there are many base-broadening options outside of tax expenditures.
Robert Pozen, a senior lecturer at the Harvard Business School and a senior fellow at the Brookings Institution, demonstrates, detailing a corporate tax reform that he estimates would adhere to revenue-neutrality. His plan? Disallow 30 percent of corporate interest deductions.
He says that simply relying on reducing tax expenditures to finance a rate cut would not be sufficient. The smaller preferences do not raise much revenue, and it may be desirable to keep some of the larger ones because of their positive effect on economic growth (for example, research and development preferences). He explains his rationale for limiting the interest deduction as follows:
Currently, when a corporation pays interest, it may deduct that interest on its tax return. By contrast, a corporation may not deduct its dividend payments to shareholders. This bias distorts the financing decisions of corporate managers, who might choose, solely for tax reasons, to finance a certain project with debt instead of equity. This bias also distorts investment decisions in favor of easily collateralized equipment suitable for debt finance, at the expense of investments better suited for equity finance, such as capital-raising by small business.
The tax code’s bias for debt is even more worrying, because excess leverage often imposes costs on external parties other than the debt issuer. For instance, a highly indebted company is more likely to go bankrupt, which can seriously harm its employees, customers and suppliers. Companies are unlikely to fully consider those external costs when deciding how much debt to take on.
Furthermore, reforming the treatment of interest expenses can raise a large amount of revenue and thus pay for a significant reduction of the corporate tax rate. In 2007, corporations with net income paid $294 billion in corporate taxes and claimed $1.37 trillion in gross interest deductions, according to the Internal Revenue Service.
Pozen estimates that allowing a deduction for only 70 percent of interest expenses would finance a rate cut to 25 percent in a revenue neutral way. It is clear that this option takes a much bigger bite out of interest deductions than the option in our tax calculator, taken from the Wyden-Coats plan, to reduce interest deductions by the portion of interest attributable to inflation (that option also uses net interest while Pozen uses gross interest). That option would only finance about a 1.4 percentage point reduction in the rate, or raise about $15 billion per year.
Pozen's idea is certainly an intriguing one and could play an important part in any corporate tax reform plan. At the same time, we caution against ruling out tax expenditure reductions altogether, since many tax expenditures in the code work to distort economic decisions and prove to be quite costly. In any case, corporate tax reform must be designed in a fiscal responsibility way to ensure that the potential growth benefits are not overwhelmed by growing levels of debt.
CBO's final Monthly Budget Review for FY 2012 came out today, showing the (preliminary) final estimate for the deficit that year: $1.09 trillion, or 7.0 percent of GDP. This figure is about $40 billion less than the $1.13 trillion deficit (7.3 percent of GDP) that CBO projected for 2012 in August and about $210 billion less than the $1.3 trillion (8.7 percent of GDP) deficit in 2011.
Compared to 2011, revenue was up by about $150 billion (6 percent) and outlays were actually down slightly by $60 billion (2 percent). Outlays fell due to the discretionary spending caps in the Budget Control Act, diminished spending in countercyclical programs as the economy continues to recover, and the expiration and winding down of some spending from the 2009 stimulus or extensions of its policies. Another factor is that October 1, 2011 occurred on a weekend, so some payments that would have been made in FY 2012 were pushed into FY 2011. This timing shift appears to total around $60 billion, meaning that the FY 2011 deficit would have been $60 billion lower and the FY 2012 deficit would have been $60 billion higher if that timing shift did not occur.
Revenue increased as the tax bases for the income tax and payroll tax increased compared to last year, outweighing the fact that the payroll tax cut was not in effect for part of FY 2011. Corporate revenue jumped by one-third mostly due to the expiration of the full equipment expensing at the end of 2011.
In short, the moderate shrinkage of the deficit for 2012 comes from general economic expansion, deliberate deficit reduction, the expiration of temporary spending and tax measures, and the timing shift that pushed payments for October into the previous year.