Op-Ed: How to Pay for the Payroll Tax Cut

The Atlantic | December 12, 2011

A solution to pay for $300 billion of stimulus that doesn't include the words "tax hike" or "spending cut"



It's become a Christmas tradition for Congress to end the year by extending all the policies which expire at year's end. There is the Alternative Minimum Tax, which has to be "patched" every year so that it reaches only four million taxpayers instead of thirty million. There is the looming 27% cut in Medicare payments to doctors which policymakers will need to protect with a "Doc Fix." And on top of that, this year, we're dealing with the expiration of a payroll tax holiday and extended unemployment benefits meant to help boost a weak economy.

Extending these provisions every year is really expensive. It comes out to about $275 billion for a single year. That's more than a quarter-trillion dollars added to nation's credit card.

But here's the good news. For the first time in a long time, our politicians are actually talking about finding spending cuts and tax increases to finance the costs of these extensions. Democrats are focusing on a new tax for millionaires. Republicans are focusing on cuts that will impact the size and cost of the federal workforce. With our debt already on a dangerous path, anything worth having is also worth paying for. But Democrats will balk at an all-cuts solution, and Republicans have made it clear they don't want to raise taxes.

I have a different solution. It's a single, simple change. It wouldn't drastically cut domestic spending. It wouldn't change tax rates. Instead, it would pay for a payroll tax cut, AMT patch, and unemployment extension with a slow, phased-in policy called "chained CPI." Don't know what that is? Let me explain.




Every year, wages and prices go up. The government wants to measure this inflation to index everything from Social Security checks to tax brackets. The government makes these measurements by focusing on a "basket of goods" to compile its so-called consumer price index, or CPI.

The weakness of regular CPI is that we don't account for when consumers start changing their relative buying habits. If the prices of apples skyrocket, the regular CPI assumes cost-of-living will go way up. But in the real world, most people just buy fewer apples and more oranges.

Moving to the "chained CPI" corrects for this technical flaw by trying to provide an honest assessment of each month's basket and creating a "chain" between them. Moving to a more realistic measure of inflation would save well over $200 billion over the next decade, including from Social Security, other inflation-index programs, and from the tax code.




1) Social Security Savings Pay for Social Security Losses: Since the payroll tax is used to finance Social Security benefits, a payroll tax holiday necessarily takes revenue out of the system -- about $120 billion worth. Last year, we made up that money through a transfer from general revenue; but those types of transfers -- necessary as they might be -- threaten the contributory nature of the program. The chained CPI, though, would lead to savings within the Social Security program from lower COLAs. This would allow the Social Security trust funds to make up the lost revenue in ten years; and after that the chained CPI would help to close over a fifth of the long-term funding cap.

2) Income Tax Revenue for an Income Tax Cut: Patching the AMT will cost us $90 billion worth of income tax revenue over the next year or so. But because the income tax has so many parameters indexed to inflation, switching to the chained CPI can help us make that money back. The main reason chained CPI raises revenue is because of something called "bracket creep," where growing incomes push people into higher income tax brackets over time. Because we over-measure inflation, though, income is not being pushed as fast as they should in an inflation-indexed tax code. Using the chained CPI to index the tax code would reduce the deficit by about $60 billion through 2021, and make future AMT patches roughly $40 to $50 billion cheaper.

3) Other Spending Cuts for Other Spending: In addition to the Social Security and revenue savings, switching to the chained CPI would save over $50 billion over a decade by slowing the growth of various government benefits and eligibility thresholds. This mandatory savings should be enough to pay for an extension of unemployment benefits.

4) A Pro-Growth Phase-In: Sharp immediate deficit reduction could prove economically dangerous in a time of weak growth, but the markets also need to see a credible plan to reduce the deficit over the medium and long-term. The chained CPI saves money because it grows a tiny 0.25% slower than the current CPI measure. Because of this, savings are very small up front but compound and grow over time in a way that provides substantial deficit reduction over the long-term.

5) It's a No Brainer: The chained CPI is the right measure of inflation -- economists and experts from the left and right agree on that. Ideally, it shouldn't even be an offset for new deficit spending -- we should just do it. Of all the hard and painful choices we need to make to right out fiscal situation, measuring inflation right is not one of them. We should get it done now, and move on to the serious choices.

Op-Ed: Tax Reform: 25-Years Old Today, and Ready for a Facelift

The Atlantic | October 22, 2011

We've spent a quarter-century undoing the smart, simple tax reforms of 1986. Here's to hoping Washington can act like its old self before it's too late. 



Today marks the 25th anniversary of the Tax Reform Act of 1986, the last major overhaul of the federal tax code. Signed into law by Republican President Ronald Reagan and championed by Democrats such as Bill Bradley and Richard Gephardt, the enactment of the law was a remarkable bipartisan achievement. It dramatically lowered marginal rates with a top rate of 28 percent, removed millions of working poor off the tax rolls, and simplified the tax code by closing a myriad of tax loopholes.

Unfortunately, many of the loopholes that the 1986 reform eliminated have returned, with a few extra ones slipped in for added measure. Since the law's enactment, more than 15,000 changes have been made resulting in a tax code that is several volumes longer than The Bible and requires 71,684 pages to spell out the rules. Because of this complexity, 80 percent of American households use a tax preparer or tax software to help them prepare and file their taxes.

But complexity is only part of the problem. The other is cost. Year-after-year, elected officials in Washington shovel more tax breaks into the trough (tax breaks now account for $1.1 trillion) causing both deficits and marginal tax rates to be higher than is necessary or optimal for the economy.

Despite the obvious need for tax reform, some in Washington are advocating that congressional Super Committee charged with finding a balanced deficit reduction package not tackle tax reform. They claim it's too complicated, too hard, or too long-term.

They're wrong. Delaying tax reform will only make implementing the solution harder and more painful. There has never been a better time in which to enact tax reform. The Super Committee was created as part of last summer's debt ceiling agreement to require Congress to vote up or down, without amendment, on tax reform as part of its plan to address the federal government's medium and long-term fiscal imbalance. This BRAC-like power is designed to limit the influence of special interests whose work in the past has littered the tax code with loopholes. This opportunity is not likely recur anytime soon. It is, therefore, in the Super Committee's interest to act now rather than wait.

Tax policy is complicated. But lawmakers on the Super Committee don't have to start from scratch. There are already a number of plans that would dramatically lower marginal rates for individuals and businesses, eliminate tax expenditures, and grow revenues for deficit reduction. For example, the Zero Plan put forward by the Bowles-Simpson Fiscal Commission (what some refer to as 1986-style tax reform on steroids), would lower marginal rates and simplify the tax code from six to three tax rates, tax capital gains and dividends as ordinary income, eliminate the burdensome Alternative Minimum Tax, align the corporate and the top individual rate, move our corporate tax code to a territorial system, and eliminate all or most of the $1.1 trillion in tax expenditures.

Furthermore, the Super Committee does not to choose between writing a full tax reform bill in two months or agreeing to an open ended process for tax reform in the future. The Bowles-Simpson Fiscal Commission, Gang of Six, and others have proposed setting up a procedure for expedited consideration of tax reform that sets out parameters and criteria for what tax reform must include in addition to the revenue target while leaving details to the Senate Finance and House Ways & Means committees. Such an approach ensures true tax reform will be voted on while leaving the details to those who have the expertise to get the job done.

In addition, fundamental reform, which broadens the base by reducing deductions, credits, exemptions, and other tax expenditures; simplifies the code; and lowers individual and corporate tax rates, has the potential to substantially improve economic growth. The Joint Committee on Taxation has estimated that income tax reform that wipes out most tax expenditures in order to lower marginal rates, could increase the size of the economy by 1.2 to 1.9 percent of GDP over the medium-term, and even more over the long-term.

Finally, the new revenues generated by fundamental tax reform would help the Select Committee to achieve substantial deficit reduction. The Super Committee is charged to identify $1.5 trillion over ten years in deficit reduction, though $1.2 trillion over ten years would be enough to avoid an automatic sequester. While this would represent significant savings, members should be shooting t at least double, or triple this target in order to put the debt on a sustainable course. Relative to a realistic budget baseline, it would take about $3 trillion in deficit reduction just to reduce the debt to below 70 percent of GDP by 2021 and put it on a modestly downward path. Identifying an amount of deficit reduction significant enough to put the debt on a downward path will almost certainly require looking beyond discretionary spending to major entitlements, other mandatory programs, and ways to produce more revenue.

No doubt taking up tax reform will be a difficult challenge for the Super Committee. But the benefits of enacting fundamental reform are worthy of the effort. Besides, enacting tax reform is a whole lot better for the economy, and for politicians of both parties, than continuing the on-going fight over extending the Bush and Obama tax cuts for another year.

Op-Ed: Supercommittee Needs to Go Bigger

The Hill | September 7, 2011

With the president’s highly touted jobs speech this week, national attention is about to pivot from deficits and debt — where the focus has been for much of the summer — to jobs and how to boost the struggling economic recovery.

You can almost hear the sighs of relief coming from the halls of Congress and the White House, because even though there is vehement disagreement over what should be done to fix the economy, the types of measures that will be floated are ever so much more fun from a political perspective. What politician doesn’t prefer to talk about tax cuts and government spending that doesn’t have to be paid for, as opposed to the spending cuts and tax increases required to close that gaping deficit hole?

The reality, however, is that these two issues can’t be separated. Any further measures to stimulate the economy are unlikely to move other than as part of broader debt reduction. More importantly, done right, a smart debt-reduction plan is absolutely central to an economic-growth agenda.

In the short term, due to expiring tax and spending provisions, between $250 billion and $300 billion will be removed from the economy at the end of the year, if policies such as the payroll tax holiday and unemployment benefits are not extended or replaced. The principle here should be “Do no harm.” Now is not the time to be pulling resources from the economy. At a minimum, stimulative measures of at least the same amount should be extended for another year.

Given the spate of discouraging economic news, probably much more should be done. But there is no more room in the budget to treat these measures as fiscal freebies.

Instead, they need to be paid for over a reasonable period of time, say, five to 10 years. Not only will covering the cost of stimulus help the deficit, it will help keep at bay the tons of bad ideas that regularly get thrown into stimulus packages, if they actually have to be paid for.

But policymakers also need to understand that putting in place a multiyear plan to fix the budget is not at odds with fixing the economy, but a central piece of doing so.

The reality is that reducing debt levels may well decrease growth in the very short run as we turn from stimulus to debt reduction, but it will lead to higher growth levels in subsequent years. And if we wait too long to make these changes — and time is quickly running out — we will be hit with a full-blown fiscal crisis, which would be the worst scenario imaginable for helping the economy.

The newly formed supercommittee has been charged with finding savings of $1.5 trillion. Difficult as that may be, the amount is not nearly enough. Given the size of our current borrowing path, this would fail to stabilize the debt as a share of the economy, and it would fail to reassure market- and credit-rating agencies.

Instead, the supercommittee members should “go big” and find savings of two to three times that much, in a credible multiyear plan. One benefit of a medium-term plan is that it can leave room upfront for the economic recovery to continue to take hold.

Moreover, businesses are unlikely to start spending the trillions in cash on their balance sheets until a budget plan is in place. At the moment, businesses know changes will be made, but with no idea what they will look like, making it nearly impossible to plan, invest and create jobs.

Given that both consumers and the government are tapped out, the best hope we have for strong economic recovery is one that is business-led, and an understanding of what the future holds in terms of the budget, taxes and regulations would do wonders in fueling the recovery.

Finally, it is only through a larger plan that real reforms to the tax code and entitlements will come into the picture. If we overhaul the tax system by dramatically broadening the base — by cutting the breaks that litter the tax code — and lowering rates, it would do wonders for economic growth and raise revenues.

Likewise, reforming health and retirement entitlements so they are sustainable, and transforming the budget from one that focuses excessively on consumption to one that favors investment, would transform our nation’s potential for long-term growth.

Neither major tax nor entitlement reform is likely to enter the picture, if we continue to play small ball with budget reforms. The way to focus on the real drivers of the budget problem and the real keys to growth is for the supercommittee to choose to go big and tackle all these issues in one large deal.

Op-Ed: Drawing a AAA-Road Map for Post-Downgrade America

The Atlantic | August 11, 2011

The country's most critical structural problem isn't employment or entitlements. It's Washington. And its window to govern by leadership rather than crisis is getting narrower every day.

The S&P downgrade late Friday afternoon in Washington kicked off the most anxious and frenetic week in world markets since the Great Recession ended. The rating agency's observation that U.S. politics was broken might have seemed like old news to voters, but to outsiders it was a stunning confirmation that the recovery is all but over and Washington has no clue how to get it back on track. But the panic over the downgrade and subsequent sell-off has glossed over what exactly our AA+ means for the economy, our prospects, and the road back to a sterling rating. With a little help from a report published yesterday by the Committee for a Responsible Federal Budget, here is your guide to the downgrade.

Don't Panic ...

The first thing to understand about this downgrade is that it is not, in itself, a reason to panic. U.S. long-term Treasury bonds have been downgraded from AAA to AA+, which according to S&P means that instead of an "extremely strong capacity to meet" our financial commitments, we now have a "very strong capacity" to do so - not much of a difference.

In addition, at least for now, the other two major rating agencies - as well two of the other three minor certified agencies that rate US debt - still rate U.S. Treasuries as AAA, also denoted "Aaa."



Those concerned that everyone will start dumping our debt en masse as a result of this downgrade shouldn't be. In the case of domestic money market funds, recent regulations basically deem U.S. Treasuries as safe assets no matter what happens to them; and frankly there aren't many other assets to flock to right now. As former CBO Director Rudy Penner would say, "we're still the finest looking horse in the glue factory." This second point also rings true with respect to our international investors. We are the world's reserve currency and have more bonds in the global market than all AAA-rated countries combined.

Rather than going up, interest rates have actually fallen a bit since the rating downgrade. This is not inconsistent with what has happened to other AAA-downgraded countries, where interest rate effects have generally been quite small.

... Okay, Panic a Little

If rating downgrades don't augur immediate crises, they tend to indicate trouble on the horizon. Of the 10 other countries that have been downgraded from AAA, eight experienced further downgrades and five have still never recovered their AAA rating. Deeper downgrades have been associated with interest rate spikes, and the fact that both S&P and Moody's have us on a negative outlook suggests that more downgrades could be in our future.




What are the consequences of further downgrades? The most direct one could be higher interest rates, as investors insist on a risk premium. Even a 0.1 percent increase in interest rates would mean an additional $130 billion in government spending on interest over the next 10 years that we would have to offset in hiring taxes or fewer investments to meet the same debt goal. A 0.7% increase in interest rates would be enough to erase all of the gains from the recent debt deal.

In addition, higher interest rates could reverberate throughout the market, impacting everything from mortgages to small business loans - and ultimately leading to something economists call "crowd out," where fewer dollars go into growth-driving investments.

The biggest concern, though, should be that these rating downgrades could advance the day of a fiscal crisis. At some point, if we don't make some changes, investors will lose confidence in our nation's ability to make good on its debt. When that occurs, it is possible we could experience a global economic crisis akin to the financial crisis of 2009, except with no one available to bail out the U.S. government.

It's Not About the Money

The United States has a higher burden of gross debt than any other AAA-rated country in the world. We're also the only country besides Finland to expect our debt share to grow through 2016. Our entitlement programs are growing uncontrollably as a result of an aging population and rapid health care cost growth - structural problems that make it difficult to deal with our debt. But despite all this, the downgrade was not fundamentally about money. It was about politics.




The country's most critical structural problem isn't employment or entitlements. It's Washington. There is, outside the wide halls and narrow minds of Congress, an emerging consensus on how to fix our problems: Cut future spending and raise future revenue. Enact stimulus today and reform taxes tomorrow. Encourage people to work longer and take more responsibility for their own retirement. Do everything we know how to do to slow health care costs now, and keep looking for solutions.

But the political system hasn't yet been able to reach these solutions and address the inherent tradeoffs between them. As S&P wrote:

"The difficulties in bridging the gulf between the political parties over fiscal policy... makes us pessimistic about the capacity of Congress and the Administration to be able to leverage their agreement this week into a broader fiscal consolidation plan that stabilizes the government's debt dynamics any time soon."

If Washington can't fix itself, the opinion of S&P should be the least of our worries.

As Leon Panetta used to say, "we govern by leadership or crisis." We need to do the former. Our time is running out.

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