Tax

Op-Ed: Inside America's Tax Battle

Project Syndicate | November 26, 2012

America’s recent presidential election answered the question of whether an increase in revenues will be part of the country’s long-run deficit-reduction plan. The answer is yes: there is now bipartisan agreement on the need for a “balanced” approach that includes revenue increases and spending cuts.

But there are still deep political and ideological divisions about how additional revenues should be raised and who should pay higher taxes. If a preliminary agreement on these questions is not reached by the end of the year, the economy faces a “fiscal cliff” of $600 billion in automatic tax increases and spending cuts that will shave about 4% from GDP and trigger a recession.

The majority of citizens agree with President Barack Obama that tax increases for deficit reduction should fall on the top 2-3% of taxpayers, who have enjoyed the largest gains in income and wealth over the last 30 years. That is why he is proposing that the 2001 and 2003 rate cuts for these taxpayers be allowed to expire at the end of the year, while the rate cuts for other taxpayers are extended.

So far, Obama’s Republican opponents are adamant that the cuts be extended for all taxpayers, arguing that increases in top rates would discourage job creation. This claim is not supported by the evidence. Recent research finds no link between tax cuts for top taxpayers and job creation. In contrast, tax cuts for the bottom 95% have a positive and significant effect on job growth.

During the past three decades, income inequality in the United States has increased significantly; indeed, the US now has the fourth-highest level of income inequality in the OECD, behind Chile, Mexico, and Turkey. At the same time, as the largest tax cuts have gone to high-income taxpayers, the US tax system has become considerably less progressive. The US needs fiscal measures that both curb the deficit and contain rising income inequality – and the inequality of opportunity that it begets.

But how should additional revenues be raised from top taxpayers to achieve these two goals? Most economists believe that increasing revenues by reforming the tax code and broadening the tax base is “probably” better for the economy’s long-term growth than raising income-tax rates. The analytical case for this belief is strong, but the empirical evidence is weak.

In theory, higher marginal tax rates have well known negative effects – they reduce private incentives to work, save, and invest. Yet most empirical studies conclude that, at least within the range of income-tax rates in the US during the last several decades, these effects are negligible.

A recent Congressional Research Service report, withdrawn under pressure from Congressional Republicans, found that changes in the top income-tax rate and the rate on capital gains had no discernible effect on economic growth during the last half-century. A recent review of the economic literature by three distinguished academics found no convincing evidence that real economic activity responds materially to tax-rate changes on top income earners, although such changes do affect their tax-avoidance behavior. So Obama has evidence on his side when he says that allowing the tax cuts for high-income taxpayers to expire at the end of the year will not affect economic growth.

Republicans have proposed tax reforms in lieu of rate hikes on high-income taxpayers to raise revenues for deficit reduction. Obama has signaled that he is willing to consider this approach, provided it increases tax revenues from the top 2-3% by at least the same amount as higher rates while protecting other taxpayers.

The federal tax system is certainly in need of reform. Tax expenditures – which include all deductions, credits, and loopholes – account for about 8% of GDP. Indeed, the US tax code is riddled with special preferences and contains large differences in effective tax rates across individuals and economic activities. These differences distort decisions about investment allocation and financing. Reforms that made the tax system simpler, fairer, and less distortionary would have a beneficial effect on economic growth, although economists concede that the size of this effect is uncertain and impossible to quantify.

Because tax expenditures are so large, limiting them could raise a significant amount of additional revenue that could be used both for deficit reduction and to finance across-the-board cuts in income-tax rates. Analysis of the Simpson-Bowles and Domenici-Rivlin deficit-reduction plans by the nonpartisan Tax Policy Center confirms that this approach is arithmetically feasible. Reducing large regressive tax expenditures like preferential tax rates for capital gains and dividends and deductions for state and local taxes, and replacing deductions with progressive tax credits, could generate enough revenue to finance rate cuts for all taxpayers, increase the tax code’s overall progressivity, and contribute meaningfully to deficit reduction.

But the odds of such an outcome are very low: what is arithmetically feasible is unlikely to be politically possible. Efforts to cap popular tax expenditures will encounter strong opposition from Republicans and Democrats alike. Nonetheless, some tax reforms are likely to be a key component of a bipartisan deficit-reduction deal, because they provide Republicans who oppose increases in tax rates for high-income taxpayers with an ideologically preferable way to increase revenue from them.

Unfortunately, it will take time to negotiate tax reforms – more time than remains until the end of the year, when the 2001 and 2003 tax cuts are scheduled to expire for all taxpayers. But there is still time to negotiate an agreement that extends these cuts for the bottom 98%, and that contains temporary measures to cap deductions and credits for high-income taxpayers in 2013. Such an agreement could help to break the political impasse over whether and how much these taxpayers’ rates should rise next year, thereby preventing the US from falling over the fiscal cliff and back into recession.

Report: Raising Revenue From High Earners Through Base Broadening

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Update (12/12/12): Figure 1 has been corrected from an earlier version that was based on estimates that "stacked" the provision to tax dividends as ordinary income before the provision to increase rates, therefore counting the interaction within the rate changes. This correction does not affect the overall savings, and actual savings from allowing only some of the upper-income tax cuts to expire may differ from the sum in the figures above due to various interactions.

Op-Ed: Throwing My Hat in the Ring

The Government We Deserve | October 4, 2012

My fellow Americans.

Grave issues face this country. This year is unlike any other year.  After listening to the Presidential candidates debate, I’ve decided to give Americans a real choice for president: me.

First, a little bit about myself.

I know what it’s like to be poor. My great-great grandfather was poor, so I understand getting by on almost nothing. I can think back to a time when he didn’t even have indoor plumbing.

I know what it’s like to be a minority. I’m a male, and the majority of the population is female. Most people belong to religions other than mine. Only a small share of the population is my age.

But, unlike my opponents, I don’t identify with some narrow subgroup of the population. I support the right of women and men of all races and religions to pursue the American dream––as long as they agree with my policies. Now, one of my opponents has special appeal to female Tibetan Scientologists from Utah, the other to black male lumberjacks living in New York City. That means the rest of you still have a chance to be represented by voting for me.

In today’s troubled world, I know what it is to be a real man who deals with power. Just thinking about putting troops or police in harm’s way exhausts me. Heck, my hair has already thinned and grayed thinking about the sacrifices I will have to endure as the most powerful person in the world. I’ll try to make available some before-and-after pictures for you to see, too, how eight years in the White House will age me eight years. One day, others will testify how they witnessed my bravery when they weren’t out grabbing me another Diet Coke so I could stay awake past midnight in the Situation Room.

And, I know what it’s like to be a woman. My mother was a woman. I know all too well the difficulties of childbirth: I was right there next to my mother when thrown into the spurned class of the bare at birth. Now, as a candidate, I’m not supposed to talk too sympathetically about myself, but my surrogates have put together candid shots of what my mother, if still alive, would have said about my destiny even from a young age. Other women who have known me when I was out in the working world pursuing my destiny while they were taking care of the family will talk about my humanity and dedication to my family.

Finally, I know what it’s like to struggle. At times I’ve even been between jobs. After leaving the presidency, I’ll have to struggle while I decide whether to sit on corporate boards or make millions of dollars writing my autobiography.

But enough about me. Now to real policy for real Americans––that is, those who show their respect for America by voting against my opponents.

First, you. You’ve paid an unfair share of taxes and gotten an unfair share of benefits. You’re not like that rich guy who pays no income tax or the welfare cheat with houses in Malibu and Miami. They support my opponents. But I understand you. If you’re rich, you already pay infinitely more tax than someone with no income with which to pay taxes. That’s not fair. And if you’re poor, it’s clearly because my opponents’ government policies don’t support you enough or don’t give you adequate incentives. That’s not fair, either.

As for the 99.5 percent of you who are in the middle class, my opponents continually tell you how much they care, but they really don’t.  If they did, why do they confine their borrowing from China and other friendly lenders to a few trillion dollars?

Next, jobs. My opponents hire Harvard economists who calculate the expected growth in the labor force assuming that the unemployment rate will decline to about 5 percent. Then each claims that he individually will create the jobs that the economy would normally create. Not me. Under my policies, the unemployment rate will fall to 4 percent, so I will create at least 1 million more jobs than either of my opponents.

To spur economic recovery, I’ve combined the Democratic Keynesian and Republican supply-side economics of my opponents. That means I can spur demand when I provide you more benefits and increase supply when I reduce your taxes. The former will induce people to spend more, the latter will encourage them to work and save more. Under Steuerle-conomics, a dollar of spending and a dollar of tax cuts will together spur several dollars of increased output, while reducing the deficit because of the economic expansion and investment.

And let me thank you in advance, my fellow Americans, for accepting those higher benefits and lower taxes for the good of your country.

As for the budget, I will take whatever increased deficit I might induce and cut it by two-thirds by the end of my two terms. My opponents pledge to cut their additional deficits only by half, and usually for years after they’ve left the White House.

I could go on. For instance, one of my opponents favors healthcare vouchers for the nonelderly and opposes them for the elderly, the other favors just the opposite.  Both my opponents would reduce Medicare benefits, either through vouchers and greater price controls.  I, however, would grant healthcare providers higher incomes and health consumers more benefits than either of my opponents. And it won’t cost existing taxpayers or Medicare recipients a dime. I’ll just create a special form of government debt that will be paid only by future generations not yet voting.

As you can see, I have everything it takes to run for president in today’s world. I simply take today’s campaign strategies to their logical conclusions. Honest deception! That’s my motto.

Op-Ed: "How to Cut the US Deficit by Fixing Tax"

The Financial Times | September 17, 2012

One of the few issues on which Barack Obama and Mitt Romney agree is the need for tax reform. Since the last overhaul in 1986, loophole after loophole has been added, producing a tax system that is complex, unfair, inefficient and detrimental to growth. Today, tax reform must also address three major challenges: escalating federal debt, rising income inequality and intensifying global competition.

Addressing the long-run deficit and stabilising the debt will require more revenue. Even after the economy recovers, current tax policies will not generate enough revenue to cover future spending on social security, health, defence and debt interest, let alone basic government operations and investments. In 2012, federal tax revenues are likely to be less than 16 per cent of gross domestic product, compared with an average of more than 18 per cent in the 20 years before the crisis hit in 2008.

When the US economy is operating near capacity, total tax revenues – federal, state and local – are much smaller as a share of GDP than in other developed countries. And there is scant evidence that taxes as a share of GDP and economic growth are negatively correlated. Indeed, there is a small positive correlation between income per capita and tax revenue as a share of GDP.

Special tax rates and allowances are a major reason why tax revenues are comparatively low in the US. So-called tax expenditures amount to about 7 per cent of GDP; more than what the federal government spends individually on defence, health and social security. Reducing the number and limiting the size of tax expenditures would simplify the tax code, remove distorting incentives and raise revenue. Mr Obama proposes to use some of the revenue from reforming tax expenditures for deficit reduction; Mr Romney would use all of it to cut tax rates, with disproportionate benefits to high-income taxpayers.

But tax reform should not come at the expense of progressivity. Income inequality is greater in the US than in the other developed countries of the OECD. The US tax system is considerably less progressive than it was a few decades ago and it does less to counteract pre-tax income inequality than other OECD systems.

Widening inequality is reflected in opportunity gaps between children born into different income groups and a decline in intergenerational mobility: an American child’s future income is more dependent on his or her parents’ income than in most other OECD nations. Mr Obama’s plan counters these trends. The Romney-Ryan plan exacerbates them.

Proponents of greater progressivity often call for an increase in corporate taxes but this would lead to slower growth and fewer jobs. The US has the highest statutory corporate tax rate in the developed world. Even after tax expenditures are included, its effective marginal corporate tax rate is one of the highest in the world. Business decisions about where to locate investments are responsive to differences in taxes and have become more sensitive over time. Of all taxes, corporate income taxes do the most harm to economic growth.

Both Mr Obama and Mr Romney advocate corporate tax reform that lowers the rate and broadens the base. The economic benefits could be significant. The current system has large unjustifiable differences in effective tax rates that influence business choices about what to invest in, how to finance an investment, where to produce and even what form of organisation to adopt. These differences distort capital allocation, add complexity, increase compliance costs and reduce corporate tax revenues.

A lower rate would stimulate investment, narrow the tax preference for debt over equity financing and weaken the incentives for international companies to move production to lower-tax locations. But lowering the corporate tax rate is expensive – each percentage point reduction would cut revenues by about $120bn over 10 years. Scaling back the three largest corporate tax expenditures to pay for a cut could increase the cost of capital, thereby reducing investment and growth.

A more efficient and progressive way to pay for a lower corporate tax rate would be to increase taxes on dividends and capital gains. This would shift more of the burden towards capital owners and away from labour, which bears the burden in the form of fewer jobs and lower wages. Mr Obama proposes to raise rates on capital gains and dividends for the top 2 per cent of taxpayers. Most capital gains and dividends go to this group. Mr Romney would leave these rates unchanged for this group.

The US economy needs efficient and progressive tax reform and it needs more revenues for deficit reduction. Revenue increases have been a significant component of all major deficit-reduction packages enacted over the past 30 years. This must be the case now, too. Additional revenues as part of a credible long-run deficit-reduction plan and supported by progressive tax reforms will boost economic growth and job creation.

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