The Federal Balance Sheet

Matthew Klein at The Economist‘s Free Exchange blog has some interesting ideas on how to view the financial position of the government.

My modest suggestion is that we start calculating the public sector’s “book value” by taking the difference between its actual assets and liabilities. (Since governments have the power to tax their productive citizens, the asset side of the public sector’s balance sheet should be thought of as a share of the country’s total asset holdings.) This approach would probably be more useful than the simple public debt to national income ratio, even if it comes with its own (significant) complications.

He goes on to note:

Under this framework, all government spending could be divided into three basic categories: investment to increase the future standard of living, hedging that reduces the nation’s risk exposure, and resource redistribution.

The post is fairly long and definitely worth reading.

The Economist on tax proposals

The Economist this week includes a summary (above) of some of the major tax policy proposals being tossed around.  It also includes this blurb about some GOP ideas:

One way this could be done is to target deductions that primarily benefit the rich. During the election campaign, Mitt Romney proposed paying for big marginal rate cuts by setting a cap on total deductions. The Tax Policy Centre, a think-tank, reckons a cap of $50,000 would raise $749 billion over ten years, comparable to the $800 billion that Mr Boehner entertained during failed negotiations with Mr Obama in 2011. Importantly, this fix would make the tax system much more progressive: 80% of the additional money would come from the top 1% of earners. This has helped draw interest from some Democrats.

A slightly different proposal by Martin Feldstein, a prominent Republican economist, and Maya MacGuineas of the Committee for a Responsible Federal Budget, a think-tank, would cap the tax benefit of itemised deductions at 2% of income for all households. Mr Feldstein reckons that would raise more than $2 trillion over ten years, although almost all families would pay more tax, not just the rich.

 

 

The Marginal Impact of Tax Credits (plus some thoughts on progressive consumption taxes)

Timothy Taylor reviews some of the CBO’s findings in its Effective Marginal Tax Rates for Low- and Moderate-Income Workers report.  He concludes (referencing the graph below in part):

These high marginal tax rates on those with low and moderate levels of income raise some questions for those on all sides of the tax debates. For those who don’t believe that high marginal tax rates have much affect on incentives to work at higher income levels, like households earning $250,000 or more per year, consistency would seem to suggest that they shouldn’t worry too much about incentives to work at lower income levels, either. For those who express a lot of concern about how high marginal tax rates would injure incentives to work for those at the top income levels, consistency would seem to suggest that they express similar concern over lower marginal tax rates for those at the lower and moderate income levels, too–which means making programs like the Earned Income Tax Credit, food stamps, welfare, and others more generous, so that they can be phased down more slowly as people earn income.

From the report itself, I particularly enjoyed this section on marginal tax rates and the decision to enter the workforce.

A person’s marginal tax rate influences many different decisions about working: whether to increase or decrease the number of hours worked, bargain for wages or nontaxable fringe benefits, get or quit a second job, or enter or leave the labor force. For people who are already working, an increase in marginal tax rates on additional earnings lowers the financial gain from working additional hours, which in turn has two effects:

• Hours worked tend to fall from their initial level because other uses of time become relatively more attractive; and
• Hours worked tend to increase from their initial level because the amount of additional disposable income (income after accounting for taxes and transfers) available to reach consumption and saving goals is lower.

Because those two effects work in opposite directions, the net effect depends on which one dominates.On balance, in CBO’s judgment, increases in marginal tax rates on earnings tend to decrease the supply of labor by inducing people already in the workforce to put in fewer hours or to be less productive. The responsiveness of labor supply to tax changes varies across groups. On average, working-age men are not very responsive to changes in marginal tax rates. Married women, who tended in the past to be the lower earner in the household, typically decreased their hours of work—on average—when marginal tax rates rose. In recent decades, their decisions about decreasing or increasing the number of hours worked have become more similar to those made by men.

Marginal tax rates that result from a relatively large increase in income are relevant to the decision to enter the workforce. For instance, because the earned income tax credit increases disposable income for all eligible workers, the ability to qualify for the credit makes work more appealing. Studies have found that expansions of the EITC between 1986 and 1996 significantly increased the movement of single mothers into the workforce but had little effect on the number of hours they worked.

This, I think, adds some granularity to the debate of the disincentives of things like the EITC; though I would add one very important caveat.  The work incentive is only a component of the overall picture related to tax policy benefits for the unemployed and working poor.  As the fiscal debate continues in Washington, I suspect the quantification of specific tax and spending policies will become very popular (rightfully so).  What I will be interested in seeing is if there is any quantification of secondary and tertiary effects of policy changes.  For instance, I have been reading quite a bit lately about the idea of progressive consumption taxes (something I’ve written about in the past) as an alternative to income taxes.  Beyond the practical and political challenges of implementation; there are two problems I see with such a system (not to imply that these issues are without remedy).

1. A PCT does not easily allow for fiscal policy shocks through the tax code.  While tax preferences for certain behavior are generally distortionary and not beneficial, things like education and HSAs ought to be encouraged.  Obviously tax relief for such spending could be implemented, but I think it amplifies some of the practicality concerns.
2. I have seen no writing as of yet on the transition costs of such a system.  Businesses, individuals, investors, savers, spenders, charities, etc. have all developed systems based on an income tax structure.  Not to say the status quo is best by virtue of being the status quo, but there are certainly costs for any change that must be analyzed.

Point 2 above really goes to my concern in the current and upcoming debate over taxes and spending.  Will we properly access the impacts of our various tax and spending proposals?  Will we consider the fact that by incentivizing increased transitions from the unemployed poor to the working poor without increasing HHS benefits, we are potentially disincentivizing focusing on children’s behavior.

The numbers mandate action on the fiscal front and I am very much in favor of creating work incentives, but that probably also means maintaining strong familiar support for certain segments of society.

A Debate Worth Reading

The debate is introduced by the moderator saying:

[W]hy should arts funding be the government’s responsibility? Some are quick to argue that tax dollars are better spent on keeping the streets safe and the lights on, not on enabling plays and paintings of subjective merit. Though arts subsidies in America are a fraction of the funds provided by many European governments, Mitt Romney recently pledged to end them all if he is elected president. If there is a demand for such things, the argument goes, the market will keep them around.

The ongoing debate at The Economist (linked above) is obviously about public funding of the arts. It’s an issue that hasn’t been discussed very much in the United States but is often very polarizing when it does become the topic of conversation. Not surprisingly, that is the direction that the online debate is taking as well.

The Real Fiscal Threat

Greg Ip at The Economist writes:

Here’s the real threat. Even if the Bush tax cuts are extended and the sequester delayed, a huge amount of fiscal drag remains in place. They include the expiration of the payroll tax cut, the expiration of extended unemployment insurance benefits, imposition of a new 3.8% Medicare investment tax on the wealthy, and the bite to discretionary spending embedded in the Budget Control Act and prior continuing resolutions. ISI Group projects $220 billion of fiscal tightening in 2013, or 1.4% of GDP. JPMorgan, noting that many Recovery Act programmes are rolling off at the same time, puts the hit at a slightly higher $266 billion, or 1.7% of GDP. The IMF reckons fiscal policy will tighten more in America next year than in Spain, Italy or Portugal. Though smaller than the full fiscal cliff, the fiscal clifflet still poses a significant headwind to the economy. If enough other bad stuff is going on, it could push the economy back into recession.

Thanks to Tyler Cowen for the pointer.

A Little Ryan Commentary

As is typical for me, I’m still not quite sure where I fall in the Ryan pick.  I think he’s an intelligent person who’s willing to ask the tough policy questions and offer his ideas.  However, I think he has a little more of an ideological streak than I prefer.  If you’d like some commentary from each side, I’d suggest reading The National Review‘s Agenda blog by Reihan Salam for the right and The Washington Post‘s Wonkblog by Ezra Klein for the left.  Specific articles by Salam and Klein also dive into pick a little more. It is Josh Barro, though, who best explains my hesitations on what the Ryan pick means.  Writing for Bloomberg he says:

I can imagine Ryan being a good partner for Romney on long-term fiscal policy. But on short-term policy — probably the more important issue — any advice he is likely to give Romney is bad.

Borrowing from another Klein post, I’m interested in knowing how the graph below happens.  How does Paul Ryan believe we ought to change the spending patterns in this country and maintain growth?

Visualization of Campaign Policy Alternatives

From The Economist:

Step One for Mitt

Yesterday I wrote a post about the opportunity for a strong centrist campaign season between President Obama and Governor Romney. Step one, for Mr. Romney if he chooses to take a policy solutions campaign strategy ought to involve the tax code. David Leonhardt (whom I linked in yesterday’s AM Reads) offers an outline of the impending tax debacle debate in Washington. This piece of the puzzle will be central to both campaigns and is probably the best opportunity for Romney to distinguish his campaign and vision for America. This could be as simple as a clearly defined revision of the current income tax structure with lower rates, broader bases, and a clearer tax policy towards corporations and capital gains or as bold as a progressive consumption tax to replace much or all of the income tax. Either way it is a way to distinguish the Romney campaign from the Obama White House while increasing revenues to address the deficit in a pro-growth manner. If you need evidence of the ability of a centrist view of taxes to differentiate ideas, see this post by Reihan Salam on the progressive consumption tax.

Some details of Mitt Romney’s budget policy

The New York Times reports that:

Mitt Romney inadvertently offered a public preview of some of his economic plans on Sunday, revealing to high-dollar donors at a private fundraising event that he wants to eliminate tax deductions for wealthy people who own second homes.

Furthermore:

Mr. Romney also told the donors that he might eliminate the Department of Housing and Urban Development and reduce the size of the Education Department.

Cooking the Books the Public Sector Way

The Economist this week has an article focusing on the accounting standards used by most governments. It discusses the ability, and standard in fact, of governments to use deferred accounting techniques to mask expenses and improve financial positions. Of course these techniques also do not recognize things like governments’ taxing power. The IMF Paper that inspired the Economist article made recommendations on how governments can improve their standards to better report their financial situations.

Governments can be encouraged to prepare audited financial statements—income statement, cash-flow statement, and balance sheet—according to international accounting standards, and statisticians, who in many countries use accounting data to compile the most important (“headline”) fiscal indicators, can be given the resources and independence to be both expert and impartial, as well as the authority to revise standards in the light of emerging problems. To help reveal remaining problems in headline fiscal indicators, a variety of alternative fiscal indicators can be monitored, since a problem suppressed in one fiscal indicator is likely to show up in another. Many of the devices documented in this note would be revealed if governments also reported change in net worth and high-quality long-term forecasts of the headline indicator of the deficit under current policy.

The paper also includes a helpful taxonomy of deficit reducing techniques that governments use.

While changing government accounting standards would almost certainly result in the expansion of government size, at least in the size of government accounting departments, the transparency benefits of such standardized and honest accounting principals would help reduce volatility and uncertainty in economic planning in botht he public and private sectors.