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.

The Return of Simpson-Bowles

From the Wall Street Journal:

A bipartisan group of House lawmakers, bucking Democratic and Republican leaders, is moving to propose a broad plan that would aim to reduce the federal budget deficit by more than $4 trillion over 10 years through a combination of spending cuts and tax increases.

The plan is clearly a moderate approach to the budget. The WSJ article goes on to say:

It includes broader changes in entitlement programs than many Democrats have supported and larger increases in tax revenue than many Republicans have supported.

Paul Ryan wants to balance the federal budget on the backs of the states. Here’s why we shouldn’t.

Count me among the people who think Paul Ryan’s budget proposal cuts too much and taxes too little. I agree with Dana Milbank that it is both penal and patronizing to the poor. I agree with Ezra Klein that the “assumptions” underlying its math are unrealistic, if not downright farcical. And I agree with Newt Gingrich that his vision amounts to “right wing social engineering.” (All right, so that was last year, but it still applies.)

But I’m not as concerned about where the budget slashes as where it spends. Or more precisely, who does the spending.

Hidden underneath dire warnings about Obama’s bankrupt and statist dystopian future, Ryan proposes a massive shift of fiscal policymaking from the national to the state level. Federal Medicaid and food stamp contributions would be turned into block grants and handed entirely to the states. Infrastructure, education, and other discretionary spending would also be pushed onto state governments.

(More after the jump)

A partisan view of the Ryan Budget

Keith Hennessey writes:

Over each year of the next decade the Ryan budget would result in lower deficits, less debt, and a better long-term debt trend than the President’s budget.

Klein has Questions for Paul Ryan

Ezra Klein asks four questions about the upcoming Ryan Budget on Wonkblog this morning. He writes:

1) Ryan’s original plan avoided raising taxes by implausibly promising to hold spending growth in Medicare and Medicaid to inflation. If costs in either program exceeded inflation, then the beneficiary, or some other actor, paid the difference. Ryan-Wyden aims for the strict, but more achievable, goal of holding spending growth to GDP+1%, at least in Medicare. If Ryan’s budget adopts that goal, or something closer to it, a substantial portion of his long-term savings evaporate. So how does he handle that?

2) Ryan’s budget includes an ambitious tax reform proposal that takes the tax code down to two rates: 15% and 25%. But he’s not expected to say which income levels pay which rates. Moreover, he’s expected to say that the plan is revenue neutral because it will include closing tax loopholes, but he’s not expected to identify which tax loopholes will be closed. For obvious reasons, a tax reform plan that doesn’t explain who will pay which rate and how the lost revenue will be made up is not much of a tax reform plan, and it’s not an exercise in making tough choices. But perhaps Ryan will offer more detail than we think.

3) Ryan’s original budget cut miscellaneous domestic spending — so, both the categories contained in the “non-defense discretionary spending” bucket and the lesser known items in the mandatory bucket — down to a nubbin. That is to say, federal spending on things like education and infrastructure and research would be far, far, far lower than in the future than they are today. If Ryan has to make up savings from the Medicare portion of his budget, is this where he does it? And, if so, how does the government fund, say, roads, in the coming years?

4) Does anything in this budget seriously conflict with Mitt Romney’s plans? If Ryan moves to a variant of Wyden-Ryan, for instance, that brings the House GOP much closer in line with Romney’s proposed Medicare reforms, which broke with the previous Republican budget by retaining fee-for-service Medicare as an option. Romney has also made some very specific promises on defense spending and, though he hasn’t yet explained how his tax plan actually fulfills this condition, holding the tax burden on the top one percent steady. So keep an eye on whether this budget is moving the House GOP towards Romney, or whether it’s trying to lay out a more ambitious position that they can bring to budget negotiations with a Romney White House.

Awesome NY Times Graphic of the Obama Budget

This is a fun way of viewing where spending goes and how the President proposes changing it from the current budget.

Charles Blahous simultaneously gets and misses a point

The graph after the jump doesn’t paint a pretty picture as a somewhat likely scenario of future budgetary behavior.

CBO projects decreased deficit in 2012 but still over $1 Trillion

The CBO released today it’s budget outlook for 2012 to 2022. More to come on this later, but I wanted to highlight that the deficit is expected to be the smallest since the recession began (in amount and percent of GDP) but will still be around $1.1 trillion.

A Response to Roun McNeal

On his blog, Roun McNeal, recently gave our humble blog a shout-out, which is appreciated, in a post about a balanced budget amendment. Specifically, he proposes linking a balanced budget to individual Congressmen and Congresswomen’s ability to remain in office. He suggests:

Hence, the only novel idea I have really come up with, fire them all if they run up the debt. I am very serious, and I am not speaking electorally. I’m talking about Total Recall. Enshrine in the Constitution a rule that automatically removes every sitting member of Congress and disqualifies them from further service in the event that our books go so far in the red as to violate the Balanced Budget Amendment, however it be written. The primary obstacle to imposing order upon our growing public debt is the Congressional re-election incentive to think short-term. Think about it: if the penalty for Super-Committee failure had been the wholesale recall of Congress (instead of some measly $1.2 trillion) would a deal have been cut? Our Congressmen need a more pronounced personal incentive to consider our fiscal house in the long-term. Putting all their jobs at risk sounds right.

Now I tend to be somewhat of a fiscal hawk. I think we can and must get our fiscal house in order to remain strong and relevant going forward. However, I am not a fan of a balanced budget amendment, especially one the further skews incentives members of Congress already have to think about reelection over the best interests of the country. At its heart, such an amendment assumes balanced budgets to be preferable to any other policy option at all times; thus, making it a Constitutional issue. It simply is not worthy of such high regard. Fiscal responsibility is important and is definitely something on my mind when I go to the ballot box, and the ballot box is where it should be handled. Voters should make the decision on how the country’s preferences are ordered at any given time.

Beyond the question of Constitutional appropriateness of a balanced budget amendment, is the question of economic appropriateness. In theory, any balanced budget amendment would include a process for not having a balanced budget (both deficit and surplus); practically of course a balanced budget would almost always exist (even when a surplus was due) because of political stagnation. Also a balanced budget requirement ignores the budgetary impact of inflation. If the government can borrow (i.e. sell treasuries) for a 1% yield and inflation is around 2% per annum, it is extremely logical to borrow money since the real borrowing cost is negative (interest rate minus inflation).

Overall a BBA is probably not preferable policy. It could easily increase the partisanship in Congress by forcing significant budget fights every year. There is no clear mechanism for determining the level of spending available in a given year. Pro-cyclical fiscal policy becomes more likely. And it becomes almost impossible to manage the national debt. The sentiment behind the policy is respectable, that being responsibility, but as a mechanism, I find a BBA to be lacking.