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If Only REINing in the Deficit Were As Easy As RAIN

September 8th, 2011 . by economistmom

rainfall-totals-noaa-rain-map-090811-600x212

Just had to “tweet” that!  Mainly wanted to combine a complaint about the rain and a link to my Tax Notes column (reprinted on the Concord Coalition site, here) that argues that the first easy thing the debt limit deal’s “super committee” could do is commit to strict pay-as-you-go rules on the Bush tax cuts–and on other expiring tax cuts and on spending as well, by the way, but the biggest difference this would make in on tax policy.

Committing to pay-go rules on the Bush tax cuts wouldn’t be so hard in terms of making tax policy.  I explain in my column that there are three main ways we could get there–each with their economic and political pros and cons:

1. Do Nothing. Allow all expiring tax cuts to expire as specified under current law. That would mean reverting to Clinton-era marginal tax rates. (Hmmm, what was so bad about those tax rates for our economy?)

2. Do It Big. Extend some or all of the marginal tax rates under the Bush tax cuts, but fully offset the costs of extending the low rates by broadening the tax base and reducing some tax expenditures (for example, limiting itemized deductions or reducing the exclusion of employer-provided health benefits). This is the fundamental tax reform approach.

3. Do It to the Rich. Extend some or all of the Bush tax cuts — particularly those that affect middle-income taxpayers (lower tax rates, child tax credit, marriage penalty relief) — and fully offset the costs by imposing an extra tax on the very rich, such as a surtax on households with incomes in excess of $1 million.

I admit that’s still not as easy as rain, but it’s also far easier than the super committee having to do full-blown fundamental tax reform within the next few months.  And not being able to do all of fundamental tax reform right now isn’t a reason to avoid committing to a budget rule that would encourage smart and fiscally-responsible tax reform in the future.

8 Responses to “If Only REINing in the Deficit Were As Easy As RAIN”

  1. comment number 1 by: Vivian Darkbloom

    I had a difficult time understanding this article. Perhaps others did, too, and that explains the lack of comments to date. First, I think EM misunderstands the mandate of the Super Committee and so her article is a curious and confusing jumble of what the Committee “should do if they could” and what they are *required* to do. The “current law baseline” is not optional—under the law establishing the Committee and the goal the Committee is mandated to target ($1.5 trillion in deficit reduction as measured against that current law baseline) it is *required*. The Committee cannot waive it. Of course, the Committee can present their findings against other baselines, but doing so would be “for illustrative purposes only”. Whether the Committee has met its mandate is not affected by those other comparisons. This is clear from Title IV of the Budget Control Act.

    With this in mind, much of what EM wrote does not make much sense, practical or otherwise. For example, in number one on her list (“Do Nothing”) , she suggests that Committee could meet their mandate by simply letting the “Bush tax cuts” expire. Not true. Because the Committee is operating against a current law baseline, letting those cuts expire contributes *nothing* toward their deficit reduction goal. In order to contribute towards that mandated result, the Committee would need to go beyond the Bush tax cuts. For example, revenue resulting from raising the highest marginal rate above 39.6 percent (or raising any intermediate marginal rates after expiration of those cuts) would count. Again, the law establishing the Committee does not give them discretion to change this. But, the whole point of EM’s article seems to be that they can. And, in a very curious twist of logic, she’s completely turned Bill Gale’s point about the preference for a current law baseline to reduce the deficit on its head, distorting , I think, the original meaning.

    Here’s the second option, per EM:

    “2. Do It Big. Extend some or all of the marginal tax rates under the Bush tax cuts, but fully offset the costs of extending the low rates by broadening the tax base and reducing some tax expenditures (for example, limiting itemized deductions or reducing the exclusion of employer-provided health benefits). This is the fundamental tax reform approach.”

    Under the required baseline approach, “extending some or all of the marginal tax rates under the Bush tax cuts” does nothing to meet the $1.5 trillion goal. But, revenue raised by broadening the tax base or reducing tax expenditures does (whether or not you perceive it as “offsetting the tax cuts”). Baselines aside, I fail to see how this is “Doing it Big” anymore than letting those cuts expire, but I agree it’s better policy if done correctly.

    And, here’s the third option:

    “3. Do It to the Rich. Extend some or all of the Bush tax cuts — particularly those that affect middle-income taxpayers (lower tax rates, child tax credit, marriage penalty relief) — and fully offset the costs by imposing an extra tax on the very rich, such as a surtax on households with incomes in excess of $1 million.”

    This is a very curious one. Starting with “Extend some or all of the Bush tax cuts…”. Assuming that we extend them all, that means that the top rate would remain at 35 percent. I assume the “surtax” on the rich would come on top of that. Unless the CBO is willing to put form over substance, my guess would be that any “surtax” of less than 4.6 percent would not be counted at all towards deficit reduction. So, any “surtax” would need to push the marginal rate beyond 39.6 percent. How this jives with “extending… all the Bush tax cuts” is a real mystery.

    The bottom line is that due to the requirements of the law establishing the Super Committee, it is indeed very difficult to satisfy the deficit reduction mandate by merely raising tax *rates because those rates are scheduled to rise anyway under current law. But, that practical emphasis is actually a good thing. First, it does place emphasis on cutting spending. If that is not your philosophical preference (it appears not to be EM’s) , then it forces one to think of ways to raise revenue by “reforming” the tax code. This means eliminating tax deductions, credits or exemptions that are bad policy either because they subsidize things we don’t want or they distort economic decision-making.

    With this in mind, I would think a more constructive use of time, energy and space among those who care about these things and want to have a positive influence on the debate would be to propose some concrete things the Committee might feasibly do, given the legal and political restraints. And, there are actually quite a number of things that can be done that, cumulatively, would raise significant revenue and at the same time make improve the long-term prospects of the economy. In that spirit, here’s my number one choice.

    Eliminate the interest deduction on “home equity loans”. It’s clear that this contributed to the current crisis as homeowners in unprecedented numbers borrowed against their homes. The debt represented by these loans is a significant part of our current “debt overhang” (or hangover). It’s a no-brainer that should have bipartisan support. It would raise revenue, but how much is not clear. The JCT and the OTA estimate the mortgage interest deduction reduces revenues by about $100 billion per year. The home equity loan is part of the estimate. Interestingly, the Treasury recently issued a Revenue Ruling that expands the deduction on home equity loans to include acquisition indebtedness in excess of $1 million, thereby ignoring two Tax Court cases to the contrary. Now, in effect, home mortgage interest for acquiring a home is deductible on $1.1 million rather than $1 million. This strikes me as a political ruling intended to provide support to the housing market without the need to go through Congress. It’s this type of misguided government subsidizing of the housing market that got us in the mess we’re now in.

    http://www.irs.gov/pub/irs-drop/rr-2010-25.pdf

  2. comment number 2 by: Arne

    Having linked through I see a post that is much clearer (and somewhat longer). To make this post clearer she could have quoted this part.
    “policymakers will have to set a revenue target somewhere far closer to — ideally, precisely at — current law.”
    Then this post makes clear that there are multiple ways to meet that revenue.

  3. comment number 3 by: Vivian Darkbloom

    Arne,

    That does not help me at all. But, here’s something that possibly does.

    If the Committee recommends that the Bush-Öbama tax cuts be retained, in whole or in part, that in itself is a change in current law. Thus, as measured against a current law baseline, this would *reduce* revenues and increase the deficit. If we assume, for example, that all the Bush-Obama tax cuts are worth $1 trillion over a ten year period, this *increases* the deficit by the same amount and the Committee would have to come up with $2.5 trillion elsewhere to meet their target $1. 5 trillion plus the $1 trillion additional deficit “they created”. That $2.5 trillion could, of course, come solely from $2.5 trillion in spending cuts. Or, it could come from additional tax revenues raised elsewhere.

    *If* Economist Mom is saying that the Super Committee should agree among themselves that any of the deficit costs of retaining the Bush-Obama tax cuts should come from additional revenue rather than reduced spending, that is something they *could* do consistent with their mandate. It’s not entirely clear to me that that was the intent, but if it was, it was not clearly stated, to this reader, at least. And, if that was the intent, some of the scenarios are pretty unrealistic. For example, take Option 3 (Do it to the Rich). If *all* the Bush tax cuts are retained (a contradictioin in terms given the proposed surtax on high-earners, but nevertheless) and those cuts are worth $1 trillion, there would need to be a $1 trillion surtax to make that up.

    Of course, if this is indeed the intent, the chances that the Super Committee would make this commitment is pretty much zero so I think it is a relative waste of time to dream about it (or have nightmares about it). Again, I think efforts are better spent on stuff that is both concrete and feasible. I’ve put my first choice on the table—what’s yours?

  4. comment number 4 by: SteveinCH

    From my perspective, the Supercommittee will say nothing about the Bush/Obama tax cuts. If it says nothing, the presumption is that they will end (even if they don’t). By CBO scoring rules, it will count as a net neutral because current law will be assumed.

    To do as Diane describes would require a massive surtax above the 39.6 percent assumed statutory rate…no way such a thing is happening.

    I’d also note that the President has now set the precedent that allowing a tax cut to end is a “tax increase.” In describing the payroll tax, those were exactly the words he used. I’m sure that was painful to Diane and it bodes ill for the tax conversation next fall (at least if you are in the camp that wants to see tax rates increase). Parenthetically, I think the President is correct…all this baseline stuff is hooey. If taxes are higher this year than last year, it’s a tax increase. If they are lower, it’s a tax cut. The rest of it is just mental gymnastics by people who spend too much time thinking about it.

  5. comment number 5 by: SteveinCH

    Oh sorry, I didn’t reply to Vivian’s request. My solution is simple. Put government on a COLA equal to CPI-U plus population growth…

    Problem solved.

  6. comment number 6 by: Vivian Darkbloom

    “From my perspective, the Supercommittee will say nothing about the Bush/Obama tax cuts. If it says nothing, the presumption is that they will end (even if they don’t). By CBO scoring rules, it will count as a net neutral because current law will be assumed.”

    I’m not sure that they will say nothing; but, I think you are right about the consequences if they don’t address the issue at all. That points out a very curious aspect of the Budget Control Act and the mandate given the Super Committee and the manner in which CBO will ultimately score their work. By saying nothing about the Bush-Obama cuts, they would take no responsibility at all one way or the other. In particular, if they were to recommend that some or all of the cuts be retained, they would be responsible for making up the “deficit” that creates under a current law baseline. By saying nothing, their job is much easier and it punts the issue back to Congress.

    In general, I agree with you on the baseline issue (double entendre there), but at this juncture we’ve got to live in the world that has been given us, not the one we would like to live in.

    In the spirit of feasible and reasonable reform, my second contribution would be the carried interest rule that is used widely by private equity partnerships to convert ordinary income to capital gain income. This is, of course, a progressive pet peave and an administration proposal, even though they ignore the root cause of the problem. Did you know that more than 70 percent of carried interest plays involve tax exempt entities? In order for this to work, one needs a tax exempt partner for whom the ordinary income/capital gain distinction is irrelevant. A more fundamental reform would be to do away with tax exempt status completely which would solve most of the carried interest problem and much, much, more (I’m talking about the Harvard Endowment Fund, etc). But, being a realist, I know that is not going to happen (Obama is a Harvard grad). Perhaps a rule that states that carried interest can only apply if your counterparty (i.e., partner) is subject to ordinary US tax (this would exclude US tax exempts, most foreign investors without US ECI, but would not exclude those with NOL’s) would be acceptable to enough persons on both sides of the great ideological divide.

  7. comment number 7 by: Vivian Darkbloom

    Further to the above point, the reform could borrow from the definition of a tax exempt person as used for the “earnings stripping rules” under section 163(j).

  8. comment number 8 by: Xxdjpxsv

    Is this a temporary or permanent position? Bbs Preteen jvjwiv