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The New CBO Report: Still a Best-Case Scenario After All These Years

January 31st, 2012 . by economistmom

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The Congressional Budget Office’s new budget and economic outlook is out, and as usual, it really doesn’t seem all that bad when you look at their “baseline” numbers.  (Deficits as a share of GDP over the next ten years are still at economically sustainable–less than the growth rate of the economy–levels.)  Oh, except that the CBO baseline is (by law) a projection of current-law policies, which assume a lot of very optimistic (some might say “delusional”) things about Congress’s proclivity toward fiscally responsible behavior.

You see, in current law there are lots of costly policies that expire after a year or two…or nine, or two–as in the 2001 Bush tax cuts which were first scheduled to expire at the end of 2010 and now again are scheduled to expire at the end of 2012.  Expiring tax cuts have been the most fashionable way to deficit spend in this town ever since.

In their budget outlook, CBO assumes any tax cuts scheduled to expire actually expire.  That could mean CBO’s assuming they will actually expire, or it could mean (more realistically but still very optimistically) that if Congress and the president extend the tax cuts in the future, that they will fully offset their cost, by cutting spending or raising other taxes–a novel concept known as “pay as you go.”  Once upon a time, Congress followed strict pay as you go rules–on both tax cuts and mandatory spending–and they complied with discretionary spending caps, too.  By the way, that was the last time we were actually running budget surpluses, at the end of the Clinton Administration.

Now Congress prefers to make policies look less costly by making them “temporary,” with official expiration dates that CBO has to officially score as being less costly because they (are supposed to) expire.  But a more realistic “business as usual” projection would assume that these previously-always-extended-and-deficit-financed tax cuts will continue to be extended and deficit financed.

Enter the Concord Coalition’s “plausible baseline” (illustrated above), which we’ve been calculating for many years now, and which has told (really) the same old story for many years now, just the numbers keep getting worse because the fraction of the tax cuts that are on unofficial time (past expiration dates) vs. official time keeps growing.  Every year it seems that the multiple of the deficits under Concord’s plausible baseline relative to those under the CBO official baseline keeps swelling.  Last year I remember saying that the plausible baseline’s deficits were triple the CBO deficits.  This year it’s closer to quadruple.

Most of the $8.7 trillion ten-year difference, $6.5 trillion, is due to tax policy.  The (expiring) Bush tax cuts and associated Alternative Minimum Tax relief alone account for over $4.5 trillion of the difference, even without associated interest costs.  (With interest, the deficit-financed extension of the Bush tax cuts and AMT relief would add almost $5.4 trillion to the ten-year deficit numbers.)

Some of you might remember what the so-called “super committee” was trying to do: they were trying to “go big” and find, hmmm, maybe $4 trillion worth of deficit reduction relative to the “business as usual” or “policy-extended” baseline.  The “go big” solution is that which most economists feel is necessary to get deficits back down to economically-sustainable levels… like those very ones that are shown in this new CBO report.  So that would have been a piece of cake for the super committee–or anyone else in Congress who might want to be a fiscal superhero–if they just looked at the CBO baseline and figured out how to stick to it.  (Hint: PAYGO.)

So there’s not much new here.  The CBO report still provides us with a fiscal roadmap with one very clear route highlighted as the fastest one to the land of sustainability.  All the road signs point clearly to that one route, but all the policymakers keep missing that turnoff ramp, over and over again.  And none of them really want to talk about it.

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***Addendum:  Here’s the Concord Coalition’s press release on the CBO report.

Why Limiting Itemized Deductions (Still) Makes Sense

January 23rd, 2012 . by economistmom

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It’s a proposal that has come up over and over again in President Obama’s budget, and one that I hope will come up yet again.  In my column in today’s Tax Notes (subscription-only access here), I remind readers that this is a great idea whose time has (been overdue to) come: the proposal to limit itemized deductions–to either 28 percent (the President’s version) or 15 percent (the more aggressive version suggested by CBO’s budget options volume). I like it because it’s a proposal to raise a lot of revenue (and reduce the deficit), yet by reducing a large tax expenditure in a progressive way.

How much revenue would the proposal likely raise?  A lot.  I refer to CBO estimates:

The CBO estimates the president’s proposal would raise $293 billion over 10 years. A more ambitious version limiting itemized deductions to a 15 percent rate, as presented in the CBO’s compendium of budget options, would raise $1.2 trillion over 10 years — in other words, equivalent to trimming overall tax expenditures [which are over $1 trillion per year] by about 10 percent through that one policy change alone.

A lot of people get confused about this proposal, thinking that it eliminates the tax subsidy for households above the limiting bracket, but it does far from that.  It only limits the size of the subsidy so that the richest households don’t get the biggest subsidies per level of the subsidized activities (in both percentage terms and dollar terms), which makes the proposal a very “progressive” way to reduce a (huge) tax expenditure.  Right now the subsidy is a regressive one, because for any given level of subsidized activity, higher-bracket households get the biggest subsidies.  I constructed the table above to make clearer how that upside-down subsidy works, and how the limit would level at least part of it–the upper end–out.  These proposals would not get rid of the regressivity below the limiting bracket, however, which could only be achieved if we went all the way to converting the deduction to a (refundable) credit.  Ideally, I would like to see all deductions converted to credits, but limiting deductions to 28 or 15 percent is a good step along that policy path.

And to counter arguments that this would kill the economic activities currently subsidized by the (full) itemized deduction, well, the evidence is actually very inconclusive about how much this tax subsidy actually makes a difference in the level of the subsidized activities (charitable giving, borrowing for homeownership), because it is always difficult to distinguish between real behavioral responses versus tax-strategic ones.  Often these tax subsidies just reward behavior rather than influence it, or they encourage something that is not quite the lofty social goal that policymakers had in mind.  As I point out in my column:

Assuming that the goal is in fact to encourage and steer resources to the activities that are subsidized, the case for the effectiveness of this particular form of subsidy depends on how much more responsive higher-income households are to the [price incentive] effect than are lower-income households. This is an empirical question that’s difficult to answer from the data because high-income households with the biggest price subsidies are also those with the greatest income capacity (who might donate the most to charity or buy the largest houses regardless of the itemized deduction). And while the evidence that’s out there shows some price responsiveness, it’s not always clear that it’s the type of responsiveness we would want. A larger charitable deduction might encourage more reported giving without increasing real giving, and a larger mortgage interest deduction might encourage people to buy larger houses rather than helping them to buy any house. And all of the deductions may merely reward behavior that would have taken place anyway.

So I put out my column as my strong endorsement of this proposal. The bottom line is that this is a way to raise substantial revenue from only higher-income households and would actually improve economic efficiency (reduce the distortions caused by the tax subsidies).  It’s a base-broadening, revenue-raising, deficit-reducing, yet government-shrinking proposal.  It’s consistent with the fiscal policy goals of both Democrats and Republicans.  It would also be a piece of cake to implement, unlike other base-broadening proposals that have similar economic advantages.  Why don’t we just do it, finally?!!

Ruth (Marcus): Romney Reforms More Ruthless Than (Even) Ryan’s

January 18th, 2012 . by economistmom

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The Washington Post’s Ruth Marcus points out that if Mitt Romney really cares about the poor, he has a funny way of showing it–in this case, regarding his ideas for fiscal policy reforms:

“I’m concerned about the poor in this country,” Mitt Romney said the other day. “We have to make sure the safety net is strong and able to help those who can’t help themselves.”

I perked up at those words, because they were something of a departure from his usual stump speech and because they happened to come on a day when I had written about the dire implications of Romney’s proposals for the social safety net.

I don’t question his sincerity. The problem: This fine sentiment doesn’t square with his actual policies…

The impact of Romney’s approach on the safety net would go far beyond Medicaid. The brutal arithmetic of his stated plan to cap spending at 20 percent of gross domestic product — while, unlike Ryan, increasing defense funding — is that safety-net programs would have to be chopped significantly beyond where even Ryan would take them.

Romney’s tax plan would exacerbate the unfairness. He would continue the Bush tax cuts for the wealthiest Americans and provide extra breaks that would primarily help the rich…

At the same time, Romney would do away with recent increases in the child tax credit and the earned-income tax credit — provisions that help low-income families…

This is one way to make the necessary tough choices regarding the federal budget:  if we choose to keep taxes low and defense spending high, the rest of the budget has to give.  There’s a lot to be said for a politician being clear about his priorities and spelling out the policies consistent with those priorities.  But as Ruth points out, the consequences must be spelled out, too:  you can’t cut spending on the poor that dramatically and expect that the poor will be better off.  To do so is either the result of delusional beliefs about extreme “trickle down” economics, or a grossly exaggerated view of how much truly “wasteful” government spending now exists–unless one’s definition of “waste” is simply “that which does not benefit me personally.”

Romney’s Effective Tax Rate: Just 15 Percent?

January 17th, 2012 . by economistmom

Well, this is going to raise some voters’ eyebrows:

“What’s the effective rate I’ve been paying? It’s probably closer to the 15 percent rate than anything,” Romney, a GOP presidential candidate, said. “My last 10 years, I’ve — my income comes overwhelmingly from some investments made in the past, whether ordinary income or earned annually. I got a little bit of income from my book, but I gave that all away. And then I get speaker’s fees from time to time, but not very much.”

(The “not very much” in speaker’s fees is apparently more than $360,000, by the way.)

Besides being good negative gossip on Romney, though, perhaps it will be a teaching moment for all of us about tax policy more generally.  It underscores the fact that even the preferential rate on capital gains and dividend income, even though it seems more an issue about tax rates than tax base, is a big tax expenditure–a big way we “spend” money via the tax code.  Relative to a comprehensive income tax base where all forms of income are taxed at the same rate, the lower rates on capital gains and dividends result in well over $100 billion a year in lost revenue.  (See Table 17-3 in the revenue section of the analytical perspectives of last year’s budget and note that just the first three capital gains provisions add up to $135 billion for just fiscal year 2012.)  So besides the distributional implications that are already unsavory, there are the budgetary implications that should make us question whether these tax preferences are worth their cost.

So let the gossip and thoughtful conversations begin!

Bruce’s New Book

January 9th, 2012 . by economistmom

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Bruce Bartlett has a new book coming out in a couple weeks; you can pre-order it on Amazon here.  It looks like another great piece of work from Bruce.  Here’s a excerpt from the first review of it, by Vanessa Houlder of the Financial Times:

In Mr Bartlett’s view, higher tax revenues are needed to stabilise the US’s finances; one of the goals of tax reform should be to make the higher tax burden more bearable. But it will not happen unless there is a much better public understanding of how the tax system works. The author sets out to guide the uninitiated through the fundamentals of taxation at the simplest level. This deceptively dry approach is the basis of a powerful critique of the myths, misconceptions and inequities of the tax code.

The public misunderstands basic facts about the tax system. Polls show that most people overestimate federal tax rates. Few know that close to half of all tax filers either pay no federal taxes or get a refund. Even for the wealthiest people, the top rate of 35 per cent – half what it was as recently as 1980 – is not nearly as high as people imagine. The reason the US has one of the most progressive income tax systems in the world is that the income threshold at which the top rate takes effect is much higher than other countries.

Rates are only part of the story. Many taxpayers in the top 1 per cent of the income distribution pay less of their income in federal income taxes than those barely in the middle class. One reason is that wealthy people often own their businesses, so can pay themselves in the form of lightly-taxed dividends. Another reason – the main target of Mr Bartlett’s ire – is the plethora of credits, deductions and tax breaks that distort behaviour and subsidise special interest groups. The curtailment of these tax “expenditures” would be enough to raise the revenues the US needs.

This is not a novel suggestion. As a veteran tax reformer, Mr Bartlett has spent years fruitlessly arguing for the abolition of cherished reliefs, such as mortgage interest deduction, which costs nearly $100bn a year. He views such tax breaks as “loopholes” and laments the absence of popular outrage about the scope they provide for gaming the system.

The reason, he speculates, is the declining emphasis on a balanced budget and the oft-repeated mantra that “deficits don’t matter”: the public no longer believes that if some taxpayers do not pay their share, others will have to pay more.

Conservative opposition to higher taxes is overwhelming and probably insurmountable. But attitudes can change. The trigger could be inflation, high interest rates and economic instability ushered in by a worsening debt crisis. Mr Bartlett points out that when inflation became a problem in the 1960s, people saw budget deficits as the primary cause. This made them more sympathetic to tax increases, such as the 1968 surtax.

I guess in the end, Bruce must sound at least somewhat optimistic or hopeful for the change in fiscal course that’s needed, for the FT review concludes with:

The challenges the book describes are not insurmountable. But reform will require compromises from all sides that are currently unthinkable as the US heads into an election year. Politicians seem unable to grapple with radical change. But once their backs are against the wall, coping with a future debt crisis, perhaps they will.

New Year’s Resolutions for Tax Policy

January 4th, 2012 . by economistmom

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In my column in this week’s Tax Notes–in which Grover Norquist has been named 2011 “tax person of the year,” by the way (more on that later)–I list a few new year’s resolutions for tax policy (emphasis and brief descriptions added):

[Here are] some New Year’s resolutions for those who make, study, and care about U.S. tax policy: (1) don’t view tax policy in a vacuum [recognize the interaction of tax policy with the rest of the federal budget and government's role in general]; (2) plan ahead for expiring provisions [look ahead to what's coming due in the next year, and start the policy debates and analysis now rather than in the 11th hour]; (3) accurately analyze short-term versus longer-term economic effects [how are the considered policies helpful or harmful to the economic goals of highest priority?]; (4) set revenue targets and stick to them [use the budget process and budget committees to bring tax policy into the deficit reduction effort]; (5) treat tax expenditures more like expenditures [recognize they're more like spending-side subsidies than simple tax cuts, and scrutinize them to evaluate whether their benefits are worth their costs]; (6) don’t be hypocritical about fiscal responsibility [don't fuss over the small-change items while giving a huge pass to the big-ticket ones]; (7) don’t be so afraid to agree with the other side [there's huge bipartisan common ground on goals for tax and fiscal reform if policymakers would only stop picking fights]; and (8) get specific about good tax policy [study, analyze, and better promote the specific tax policies that experts recognize as economically smart so that policymakers are forced to notice and respond].

Note that this list is more broadly applicable to fiscal policy–tax and spending–more generally, but I was writing for Tax Notes, of course.

The biggest item on this year’s expiring tax provisions list is of course (and yet again) the Bush tax cuts–or as I sometimes refer to them, the Bush/Obama tax cuts.  Who knows, if policymakers keep doing the same old thing with them, by next year they could become the “Bush/Obama/Romney [or Santorum or Gingrich or Paul]” tax cuts!

My Tax Notes column reprinted the CBO table above, just to highlight the point that these expiring tax cuts–just the ones set to expire by the end of this year–are worth $4 to $5 trillion over the next ten years, without interest costs.  (Remember the “go big” goal?)

Happy New Year to my EconomistMom readers!  More from me later this week.