Thursday, April 08, 2010

One more post about the federal deficits

In a previous post, I spoke of the need to pay down at least some of the national debt to avoid paying junk-bond interest rates when we have to borrow to cover the Social Security payments to retired baby boomers- something that will occur no later than 20 years from now, and possibly within 15 years.

Someone brought to my attention a paper from the Tax Policy Center, a joint project by the Brookings Institute and the Urban Institute, entitled "Desperately Seeking Revenue" "This paper poses a simple question: could incremental reforms of the current tax system raise enough revenue to reduce the deficit to an average of 2 percent of GDP over the last five years of the budget window?" Before I continue, let me note that they aren't even trying to balance the budget, much less pay down the debt; the intent is only to reduce the amount of the annual deficit.

"Raise tax rates proportionately on single taxpayers with income over $200,000 and married couples filing jointly with income over $250,000. This policy would impose tax increases only on those taxpayers targeted by President Obama during the 2008 presidential election for tax increases under the expiration of the 2001 and 2003 tax cuts. We model a proportional increase in tax rates for taxpayers for whom adjusted gross income minus the standard deduction and one personal exemption (two exemptions for married couples) exceeds the relevant threshold. To meet our revenue target under current law, the top two tax rates would have to increase more than 40 percent, lifting the top rate to 56.4 percent. Under the administration baseline, the top rates would leap by 160 percent, lifting the top rate to nearly 91 percent. (my emphasis)

None of the options we have examined would provide a realistic approach to reducing the deficit over the coming decade, particularly if we impose our more stringent goal of cutting the deficit to just 2 percent of GDP. That goal would require tax increases that would cut after-tax income by an average of just over 2 percent, a politically difficult action. All of the changes we examine would be progressive, imposing greater costs on those higher up the income distribution; some of the options would be significantly more progressive than others. However, the most progressive— raising tax rates only for the wealthiest taxpayers—would require increasing the top tax rate to 56.4 percent under current law and to over 90 percent under the administration baseline. Because most of the additional tax burden would hit the top end of the income distribution, either situation would impose substantial efficiency costs on the economy, raise less revenue than generated in our simple simulations that ignore behavioral effects, and meet with great political opposition.
We recognize that raising the statutory corporate income tax rate could increase revenues but would be unlikely to contribute much to deficit reduction. Corporate income taxes make up only a small percentage of federal revenues— less than 9 percent of total revenue and less than one-fifth of individual income tax revenue over the ten year budget window, according to CBO projections. Whether reforming the corporate tax could do much to bring in needed funds is an open question. The U.S. statutory rate is high by international standards; Japan is the only OECD country with a higher combined federal-state statutory corporate tax rate. Raising the corporate rate significantly would likely have adverse effects on U.S. businesses and on foreign investment in the United States. We do not rule out corporate tax increases (through either statutory rate increases or base broadening), but we feel that raising significant revenues through the corporate tax is not a viable strategy.

If your eyes have glazed over by now, let me summarize: it is simply not possible to balance the budget by raising taxes. Even a serious attempt to do so would have such a negative impact on the economy as to actually reduce tax receipts. We cannot grow our way out of the deficit in time- not when the deficit alone is larger than the entire US budget when Bill Clinton took office.

Without a dramatic change in the way our government operates- and soon- the federal government will be forced to default in the next 20 years. Either default on loans, or default on the promises made in the Social Security, but one way or the other something will have to give.


Crystal said...

Thank you for posting this Joel. I'm so mad about this tax stuff I can't see straight. If something like what Obama has laid out were to go into effect, either hubby or myself would likely be forced to quit work ... because while the Feds have decided that we are "rich", the only reason was are able to live where we do is because of our incomes. Living in one of the most expensive areas in the country has some major drawbacks, and the fact that the feds refuse to consider that some of us make what we do because we must to survive doesn't help ... neither I nor my family should be penalized because we actually can manage to be self sufficient.

Tim said...

Mr. Monka:

The point of the Tax Policy Center paper you link to was NOT that it is impossible to balance the budget by raising taxes. The point was that it is impossible to do so in a realistic way by raising taxes with the CURRENT tax structure.

The paper mentions that we will have to consider a value-added tax. Most advanced Western countries have such a tax. Most people who have seriously looked at the U.S.'s fiscal challenge have concluded that we will have to look at such a tax in the future.

In addition, most people who have looked seriously at our budget challenges believe we will have to seriously look at health care costs. The health care reform bill was a very modest step in that direction, but much more will have to be done.

Tim Bartik

Joel Monka said...

That's a very good point- most of the western nations that have maintained a 25%+ unemployment rate and stagnant economic growth for decades have a VAT tax.

How do you feel about the Fair Tax?

Tim said...

1. What is this about a 25% unemployment rate? For some comparable statistics over the past 25 years for Western European countries and the U.S., see

2. Most Western European countries do not have stagnant economies. See Tables 2, 4, and 6 of the below reference for statistics showing that these countries have rates of growth of GDP per capita, per employee, and per labor hour that are quite competitive with U.S. growth rates on these indicators.

3. As I'm sure you know, the Fair Tax and the VAT are both forms of a sales tax, although a VAT has some administrative advantages. However, the Fair Tax proponents overstate the revenue it would raise at the rates they prefer, overstate its economic efficiency advantages, and understate its problems in terms of distributional equity. We may be able to scale back some taxes with the advent of a VAT or some other national sales tax, but it would not be realistic or desirable to eliminate most other major taxes.

Joel Monka said...

1. I'm planning an in-depth look at unemployment in the near future; with always shifting definitions and counts, things aren't always as they seem.

2. Hmm... those stats will require more study; they don't seem to agree with other published numbers. For example, the French CAC40 spent the first decade of it's existence (87-97) hovering between 1,500 and 2,000; in the same time frame, the Dow Jones grew from 1,500 to 11,000- they had to change to a logrythmic scale to graph it.

3. Laurence J. Kotlikoff, Professor of Economics at Boston University, fellow of the American Academy of Arts and Sciences, and former senior economist, President’s Council of Economic Advisers, disagrees with you. As do economists from 79 other colleges and universities

Tim said...

1. The BLS numbers adjust the unemployment rates of different countries for differences in unemployment concepts. The official unemployment rate of course has limitations that do not make it anything close to a comprehensive measure of labor market health. It is a useful measure when combined with other measures.

2. The BLS numbers adjust for differences in prices across countries in a way that is probably about as good as one can do. I don't know of any numbers that can improve much on what BLS has done. Stock market prices are not a particularly good short-run or medium-run measure of an economy's health.

3. Kotlikoff and the other economists you mention represent a conservative minority of the economics profession in their opinions on the Fair Tax proposal. Kotlikoff happens to be very bullish on how much a consumption tax will boost capital formation.

The short-run incidence of the Fair Tax is such that it significantly lowers tax rates, relative to the income tax, on the top income groups, and significantly raises taxes for middle income groups. The economic issue is how responsive savings and investment are to moving from income to consumption taxes. If savings and investment are very responsive, then the short-term impacts of a Fair Tax become less important. This is a much-contested issue.

I would say you could find a broader group of economists who would say:

(1) Lowering federal budget deficits is a more certain way of raising national savings and investment than moving to a Fair Tax.

(2) A move to a more progressive consumption tax than the Fair Tax can achieve most of the economic efficiency advantages of the Fair Tax without the short-term (at least) hit to distributional equity.

Joel Monka said...

"...and significantly raises taxes for middle income groups."

How does it do that? If you have no income tax or SSI, and receive a rebate for that portion of sales tax spent on life necessities (the equivalent of the personal exemption in income tax), how have your taxes increased?

"(1) Lowering federal budget deficits is a more certain way of raising national savings and investment than moving to a Fair Tax."

Considering that we haven't had a genuinely balanced budget in more than 50 years, that we would need world record growth levels to reduce the deficits in the near future, and that we have the baby boomers retirement to provide SSI for after that, I'd hardly call lowering deficits "a more certain way".

Tim said...

If the "Fair Tax" is revenue neutral overall compared to the taxes it replaces, and if it reduces the taxes on some individuals compared to the taxes it replaces, it logically follows that it has to raise the taxes of other individuals. In the short-run, if overall national output and income are roughly the same with and without the Fair Tax, this implies an increase in tax rates on some individuals.

Joel Monka said...

"If the "Fair Tax" is revenue neutral overall compared to the taxes it replaces, and if it reduces the taxes on some individuals compared to the taxes it replaces, it logically follows that it has to raise the taxes of other individuals."

Yes, absolutely! It shifts the tax burden from those who spend little beyond the necessities of life to those who spend more. If you spend no more than needed to live, then with the rebate check you will have paid no federal taxes of any kind. (assuming of course that the rebate amount is an accurate reflection of reality; there are always discussions about whether the current personal exemption is adequate.) Criminals who currently pay no federal taxes will now pay whenever they buy something. The invisible economy- people who work for unreported cash- will now for the first time pay taxes.

The Fair Tax is actually far, far more progressive than the income tax is, or could ever be. Those who inherited their money pay very little tax, no matter how wealthy they are. After all, the income tax is on income not wealth. Sam Walton's heirs- they're billionaires, but not counting the interest on their accounts, what is their income? Nothing; they don't have jobs. What is their income tax owed? Nothing- they don't have jobs. But they sure spend a lot of money... and under the Fair Tax, that spending would be taxed! So the Fair Tax would shift the tax burden away from the lower and middle quintiles of both income and wealth; Paris Hilton will pay more in after-rebate taxes with the purchase of a single handbag than many people will pay in a month.

Tim said...


1. Wealth and income are highly correlated. Even the wealthy without jobs have sizable income from interest, dividends,and capital gains.

2. Current federal taxes, contrary to what people think, are generally progressively distributed. For example, the average federal tax rate for those with incomes of 50-75,000 is 15.3%, whereas the average federal tax rate for those with incomes over $1 million is 27.1%. This includes not only income taxes, but also payroll taxes and the corporate income tax.

It's pretty hard to match that progressivity with a tax that is flat beyond a certain level.

Joel Monka said...

"1. Wealth and income are highly correlated. Even the wealthy without jobs have sizable income from interest, dividends, and capital gains."

That is why I had said "...but not counting the interest on their accounts,..." which for the point of that discussion could safely be assumed to have included capital gains, etc. And it is still a valid distinction for a discussion of taxes. For example, billionaires took a huge hit in 2009. Warren Buffet, for example, lost 40% of his net worth. Now, I'm not a tax expert, but I'm guessing that if you make your living off the interest, dividends, and capital gains you mentioned above, and you lose 40% in a single year, it's going to reduce your tax burden. Just an educated guess. However, since he did still have $37 billion left, it didn't affect his lifestyle. Since the Fair Tax system taxes lifestyle rather than income, there would have been no reduction in his tax burden. So under the "progressive" income tax system, since he not only made no income, but actually lost money that year, he paid less, possibly no income tax at all; whereas under the "flat" Fair Tax, he would have continued to pay.

"It's pretty hard to match that progressivity with a tax that is flat beyond a certain level."

I'd say the "pretty hard to match " system is pretty easy to match, and exceed.

Chalicechick said...

I looked over the Fairtax stuff and I'm skeptical on the "since corporations pass their tax payments on to the consumer, we would be better off if corporations weren't taxed," which seems to suggest that corporations make a steady amount of profit and that level never changes. I really doubt that if their taxes disappeared tomorrow that corporations would drop their prices either.

Even assuming Fairtax's logic is correct, I'm imagining a lot more executives driving company cars and living in company-owned housing.

who appreciates them not wanting to tax her tuition, she will admit.

Chalicechick said...

After more attention to the website, I have to say that the focus on the "underground economy" kinda creeps me out.

--I have trouble believing illegal immigrants spend that much money.

--Due to the IRS's "we don't care if you're illegal and we won't turn you in as long as we get our money" stance, a goodly number of illegal immigrants do pay taxes and pay into social security. Employers who just straight up hire large numbers of illegal immigrants and don't pay any taxes are regularly cracked down on, which is not to say that lots of them don't remain. Most employers demand social security numbers and more or less do right by Uncle Sam, they just pay their workers minimum wage and abuse their workers other ways. The workers in the second group DO pay taxes, and indeed probably pay more than most as I suspect they are nervous about filing for refunds and they never get anything out of the social security they pay into.

--My position on immigration is pretty nuanced and not in line with what anybody who makes a big screaming deal about it ever says. People who make a big deal about illegal immigration one way or another tend to have sucky agendas and/or tend to be using the issue to upset people, a practice that I find at best distasteful.

IMHO, the best way to tax the wealthy is to raise the capital gains tax, and I find the constant refrain that doing so will discourage investment kinda bizarre. (Will investors like it? No. But I seriously doubt they will dislike it so much that they will be willing to give up their more highly-taxed gain and just sit on their money and make no gain instead. If a few middle class people decide to take more vacations rather than investing, OK, but enough money would be made from the people who have so much money that it's pretty much just something they use to keep score to more than make up for that.)


Joel Monka said...

If the corporate taxes were dropped, the corporations would have to drop their prices accordingly whether they wanted to or not in the long run. All it would take is one competitor to drop his prices and steal a huge chunk of market share to scare the others into following suit. I've owned a business... if you knew how desperately one has to fight for each and every customer, you'd be amazed.

Most of the underground economy has nothing to do with immigrants, legal or otherwise. It is mainly ordinary businesses or professionals working off the books for cash that need not be reported. I think every sort of profession I've had to hire, from plumbers to accountants to nurses, I've had somebody offer cut-rate prices for cash payments. One print shop I worked for had two cash registers; credit cards, checks, and company tabs were rung up on one register, and cash transactions on the other- and only the tapes from the first ever made it into the books. That form of underground economy is estimated to be in the tens of billions, all untaxed; those are the dollars the Fair Tax would catch when they're spent on something.

Chalicechick said...

I don't think that is necessarily true about corporations all having to drop prices. First of all, even if one corporation drops its prices a bit, that will only really affect the industry if that corporation's products are good enough that the drop in price makes buying those products worth it to most people, and I don't see how it would affect corporations outside its industry at all.

And any corporation with products that are at all unique (e.g. Pharmaceutical companies who are always the only ones selling the drugs they've invented until the patent runs out) there are no incentives to drop prices at all.

As for illegal immigration not being the "underground economy" From Fairtax's page on the underground economy: "What is largely fueling the underground economy, experts say, is the nation's growing ranks of low-wage, illegal immigrants."

Their page about the underground economy is entirely about illegal immigration:

Tim said...

There has never been any consensus among public finance economists on the "incidence" of the corporate income tax, that is whether it is ultimately paid by owners of capital, consumers, or workers. Therefore, assuming that elimination of the corporate income tax will lead to lower prices is an arbitrary assumption. This issue is complex with conflicting research findings.

Joel Monka said...

CC- Yes, if a car company drops its prices, that does not affect the canned soup company; competition is industry specific. But corporate taxes are charged on all for profit companies, so every industry will have the same dynamic. As to dropping the prices "a bit"- when the Fair Tax proposal was first floated, the average tax burden- combined income taxes, and all forms of employee taxes, was 23 cents on the dollar charged per product. (some industries, having specific taxes, like gasoline, cosmetics, rubber, and tobacco would be larger still) Thus, if all such taxes were dropped, there would be more than just "a bit" the prices could drop and make the same profit.

As to the illegal immigrants thing, few mentioned it back when the Fair Tax began; if they're harping on it now, they're taking a needlessly questionable political tack. I guess they wouldn't be the first to do so, but I wish they'd be the first to quit.

Tim- Maybe there has never been any consensus among public finance economists on the "incidence" of the corporate income tax, but there sure is among corporations. I know, I was the second largest partner of a Sub S corporation. Only counterfeiters make money, everyone else has to get it from their customers. You can play all the games about which pocket you take money from you want, but all the money in your pocket was ultimately paid to you by customers. If you have the ability to win a huge share of the market by dropping prices you take it, believe me. Being the highest priced product on the market and having all kinds of stories published about your windfall profits is not a winning business model.