Friday, January 14, 2005

"Tax reform" update

A friend with sufficient inside contacts for informed speculation says that the Bush "tax reform" plan is likely to have three main elements: (1) make the tax cuts permanent, (2) fix the alternative minimum tax problem, and (3) enact enlarged (say, $7,500 per person per year) Roth IRA style tax-free savings accounts, including large incentives to convert from existing IRAs, 401(k) plans, and the like that were deductible up front.
This certainly explains why they want to do Social Security first. In the Social Security debate, they are insisting that a $10 trillion infinite horizon fiscal gap in the program is so dire a crisis that something totally unrelated to fixing the fiscal gap must be done immediately.
In "tax reform," they would be proposing, through (1) and (2) above, an increase in the fiscal gap much larger than the entire Social Security fiscal gap. But the real hypocrisy (if you set your standard high enough) is in (3), which needs a bit more technical background to explain.
Under various assumptions, such as constant tax rates over time, you can get identical tax exemption for saving by (a) allowing the investments into the savings account to be deducted up front, and then taxing the proceeds when they come out and (b) no deduction up front and no taxation when they come out. Traditional IRAs and 401(k) plans do (a), Roth IRAs do (b).
But the alternatives look very different in terms of annual budget deficit accounting, where (a) looks bad in the year when people invest in the account but good when they take the money out, while (b) looks good up front and bad several years down the road.
So here is the "revenue gain" component of "tax reform" - by giving people large incentives to convert from traditional to Roth style, the plan raises revenue within the 5 year window, in exchange for much higher deficits down the road. The infinite horizon gap goes up because of the incentives offered to convert from traditional to Roth style.
Having insisted in Social Security that the infinite horizon is the right framework and that a $10 trillion gap is intolerable, the Administration will be insisting on a 5-year horizon, or 10 at most, and proposing to increase the fiscal gap by probably on the order of $20 trillion. And it will very specifically be fighting to make people ignore the out-year deficit increase from converting to Roth IRAs, which comes up much sooner than the Social Security out years they want to include, as current workers will be retiring a lot sooner than 75 years from now.
It will be interesting to see how fast the Administration's flaks are able to turn on a dime and completely reverse the time framework and methodology that they claim are appropriate for evaluating fiscal changes.
Once again, I am almost nostalgic for the relative honesty, consistency, and openness of the run-up to the Iraq war. At least there they stuck to the same lies.

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