Wednesday, April 27, 2011

Panel discussion on corporate tax reform

This morning, I participated in a panel discussion on corporate tax reform sponsored by the New York State Society of Certified Public Accountants. The other participants were tax lawyer & accountant Laurence Keiser, Curtis Dubay of the Heritage Foundation, and Peter Merrill of PWC.

My turn at the spotlight was entitled "Corporate Tax Reform: If the Path is So Clear, What's the Problem?" A pdf copy of my slides is available here.

UPDATE: Apparently the event was live-blogged, yielding a summary of the discussion that you can see here.

FURTHER UPDATE: Here is a link to the webcast.

Tuesday, April 26, 2011

Senate Finance Committee testimony on May 3

On Tuesday next week, I will be testifying before the U.S. Senate Finance Committee on the subject: "Is the Distribution of Tax Burdens and Tax Benefits Equitable?"

I've submitted my written testimony, with which I am reasonably pleased, and I will post it here once the Committee has released it officially.

The other witnesses are (1) Scott Hodge of the Tax Foundation, (2) Aviva Aron-Dine, who has DC tax policy think tank experience and is getting an economics PhD at MIT, and (3) Alan Reynolds of the Cato Institute.

Unfortunately, this may conceivably shape up as a bit of a tag team event, with Aron-Dine and me on the Democrats' side and Hodge and Reynolds (neither of whom I have met) on the Republican side. But I hope not. There are things that we ought to be able to agree about, plus other things on which we ought to be able to agree on why & how we disagree.

If my several friends who do tax policy at AEI were among the Republican witnesses, I know that we would have this type of positive exchange. But how it turns out may depend on a combination of who people are and what sort of expectations they believe they face. (As an academic who doesn't want to be in Washington other than very occasionally, I am relatively exempt from such pressures.) And there are certainly some things in my testimony (albeit not everything) with which a principled conservative economist should be simpatico.

BTW, as this shows, I have published at Cato, in their Regulation Magazine.

Neil Young concert

This past Sunday night I attended my first rock concert since Pavement last September: Neil Young in Avery Fisher Hall. While I'm ambivalent about some of his work, he's certainly the best age 65, full-tilt, one-person rock band that I know, although (unsurprisingly) his older, recognizable numbers made more of an impression than his newer ones. My faves remain After the Gold Rush plus the best of his early work with Crazy Horse. (Going back further, he did some good things with Buffalo Springfield, but he didn't play anything quite that old.) Remarkable how he could play several of the guitar workout rock epics from the Crazy Horse era and not appear to either miss or need the rest of the band.

Monday, April 25, 2011

April 21 Tax Policy Colloquium (with Leandra Lederman)

Last Thursday, we discussed Leandra Lederman's work in progress, "Hold the Mayo: What Respect Should Courts Accord Tax Regulations and Rulings Issued During Litigation?" Unusually for us, this is mainly an administrative law paper, addressing two main subjects: (a) the recent Supreme Court decision (Mayo Foundation v. U.S.) holding that the so-called Chevron doctrine of very broad interpretive deference to the regulations issued by administrative agencies, does indeed apply to tax regulations (but not to less formal administrative statements, such as the issuance of IRS Revenue Rulings), and (b) the occasional IRS practice of issuing what are called "fighting regulations" or rulings, i.e., those issued during the course of a particular litigation and purporting to affect its outcome, not just future cases.

Constitutional and administrative law, along with statutory interpretation, have the odd feature of lacking a determinate framework for decision. By contrast, if one is assessing tax policy questions, say from a particular welfare economics framework, then in principle there is an agreed methodology for determining what the right answer is. But that said, I personally find Chevron deference to Treasury regulations both interpretively plausible and likely to have predominantly good effects. The latter impression, however, is based on a set of very general assumptions or beliefs about how the Treasury currently acts and about how courts or Congress (if not allowed to delegate as much) would do in its stead.

The "fighting regulations" problem can be put in focus by imagining that the IRS, whenever facing litigation, could have the Treasury issue a regulation applying just to that case, and purporting to solve it in the government's favor. If (a) the government had time to do "notice and comment" on the regulation, (b) the courts would stand for it, and (c) it was consistent with statutory restrictions on regulatory retroactivity, it would cause the IRS always to win all of its litigation so long as, under the Chevron standard, the regulation adopted a defensible interpretation of underlying statutes and was not "arbitrary or capricious."

But on the other hand, if litigation alerts the IRS to a problem it didn't previously know about (e.g., due to a particular taxpayer's clever and aggressive planning), and if it can address the problem prospectively through regulations that reasonably interpret the law to shut down the game, why should the first mover in effect be grandfathered, creating stronger incentives to look for these things. (In a separate legal context, this is a big piece of the case for a broad economic substance standard in combatting tax shelters.) While I as a judge would want to cast a very skeptical eye on this-case-only regulations (and I'm sure most actual judges would as well), the fact that the IRS or Treasury is willing to publish a broader and more authoritative statement than its attorneys' briefs to the court, having future applicability to other situations, is indeed meaningful, and should be taken as such. So even mere revenue rulings, even when issued in the middle of litigation, while not determinative, are also not equivalent to mere assertions in the government brief.

Wednesday, April 20, 2011

April 14 Tax Policy Colloquium (with Josh Blank)

Last Thursday at the colloquium, Josh Blank presented his paper, In Defense of Tax Privacy. The main argument the paper makes is that individuals' tax return data shouldn't be publicized (i.e., present law in this regard should continue), not because privacy is an important value but rather because compliance would be undermined if it were easier for people to figure out how feeble the IRS's auditing resources are, and how easy it in fact is to cheat and get away with it.

As things stand, the IRS does the best it can to make a brave show of being on top of the game - e.g., celebrity prosecutions, triumphant enforcement announcements on the days leading to April 15, etcetera. My own view is that this approach is more likely to work with the general public than with the more hardcore types who actually are inclined to play the audit lottery. The sheep and the gamers, to borrow but revise Alex Raskolnikov's terminology, are different groups calling for different strategies.

Also, I'd say that the privacy issues actually matter with respect to individuals - but not public corporations, as to which there should definitely be MUCH more published tax return information. Suppose, however, that one isn't worried about individual taxpayers' privacy for its own sake, but shares the paper's concern that permitting the press to find and publicize instances of notorious tax avoidance or evasion would end up undermining compliance, without aiding IRS enforcement given the agency's limited resources. Then arguably the proper response is to give private parties strong financial incentives to find (and perhaps even participate in litigating) tax underpayments by others.

Tuesday, April 19, 2011

The Standard & Poor's Treasury bond downgrade

While I see significant prospects of a U.S. fiscal disaster at some point, reflecting my pessimism that the U.S. political system can handle a predictable set of problems that everyone sees coming, I am unsurprised that the bond market, as the Business insider blog put it, gave Standard & Poor's a "gigantic middle finger" by pushing Treasury bond prices up (and yields down) upon hearing of the S & P downgrade.

There are lots of interesting theories regarding why the bond market would react at all. E.g., the S & P downgrade would force Washington to get serious. Or, it caused stock prices to drop (as indeed happened simultaneously) on the view that economic disruption would hurt earnings, and this caused a flight to, ahem, quality.

But the big mystery is that anyone would react at all. It's not as if S & P knows anything special about the bond market situation. And even when they do arguably know something, it's not as if their reputation is (or should be) stellar these days.

Presumably it's a Keynes beauty contest reaction of some kind - investors are reacting to how they think investors will expect investors to react.

Of course, there's one surefire way for the federal government to prevent any future downgrades: pay S & P to rate the bonds. Then wow the S & P analysts with models in which (a) default is ruled out because it has never happened and (b) inflation forecasts are based purely on post-1982 data, and it's AAA, all the way, until the very end.

Income tax burdens on the average family of four

Yesterday being Tax Day (the due date for on-time calendar year income tax returns), there were naturally various stories in the media about people's tax burdens and such. One that came up at least twice concerned that old chestnut of U.S. family structure, the good old "family of four."

As it happens, I was a member of such a family as a child, and I am again a member of such a family as a parent. But meanwhile I suppose a lot of things have changed.

In yesterday's NYT, Ross Douthat has an op-ed mentioning "families of four" that I didn't get to read until today (I've been really busy lately). I didn't have it in mind, therefore, when speaking yesterday to Natasha Lennart of Salon about the taxation of families of four, so it's lucky for me that her interest didn't lie in the Douthat column (although I suppose she would have told me if it did).

As per Lennart's Salon column that was posted yesterday evening, her interest lay in a report posted by the Tax Policy Center finding that, "for the second year in a row, a family of four earning the median income is paying less in federal income taxes than at any time since at least 1955."

I posited that this presumably reflected not only continuation of the Bush tax cuts, but more particularly the continuing economic slowdown. For example, suppose a lot of two-earner families are down to one earner. While obviously this is bad for them if they want or even need the two incomes, it would certainly tend to reduce their tax liability. If this is a major factor in the data, then presumably family-of-four tax liabilities will start rising again if employment levels ever get back to where they ought to be.

In fact, however, I gather that the Tax Policy Center data is based on a representative two-parents, two-kids, one-earner family of four. So it's lucky for me that I was only quoted saying things that actually are true:

"In 1955 'family of four' described a single-earner nuclear unit: a married man and woman with two children.

"'We're certainly more heterogeneous these days,' New York University's Wayne [Perry] Professor of Taxation, Daniel Shaviro, told Salon."

Lennart then notes that, while the Tax Policy Center data that she was citing assumes a traditional 1950s-style family, "in 2005, according to census data, 42 percent of families had two income earners, and around 34 percent of children lived in single-parent families. Of course, this does not change the fact that taxes are historically low. But the 'four person family' statistic does not pay attention to the fact that a dual-earner family is dually burdened with Social Security taxes and cannot claim the same spousal benefits. As Shaviro noted, 'Secondary earners are taxed fairly highly.'

"There is nothing misleading about analyzing the income tax burden of a married couple with two children with just one earning spouse. It is mistaken, however, to assume that is what's understood by the term 'family of four' in 2011."

Anyway, back to parts of the interview that luckily didn't appear in the column. Not having yet read the Douthat column, I suggested that, while household heterogeneity is an important issue in certain contexts - e.g., distributional effects of the fiscal system as between one-earner couples, two-earner couples, and singles, as well as the system's excessive discouragement of work by "secondary earners" in a couple - it wasn't necessarily crucial (in the sense that ignoring it would be misleading) when one is talking about historically low (since the 1950s) U.S. income tax burdens today, which presumably are a function of the rates plus the down economy.

Douthart raises the issue as follows:

"Today ... a family of four making the median income — $94,900 — pays 15 percent in federal taxes. By 2035, under the C.B.O. projection, payroll and income taxes would claim 25 percent of that family’s paycheck. The marginal tax rate on labor income would rise from 29 percent to 38 percent. Federal tax revenue, which has averaged 18 percent of G.D.P. since World War II, would hit 23 percent by the 2030s and climb even higher after that.

"Such unprecedented levels of taxation would throw up hurdles to entrepreneurship, family formation and upward mobility. (Or as the C.B.O. puts it, in its understated way, they would 'tend to discourage some economic activity,' and 'harm the economy through the impact on people’s decisions about how much to work and save.')"

He makes this point to challenge the Obama side of what many see as the "Obama versus Ryan" debate over our fiscal future, on the view that entitlement growth (in particular on healthcare) will definitely have to slow, whether not as much or in the same manner as the Ryan plan posits.

Douthat then got criticized (such as here) for using an overstated income number. Apparently the number he should have used, for taxable income purposes, is $75,700. He has acknowledged that he misread a chart that includes employment-based health insurance and the employer’s share of payroll taxes, neither of which is in taxable income. So we have a rare happy ending, in terms of on-line snark exchanges, as the above-linked critic accepts in an addendum that it was an honest mistake.

But Douthat's choice of a representative family could be questioned as potentially misleading (albeit still, I trust, honestly so) in a sense that I would have mentioned, in my Salon interview with Lennart, if only, ahem, I had gotten to read the Douthat column in the morning (re-queue whining about how busy I am lately). All else equal, Douthat would have had to cite lower numbers had he chosen a one-earner family or a single individual, given how joint returns amalgamate spousal incomes. The relative burden on two-earner families, from how we treat such households via joint returns with rate brackets being significantly less than double those on single returns, is important, but makes such a family not entirely representative. (So re-queue here the heterogeneity point.)

Another important aspect that Douthat may not have recognized was the following. The tax rate increase for two-earner families that he shows presumably reflects a key fact about income tax brackets under present law. They are indexed for inflation, but not for real GDP growth. Accordingly, there is a tendency over time for movement towards having everyone, not just high-earners, end up in the top bracket.

E.g., suppose that, with the gracious assistance of Wikipedia, we compare median incomes, in constant (i.e., inflation-adjusted) dollars for past eras as compared to today. Between 1950 and 2000, the U.S. median income for men grew 80 percent in real terms, while that for women almost tripled. (The latter, of course, also reflects women's greater entry into the workforce.)

For this reason, when economists try to project future tax revenues under a "current policy" approach rather than a "current law" approach, they will typically assume that, over time, tax rate brackets are roughly indexed for real GDP growth, as well as for inflation, thus causing the brackets to kick in at the same points in the contemporary income distribution in, say, the 2030s as today. After all, permitting the U.S. income tax to evolve into a system in which more and more people hit the top rate bracket would be a genuine policy change, albeit the natural consequence of simple legal inertia.

Obviously, a long-term U.S. fiscal gap and what I would call a reasonable (and indeed indispensable) willingness to address it on the tax side, as well as on the spending side, would naturally raise the question of whether we should continue current rate bracket policy by raising the tax rate brackets for real GDP growth as well as for inflation. But my default would certainly be to assume current policy in this regard.

While I'm sure it was not deliberate, I do think that Douthat's column ends up being potentially misleading in substance insofar as it treats real bracket creep as illuminating with regard to whether we should raise tax rates (at least for the top bracket) in keeping with Obama's but not Ryan's plan. The question of how high tax rates should be is analytically distinct from where we should set the break points between brackets. And the real bracket creep tendency of present law does not by itself carry any implication that the right solution is to lower the top rate a la the Ryan plan.

Friday, April 15, 2011

Above the fray

I like to be above the fray if possible. And, given my substantive views, I am willing to consider responsible proposals from both sides. For example, like many on the right, I'm skeptical about the political process, believe that markets can work well in a lot of areas (albeit less so for healthcare and the financial sector), and do not share the left's intense commitment to existing entitlement programs.

The problem I have is that Republican devolution over the last 15 to 20 years leaves me all too often sounding more shrill than I would like.

For example, I've been forced to agree that the Ryan plan is neither serious, professional, credible, brave, nor responsible, even though (a) I would like to be able to reach a more positive conclusion, (b) someone with his general views could have met those criteria, (c) I appreciate that he's better on tax expenditures than the Norquist Republicans, and (d) I think it is within the realm of debates we should be having to argue for a more market-driven healthcare approach with vouchers (although in recent years I've moved away from agreeing with that view).

I'm therefore happy to be able to link to an excellent post in today's New York Times by Alan Viard of the American Enterprise Institute.

In particular, I agree with Alan about the following:

"The Obama and Ryan plans have one striking similarity, as neither specifies which tax preferences will be curtailed or eliminated. Each plan will face hard choices when it comes time to spell out the details. Significant base broadening cannot be achieved by eliminating unpopular loopholes.

"Instead, it will be necessary to make major changes to at least some of the most widely used tax preferences, such as the exclusion of employer-provided health insurance and the deductions for state and local taxes, mortgage interest and charitable giving. If the political will is found to make such changes, the income tax can be redesigned to facilitate a more efficient allocation of resources across economic sectors. For example, while such a tax system might still promote homeownership, it would no longer provide lavish subsidies for expensive houses.

"The economic gains from income tax base broadening are limited, though, because this approach does little or nothing to mitigate the saving and investment disincentives arising from the taxation of business profits, interest, dividends and capital gains. Long-run economic growth could be better advanced by replacing the entire income tax system with a progressive consumption tax, but neither President Obama nor Representative Ryan has embraced that far-reaching reform."

Thursday, April 14, 2011

Excerpt from the Obama Administration's budget plan

A White House fact sheet says the following about tax issues:

1) "The President’s framework would seek a balanced approach to bringing down our deficit, with three dollars of spending cuts and interest savings for every one dollar from tax reform that contributes to deficit reduction. This is consistent with the bipartisan Fiscal Commission’s approach."

COMMENT: I find it entirely obvious that tax increases need to be part of the pivot back to fiscal sustainability. It's amusing to see Republicans trying to denounce this as beyond the realm of permissible public debate.

2) "[W]e cannot afford to make our deficit problem worse by extending the Bush tax cuts for the wealthiest Americans."

COMMENT: This is a pretty small down payment on addressing the insanity of amending present law to enact hundreds of billions of dollars in tax cuts not currently on the books, not to mention on responding the staggering rise in high-end income inequality over the last 30 years. But you have to start somewhere. Everyone else's Bush tax cuts aren't really affordable either.

3) "[T]he President is calling for individual tax reform that closes loopholes and produces a system which is simpler, fairer and not rigged in favor of those who can afford lawyers and accountants to game it. The President supports the Fiscal Commission’s goal of reducing tax expenditures enough to both lower rates and lower the deficit."

COMMENT: As per my forthcoming Tax Notes article (coming out on May 23) concerning 1986-style tax reform, I would consider it foolish to lower tax rates in the current budgetary and distributional environment. And if tax expenditures are actually "spending through the tax code," then why should repealing them be deemed a "tax increase"? After all, cutting substantively identical direct spending programs would not be deemed a tax increase.

4) "If by 2014, budget projections do not show that the debt-to-GDP ratio has stabilized and is declining in the second half of the decade, the [debt] failsafe [that the plan proposes] will trigger an across the board spending reduction, including on spending through the tax code."

COMMENT: Okay, here it's accepted that tax expenditures are "really" spending. Why not elsewhere as well? Check out the discussion in my May 23 article of what tax expenditure analysis (in the public mind) has in common with viruses and zombies.

5) "[T]he President is continuing his effort to reform our outdated corporate tax code to enhance our economic competitiveness and encourage investment in the United States. By eliminating loopholes, reducing distortions and leveling the playing field in our corporate tax code, we can use the savings to lower the corporate tax rate for the first time in 25 years without adding to the deficit."

COMMENT: Don't expect anything to happen on this any time soon. I will address some of the reasons why in my portion of a breakfast panel discussion at a New York State Society of Certified Public Accountants event that will take place in midtown Manhattan, but also with a live webcast, on the morning of Wednesday, April 27. More details available soon, and at some point I will post my (already completed) PowerPoint slides for this talk.

Tuesday, April 12, 2011

Some great ideas for Eric Cantor

Cantor has been quoted as saying, not only that the Republicans should refuse to raise the debt ceiling unless they get massive policy capitulations from the Democrats, but that they should keep the hostage situation going for as long as possible - long past the date in May when the debt limit will formally be breached, and on towards (or past) July when the Treasury expects to run out of tricks that would stave off a literal act of default.

Great thinking on his part, but I have some even better ideas:

--Cantor should get his hands on some nuclear weapons and arrange to have them hidden in major U.S. cities. They should be irrevocably triggered to explode unless he and Obama turn a key together at the same time.

--Republicans on the House Intelligence Committee must have gotten some confidential information that would be of enormous interest to Al Qaeda. This information should be sent under seal to a neutral trustee in a country outside the U.S. realm of influence. The trustee's irrevocable instructions will be to turn over the information to Al Qaeda unless he gets a letter by a given date signed by both Cantor and Obama.

These plans are admittedly a bit more rigorous than merely destroying our country's creditworthiness. (Actually, depending on the exact info conveyed, the second might well be considerably less harmful than deliberate default.) But otherwise they are entirely consonant with what Cantor is advocating.

UPDATE: I think I start griping about politics and such when my time at work takes a turn away from the things that I want to do and more towards meeting obligations (even those I've taken on willingly). I've been carving away lately at a formidable backlog of talks, lectures, panels to arrange, etcetera, and summer writing seems as far away still as summer weather.

Joseph Stiglitz on rising inequality

A lot of people (myself included) have been thinking lately in similar terms to Stiglitz here. Pretty important stuff for tax policy and other such subjects - although what we think may not matter, given the perverse "reverse insurance" element of rising high-end wealth concentration, in that it feeds on itself by concentrating political and economic power in support of creating still greater wealth inequality.

Until fairly recently, I would have said (and probably did say) that distributional concerns should really focus on helping people at the bottom, who may be in dire need. I saw much less reason to worry about the top versus the middle, despite the relative status concerns that can make this topic emotionally salient (relative to helping those in need) to people who are in the middle to somewhat upper ranges.

I still view that as the right approach for a steady state distribution that is not as top-heavy as the U.S. has become. But, as the Stiglitz analysis (if you agree with it) can be construed to suggest, at a certain point one has to think about extreme high-end wealth concentration through a pollution frame, rather than a standard optimal income tax frame.

More on this in my forthcoming (May 23) Tax Notes piece concerning 1986-style tax reform. And among the big takeaways for this week's politics, what with Obama's upcoming speech on addressing long-term deficit issues, is that high-end marginal income tax rates absolutely should not be cut as part of fiscal rebalancing, no matter how much base-broadening there is (and I expect next to none anyway).

The case for cutting the corporate tax rate is stronger, given the pressures of global tax competition, but if that's done it's vital to address the potential use by high-income owner-employees of lower corporate rates as a tax shelter. I was speaking to a practitioner the other day about the fact that lots of business owners are electing subchapter S status these days (under which a closely held company is taxed as a flow-through a la partnerships, with the income being taxed directly to owners rather than at the entity level). This practitioner expects subchapter S elections to wither away if the corporate rate becomes significantly lower than the top individual rate, since the opportunity to use C corporations as a low-rate tax shelter will then simply be too tempting despite the accompanying disadvantages (such as having to worry about shareholder-level taxes).

Sunday, April 10, 2011

Blind idealogue Alan Greenspan

I've been reading Johnson & Kwak's Thirteen Bankers, and just saw a quote from Alan Greenspan that epitomizes a lot.

The Fed had been reviewing whether subprime mortgage lending should be more highly regulated. A 2000 Treasury-HUD report had found evidence of abusive "predatory lending" practices. A brief side-note here: the law and economics movement has at times debunked, or at least seriously questioned, theories that sound a bit like this. Predatory pricing, for example, has been challenged as a realistic business strategy in most circumstances where it is alleged (e.g., by rivals who can't match someone's low price). But "predatory lending" makes easy, obvious, and straightforward economic sense as a business strategy, so long as home values keep rising. You lend to a sucker who can't keep paying once the cushy early period ends, then you kick him out and have a chance of getting the home for below-value in the foreclosure sale. (Plausible even though the sale is public, since real estate markets can be thin, and sales can be under-publicized. Plus, you still break even if someone else assumes the full mortgage liability.)

Securitization presumably changes the story to one in which the original lender is merely indifferent to whether the borrower defaults, rather than welcoming it. Once the loan economics have been transferred to a big collective pool, it's other people's problem. Subprime lenders simply wanted to make as many loans as possible for the transaction fees. And downstream players were notoriously assuming that real estate prices would keep on rising forever, thus keeping borrower default a non-problem.

Then-Fed governor the late Ned Gramlich urged that the Fed step in to regulate subprime mortgages more. The banks that were making millions from the scam screamed bloody murder. And of course Greenspan backed them, barring any regulatory change. But what I found especially notable was the following Greenspan statement:

"Where once more marginal applicants would simply have been denied credit, lenders are now able to quite efficiently judge the risk posed by individual applicants and price that risk appropriately. These improvements have led to rapid growth in subprime mortgage lending," etc. (from Johnson-Kwak, p. 143.)

What's wonderful about this statement is not just the fact that it was untrue (at least, if one interprets it as asserting that the lenders actually were risk-pricing appropriately, not just that they were "able" to do so if they wanted). Nor is it just the fact that inside players at the time knew it was untrue. (They were counting on real estate prices to keep rising, and at least implicitly on a bailout if things turned ugly, NOT on appropriate pricing of credit risks.)

No, what's wonderful about it is that Greenspan asserted it in the complete absence of any supporting evidence. He believed it because that is his theoretical view on how the economy operates. He didn't need no stinkin' evidence, it just had to be true.

And this notwithstanding the fact that one didn't need a theory of individual-level irrationality for it to be false - everyone could be acting rationally pursuant to their actual incentives and it could potentially be false. To believe what he did, you need a crude and ignorant set of assumptions about how collective market institutions always get it right - no matter what incentives individuals actually have. He truly was (and still is) our era's supreme Mister Magoo.

When you combine Greenspan's anti-regulatory record with his serially bubble-priming monetary policy and the crucial political role he played in 2001 in helping President Bush to destroy U.S. budget surpluses and put us firmly on the road to long-term default, Greenspan is pretty clearly #1 in U.S. history in a singular sense. He has done more lifetime harm to our economy than any other U.S. public official who has ever lived. (Indeed, among all individuals who have ever lived, I would think that only those who waged war on the U.S. could otherwise compete with him in this regard.)

To be fair, lots of other people share in the blame for recent economic and regulatory policy (and they come from both political parties). Plus, one has to think about 1929. But while there the overall harm may have been greater (at least, scaled to contemporary population and the size of the economy), no one individual from that era is entitled to claim nearly as high a share of the blame - e.g., certainly not the unlucky if inadequate Hoover.

UPDATE: Re-reading this post a couple of hours later, while I'm still comfortable with what it says about Greenspan, the theory of history it evinces could be criticized as too much of a "great man" (or in this case "bad man") theory. There were broader social and ideological forces behind what Greenspan did that made his policies, if not quite inevitable, at least (a) far more rewarding to him than any alternative set of policies he could have followed and (b) highly likely to be followed no matter who held his position. But that doesn't make individual responsibility either wholly irrelevant or meaningless.

Saturday, April 09, 2011

The budget deal

Way to go, Washington. Last December, they agreed to $800 billion of tax cuts, most of it poorly directed as stimulus. And now they have shown how tough and fiscally responsible they are by taking an immediate $38 billion out of the economy that will definitely cost jobs at a time when we are at 9% unemployment.

One party thinks 9% unemployment is just fine, the other party appears to believe that it is too low.

I've recently been using, and I hope not overusing, the phrase "Saint Augustine in reverse." Augustine famously asked for "chastity and continence, but not yet." Washington policymakers appear to believe that we should have chastity and continence now only - when they may be severely counterproductive given the state of the economy - not in the future, when they are actually needed to head off a budget disaster.

This applies to Paul "Ready for My Close-Up" Ryan as much as to anyone else. I've been relatively gentle with him so far, because I liked what the document said about tax expenditures (admittedly, a personal hobbyhorse) and because I think there is a legitimate debate to be had about what the healthcare sector should look like.

But, even leaving aside the ludicrous economic and budget projections, the guy wants to cut tax rates to 25%, he doesn't even name a single tax expenditure that he ostensibly would be willing to eliminate, and his healthcare plan, apart from the structural change with merits that depend on one's underlying views about markets versus public provision in the healthcare sector, amounts to (1) throwing the poor off the bus plus (2) expressing a wish that Congress in 10 years will decide to let private rather than government-borne healthcare costs grow.

UPDATE: Just one more bit about Ryan: the Tax Policy Center finds that the tax changes he does specify would lose $2.9 trillion over 10 years. It doesn't estimate the claimed base-broadening because the proposal "lacks sufficient detail for an estimate including those provisions."

Such a brave, brave man.

Friday, April 08, 2011

April 7 Tax Policy Colloquium (with Jennifer Blouin)

Yesterday, at a very lively session, Jennifer Blouin presented her paper, Is U.S. Multinational Intra-firm Dividend Policy Influenced by Reporting Incentives?

Taking on a tricky empirical research question from the design standpoint, the paper finds evidence suggesting that publicly traded U.S. multinational companies (MNCs) with unrepatriated foreign source income respond not only to the possible tax advantages of keeping funds abroad, but to accounting considerations - namely, the managers' desire to report higher rather than lower accounting income.

The issue arises because U.S. accounting rules give U.S. MNCs essentially no recognized benefit on the income line of their financial statements if they avoid current U.S. tax by keeping money in lower-tax jurisdictions abroad, UNLESS they opt to designate the money as "permanently reinvested abroad" (PRE). Where a company chooses the PRE designation, the accounting treatment jumps from (a) assuming full, immediate, and certain U.S. taxation, albeit subject to the ability to claim foreign tax credits, to (b) assuming zero residual U.S. tax.

If reported earnings matter, this is obviously an appealing thing to be able to do. But investors can learn, from looking elsewhere on the companies' financial statements, how much they have by way of unrepatriated foreign earnings. Suppose the PRE designation is pure "cheap talk" that does not itself affect the subsequent likelihood of repatriation. In principle, choosing it would bring no stock price advantage if, with or without it, investors could and did assess for themselves the likelihood of repatriation and the U.S. tax hit that this would entail.

In the world we actually live in, however, where managers like high earnings and the numbers on earnings lines appear to matter more than they seemingly should, the PRE designation is obviously attractive to managers because it permits them to claim higher earnings, albeit at the price of having a negative adjustment later on if they end up bringing some of the money home. (Whereas, if they don't claim PRE, I believe that paying the tax one already said was going to pay has no financial reporting downside, at least on the income line.)

The paper finds that "reporting incentives have a negative effect on the amount of foreign earnings repatriated by MNCs .... [F]inancial reporting is an important factor in the repatriation decision of U.S. MNCs."

Every practicing tax lawyer I have ever spoken with about the role that accounting considerations plsy in companies' tax planning would say "OF COURSE this is true." They are quite aware of operating in a world where, as I once heard an investment banker say" Saving taxes is all very nice, but earnings per share make the world go round."

On the other hand, any economist with a strong University of Chicago-style orientation would likely be extremely reluctant to believe it could possibly be true. "That may work in practice, but it definitely doesn't work in theory" is probably about the strongest concession one could ever hope to get from such an individual.

Some takeaways from accepting the paper's finding (as I do) include the following:

1) As proponents of both worldwide and territorial appraoches to U.S. taxation of resident MNCs can agree, the deferred tax on repatriation of foreign earnings has undesirable incentive effects, inducing companies to engage in costly maneuvers to arrange their global cash as they prefer in the most "tax-efficient" manner. (There are theoretical conditions in which this actually might not be so - a point made by the so-called "new view" of cross-border dividend taxation, but the key precondition, a constant rate of repatriation tax that will at some point inevitably be paid, does not actually hold.) It's ironic, if that's the word for it, that a mere accounting rule, as opposed to the actual substantive rules of taxation, should also create lock-in.

2) There probably is no good accounting rationale for allowing the PRE designation, which is ridiculously discontinuous. Repatriation is treated as a one-or-zero decision rather than a probabilistic continuum as it more likely would be in practice. And managers get one more avenue for gameplaying. Other accounting rules in the neighborhood are also bad, however, such as not present-value-discounting expected future taxes, and the degree of secrecy companies are permitted regarding their U.S. and foreign tax positions and current payments is probably indefensible.

3) In principle, accounting design should take account of the real world consequences (outside accounting) that adopting a particular rule may have. Accountants generally resist this, however, and for a good structural reason. They are concerned that the long-run effects of opening the door to such arguments, which corporate insiders would then make to lobby for bad accounting rules that they hoped would reduce transparency, would be predominantly negative.

Shaggy dog story decoded

I recently gave a few listens to the unreleased "New York Sessions" version of Dylan's well-known 1975 album, Blood on the Tracks. It's kind of interesting - slower and more down, plus it has the advantage of permitting a fresh listen to several tracks that had become over-familiar in their released versions (although I probably hadn't listened to the album for at least 10 years).

One side-benefit is that "Lily, Rosemary, and the Jack of Hearts" contains an extra verse in the unreleased version that permits one, I think, to more or less definitively decode what happens in the story. Jack gets together with Lily in the dressing room. Big Jim knows they're there and bursts in holding a gun and with Rosemary by his side. This appears to be a set-up. Rosemary stabs him (a planned not impulsive act). Jack leaves town to meet up with the other bank robbers. Rosemary makes no effort to escape and is hanged for the killing.

Wednesday, April 06, 2011

More on the Ryan plan

While I don't want to get too deep into the name-calling and finger-pointing part of the biz, I will say it's pretty shocking that Ryan published a purportedly serious and "courageous" proposal based on economic projections that are simply absurd (unemployment down to 2.8%, stunning and unexplained increases in housing starts and GDP growth, etc.).

Two alternative explanations would be (1) he just doesn't care (requiring as well cynicism about whether actual credibility matters), and (2) epistemic closure caused him not to realize that the projections were absurd. But in a sense # 2 is a version of # 1, since one would likely be more careful to avoid serious and transparent errors if, say, one's own life were at stake.

It's certainly evidence in favor of those who say he's an ignoramus and a fraud.

But that said, let me quasi-almost-but-not-quite defend his Medicare proposal.

First, let's stipulate up front that the structural change he proposes for Medicare (which prominent Republicans have admitted, though not for attribution, is essentially repeal of the existing program) has actually no direct link to the long-term funding question. It's a separate structural change.

To explain, let's back up for a moment and recall President Bush's personal accounts proposal for Social Security in 2005. (I'm being nice here in using the term instead of "privatization," which is what the proponents called it as late as December 2004.) The Bush Administration admitted, with surprising honesty, that the proposal would do nothing whatsoever to address Social Security's funding shortfall. Instead, it used the funding shortfall as a convenient occasion for both (a) addressing the funding issue through changes that could essentially have been done through the existing program, and separately (b) changing the relationship within the program between taxes (or contributions, or whatever you want to call them) and benefits.

As I've written, I tend to dislike the way the existing Social Security program more or less deliberately obscures the relationship between what you pay and what you get. Some proponents like this deliberate obscurity as a political device for achieving greater progressivity within the program than one might otherwise have expected. But it also obscures big transfers within the system that we might dislike (e.g., from younger to older age cohorts, and from singles and two-earner couples to one-earner couples). And perhaps the confusing structure causes Social Security to discourage labor supply more than it would if the marginal tax-benefit relationship were better understood (and made more uniform).

So I like clarifying the tax-benefit relationship, as the Bush proposal did, although I might have preferred keeping some progressive redistribution in the program (but made more overt). I called this idea "progressive privatization" but it never caught on anywhere.

I was less thrilled about the Bush plan's inducing people to bet more of the baseline piece of their life savings on the stock market instead of having a fixed real life annuity that sound portfolio choice dictates holding as one's bedrock. But the ability to bet on the stock market was a distinct program feature from clearifying the tax-benefit relationship (privatization was an arbitrarily assembled package of distinct changes).

But back to the main point that parallels Ryan's Medicare plan. Whether one liked the set of proposed Bush changes or not, there was absolutely no true link between its merits and the long-term Social Security funding crisis (such as it is). If good, it should have been adopted even in the absence of any funding crisis; if bad, the funding crisis offered no reason to adopt it.

The same is true of Ryan's Medicare plan. We could put the current Medicare system on a sustainable path by shrinking the rate of expenditure growth under it (e.g., via reimbursement rates, the approved treatments list, co-payments and premiums, etc.). Or we can convert to Ryan's system, essentially vouchers for privately obtained health insurance, and achieve no budgetary improvement by letting the vouchers grow at the existing and expected rate of healthcare expenditure growth relative to GDP.

Ryan's projected cost savings come from constraining the rate of voucher growth. But suppose that actually doing this 10 years down the road is no less politically difficult than tightening the screws under the existing system. Then you may get no cost saving.

This strikes me as an extremely credible scenario. Why should Congress be loyal to the Ryan plan in 2025, when seniors who vote in large numbers start screaming about the affordability of care they want on the vouchers they're getting? (If we use quasi-constitutional budget rules that make this difficult, they could instead be combined with existing Medicare.)

In sum, therefore, there really are two distinct questions. One is how to put healthcare on a sustainable path (looking both at the federal budget and people's pocketbooks) given the growth scenario that we now face. The other is how the system ought to be structured.

If Ryan's design is better than existing Medicare, we should do it even in the absence of a long-term fiscal crisis. But if it's worse, then we should keep the existing system and tighten the fiscal screws via that.

All this does not rule out a political economy argument that adopting the Ryan plan makes tightening the screws easier to accomplish politically. But that would be a very different argument from the ones that we're hearing, and I don't see how it could be made convincing.

OK, what about arguments that Ryan's system would be economically much more efficient because it's more private market-driven? That admittedly might affect the fiscal tradeoffs - although serious healthcare economists such as Jonathan Gruber appear to reject it - but really it's just a part of the debate over which system is better in the fiscally sustainable steady state. After all, you'd want to be more efficient, all else equal, no matter what.

The case against a Ryan-style Medicare change concerns claims of pervasive market failure in healthcare, reflecting not just the quirks of the U.S. system but broader structural issues (e.g., consumer ignorance about desperately important treatment choice issues; problems of adverse selection; problems of moral hazard once we decide that we are unwilling to deny care to desperately ill people who can't pay for it).

The contrary position, that we should simply let markets work their magic in healthcare no less than in the market for fresh fruit or for shoes, is something that I disagree with but consider intellectually respectable. So in that sense I am inclined to be tolerant of a proponent of the Ryan plan (including Ryan himself), as within the realm where we value and may all benefit from open intellectual debate.

But the long-term fiscal gap appears to offer no particular support for Ryan's position.

One last point: perhaps it's not all that "brave" after all to count on Congresses 10 years from now to tighten the screws on healthcare spending growth in a manner quite distinct from anything that he actually proposes to implement currently. "Brave" would be advocating a large cut in healthcare spending TODAY, followed by a faster growth rate (to get to the same budgetary place long-term) given the stunning technological improvements that we have reason to hope will be available in the future.

UPDATE: Daniel McCarthy at American Conservative Magazine agrees with me that Ryan is not actually "brave" but loading all the pain off into the future so that other politicians would have to bear it.

Tuesday, April 05, 2011

Forthcoming article

I have now sent to Tax Notes my forthcoming article, "1986-Style Tax Reform: A Good Idea Whose Time Has Passed" - after making last-second revisions to address the tax reform aspects of the House Republicans' 2012 budget plan. I am hopeful that it will appear in Tax Notes in late May.

UPDATE: The pub date is May 23. I'll be out of the country right before, teaching in Singapore (at the NYU @ NUS program) from May 10 to 20.

Tax expenditure discussion in the Ryan budget plan

Not to have tunnel vision here given the various other issues presented, but I am pleased to note that the House Republicans' 2012 budget proposal is highly favorable to tax expenditure analysis.

Herewith the key discussion:

"The negative effects of high rates on work, savings and investment are compounded when a large mix of exemptions, deductions and credits are added in. Sometimes referred to as 'tax expenditures,' these distortions are similar to government spending – instead of markets directing economic resources to their most efficient uses, the government directs resources to politically favored uses, creating a drag on growth.

"The key difference is that, with spending, the government collects the money first in the form of taxes from those who earned it, and reallocates the money elsewhere. With tax expenditures, government agrees not to collect the money as long as it is put to a government-approved use. Other tax expenditures literally do take the form of spending through the tax code, because they 'return' more money than the taxes owed.

"Tax expenditures have a huge impact on the federal budget, resulting in over $1 trillion in forgone revenue each year (although the exact definition of a 'tax expenditure' is subject to debate.) To put that number in perspective, $1 trillion is roughly the total amount the government collects each year in federal income taxes.

"Eliminating large tax expenditures would not be for the purpose of increasing total tax revenues. Instead, when offset by lower rates, it would have a doubly positive impact on the economy – it would stop diverting economic resources to less productive uses, while making possible the lower tax rates that provide greater incentives for economic growth."

A cynic might note that the above analysis will earn no "profiles in courage" award. No less than President Obama when praising 1986-style tax reform on the individual side, the Republicans assiduously avoid naming even a single provision - although the revenue numbers make unmistakable the intended reference to home mortgage interest deductions and the employer-provided health insurance exclusion.

Also, the discussion formally adheres to the Norquist rule that tax revenues, as officially computed, can never rise, given the accompanying rate cuts.

But it presents the base-broadening and rate cuts as two distinct sets of changes, each to be endorsed on its independent merits. And it offers no indication that the "key difference" it cites between direct spending and tax expenditures has any policy relevance whatsoever. It is therefore effectively a straight-out endorsement both of tax expenditure analysis as the right intellectual framework, and of tax expenditure repeal in the context of addressing the fiscal gap.

The Ryan budget plan for Medicare and Medicaid

I've been mocking the idea that either party - but least of all the Republicans - has any real interest in slowing our march off the cliff of fiscal disaster. But now comes the Ryan plan to cut Medicare and Medicaid, which one could argue has the potential to steer us away from the cliff.

I only say "one could argue" that it has this potential, because the real question would be whether future Congresses were willing to deny funding for healthcare that voters were demanding. Either under present law or the Ryan plan, Congress in 10 or 15 years will face the same choice between unsustainable spending growth on the one hand, and denying people valuable and important healthcare procedures on the other.

I'm skeptical that the Ryan plan is going to go anywhere politically, at least over the next three years (i.e., spanning the 2012 election). If the Democrats have any sense (irrespective of whether the plan is actually good or bad), they will fight hard against it. It obviously can't be passed this year without their full cooperation, and cutting healthcare might be an unappealing Republican banner for the 2012 election.

But then again, who knows? I'm not convinced that either the Administration or leading Democrats in the Senate actually share their party's historic convictions. They may also lack the guts to contest this in the terms that Karl Rove and Frank Luntz would urge if working for them. Obama, I suspect, actually secretly agrees with the plan, as he has pretty broadly bought into the pro-free market ideological shift of the last 30 years - a shift that has had both good and bad policy consequences. Thus, it is not just, as Krugman intimates, that he is desperately eager to be "nice" (although that may play a role as well).

Regimes fall when their proponents no longer believe in them. I also suspect that the long-term U.S. political equilibrium is to gut Medicaid. When the political preferences of poor Americans have essentially zero political weight, as this article and the recent Hacker-Pierson book suggest, there may be no reason to expect significant medical aid to the poor. And if only the top 10 percent of the income distribution matter politically, as these sources also suggest, then why not cut everyone else's healthcare? Maybe this is politically feasible after all, and even if one dislikes it as policy it might still in principle lead to averting fiscal disaster, albeit at a social cost in other ways. But then again it may remain farfetched to think that Congress in ten to fifteen years will decline to pay for seniors' healthcare spending - even if it is willing to throw the poor off the Medicaid bus.

OK, enough on politics and projections, what actually is the plan? The most convenient source I've found is Uwe Reinhardt in his NYT Economix Blog. So what I'll do next is quote, in bold, his list of the plan's 6 key features, and then insert some commentary.

"1. The change would not affect people eligible for Medicare currently 55 or older, who would remain in the traditional program. The new rules would start in 2021 — that is, for persons currently under age 55." Ouch. I am a bit under 55; as it happens I have an older sibling who is just over. Looks like one of us will do better in this regard than the other. More particularly, this bright line is inequitable. There's no reason why older individuals who have adequate financial resources should be exempted from sharing in the budgetary hit, and treated so much differently than younger ones with only slightly more time to plan. But perhaps, as a consumer, I should take comfort from Matt Yglesias' observation as follows: "If a 'divide and conquer' strategy succeeds in abolishing Medicare for people born after 1956 ... [o]ver time you’ll have a growing set of private voucher firms lobbying for more people to lose Medicare and be put into the voucher pool. You’ll also have a declining set of people born before 1956 to object to Medicare abolition. And you’ll have an ever-growing pool of people born after 1956 who’ve been told that they’ll never benefit from Medicare no matter what happens, but who are being asked to pay the taxes that finance it. That doesn’t strike me as a remotely sustainable equilibrium."

"2. Beneficiaries who turn 65 in 2021 or later would receive from Medicare a voucher to purchase private health insurance." Ryan wants to deny it's a voucher, but his argument appears to be purely formalistic, based on sending funds directly to the insurance companies, rather than via the consumers. When you get to the rate of voucher growth over time (see below), this is the big source of budgetary saving. But it is independent of the fact that one is using vouchers rather than the current system. Vouchers that grow fast enough don't save any money, whereas the current system with tighter spending and reimbursement controls can save all the money one likes (albeit with the same painful tradeoff of people being denied care, e.g., as healthcare provides opt out of Medicare). Now, there would be big cost savings if healthcare "privatization," which is what's going on here, were itself a source of efficiency gain. But healthcare experts are skeptical of this, reflecting that it's a market in which consumer choice doesn't work very well. Jonathan Gruber, for example, referring to recent Medicare experiments with HMO-style "Medicare + Choice," says: "Our existing efforts to privatize Medicare have failed ... We don't have a good track record ... the [potential Ryan plan] savings doesn't come from all the good things from competition -- it comes from cutting Medicare over time."

"3. According to the Congressional Budget Office, 'the amount of the voucher would be calculated by taking the average federal cost per Medicare enrollee in 2012 (net of enrollee premiums) and growing that amount at the annual rate of growth in G.D.P. per capita plus one percentage point.'" This is the million-dollar question for which no one has a good answer. Healthcare expenditures are growing relative to GDP. They probably should. due to the incredible things that tecnnology increasingly makes possible - saving and extending lives, and greatly increasing suffering people's quality of life. But what is the limit given that it can't consume anywhere near 100% of GDP? This is a bit of a conundrum given that our usual model for making good allocative decisions - well-informed consumer choice - is problematic in the healthcare sector. This very likely does mean, however, that - if Congress stuck to it - increasingly people who are not rich would be denied healthcare treatment that would have enormously helped them, in life-saving and life-changing ways. BTW, Ryan has a point here, which should be acknowledged, when he insists (correctly) that merely the growth rate is being cut. If the plan were to take force, non-rich people in twenty years might in absolute terms still get better care than anyone is getting today - but they might be getting far worse care relative to what was contemporaneously available.

"4. The voucher amount would be adjusted by the beneficiary’s geographic location and health status and would be means-tested — that is, it would be higher for lower-income beneficiaries than for those with higher incomes." Obviously, the details are important here distributionally. The tax law and econ literature (see, e.g., pieces by Louis Kaplow and by Tom Griffith/Michael Knoll) is a bit skeptical of regional cost of living adjustments, which create moral hazard (I get the taxpayers to pay more by living in a high-cost area that may offer consumer amenities or, in the case of healthcare, higher regional treatment norms).

"5. Starting in 2013, beneficiaries would face a $600 combined deductible for ... [the two main parts of] Medicare combined, but pay a 20 percent co-insurance on each part — including hospital care — up to a catastrophic out-of-pocket limit of $6,000, after which cost-sharing would be zero." [OOPS - previous analysis here deleted, as a commentator suggests I misinterpreted this.]

"6. Between 2021 and 2032, the eligibility age for Medicare would be increased to 67, from 65." I might be fine with this if Medicaid were sufficiently strong, but obviously it won't be under the plan.

The fundamental question remains, what should the long-term healthcare system look like? In many areas I have strong pro-market sympathies, although I also want the government to address externalities and distributional issues (both of which can readily be seen in terms of market failure). But one has to have good sense about where markets don't work so well. I believe healthcare is one of the paradigmatic such areas, which is one reason why countries with single-payer healthcare systems often get better results than the U.S. in healthcare outcomes per dollar spent. The financial sector is another such area, as even Alan Greenspan briefly recognized (before reverting to his ignorant-idealogue type). How best to structure the healthcare portion of the economy is the real question in policy design, but I don't expect a reasoned political debate about this.

Saturday, April 02, 2011

Addressing the fiscal gap: selective program targeting

The Republicans have been targeting short-term discretionary spending as their method of choice to address (or at least say they are addressing) concern about the deficits and the long-term fiscal gap. Many have noted that this is really not a significant source of budgetary savings in the long run. Thus, as Howard Gleckman at the Tax Vox blog said about President Obama when he was doing a version of the same thing, they are being anti-Willie Suttons, looking for budgetary savings where the money isn't.

Now word has it that Paul Ryan actually is going to propose (with the Republican Congressional budget leadership) a plan offering significant long-term fiscal improvement. The piece he apparently plans to add the chopping block is Medicaid.

I believe that any sensible long-term budget plan has to include tax increases as well as reductions in the projected path of government outlays. And this includes not only tax expenditures (the repeal of which would formally be tax increases but in substance more like spending cuts), but also "actual" tax increases. These in turn could involve one or more of at least the following: increasing individual income tax rates, enacting a value-added tax, enacting a carbon tax, enacting a financial transactions tax (although this I happen to think is a bad idea), and enacting a financial activities tax that addresses undue risk-taking by our financial sector overlords.

But looking just at the spending side, it's useful to examine more fully the Willie Sutton issue of where the money is.

How to define the source of long-term revenue shortfalls is a tricky question. The best source I can find in the literature is unfortunately not very current. In May 2004, Alan Auerbach, William Gale, and Peter Orszag published an article in Tax Notes, entitled Sources of the Long-Term Fiscal Gap, that is available on-line here.

They use a number of different methods to examine where the fiscal gap really comes from if you look at the projected paths of various parts of the budget on the spending side. The method I find most illuminating is that presented in Table 6 on page 1055, entitled "Fiscal Gaps by Program, Alternative Baseline, Present-Value Allocation Method." It assigns infinite-horizon projected general revenues among various program categories, proportionately to projected infinite horizon expenditures in those programs. (Some experts might prefer the "current allocation method" in Table 7, which shows faster-growing programs as having large fiscal gaps, but the choice makes little difference for the main point I am going to emphasize.)

What I have done is the following. I've taken the infinite horizon fiscal gap for each program in Table 6, and converted it to a percentage of the overall infinite horizon fiscal gap. Results are as follows:

Social Security 6.7%
Medicare 33.3%
Medicaid 18.1%
Other entitlements, 8.6%
Discretionary: defense & homeland security, 18.1%
Discretionary: non-defense, non-homeland security, 15.2%

To be fair to Ryan and the Republicans, they appear to be interested in going after the last item on the list, which clocks in at 15.2%. And perhaps they'd really like to go after Social Security and Medicare, which add up to a respectable 40%. But because that is politically dangerous (and keep in mind that healthcare reform's Medicare cuts were a huge source of Republican demagoguery in the 2010 election), Ryan et al apparently are planning to take a meat cleaver just to the Medicaid piece, which is only 18.1%.

Admittedly this is not entirely trivial. And indeed the overall healthcare piece is fundamental - over 50% with Medicare alone added, and this doesn't include the cost of excluding employer-provided health insurance from both the income tax and the payroll tax. What's more, the Medicare and Medicaid fiscal gaps add up to more than 100% of the total fiscal gap under the "current allocation method" in Auerbach et al's Table 7, although in this rendering the Medicare fiscal gap is almost triple that from Medicaid.

So attacking Medicaid is genuinely a start in a pure arithmetic sense - unlike the shenanigans around discretionary spending in current year budget wars. But I'm really forced to ask what sort of human beings would view healthcare for poor people as the right place to focus so disproportionately when addressing the long-term fiscal problem.

This is not just a comment about Ryan and the Republicans, but about the increasingly plutocratic character of Washington politics (to which the Democrats respond as well), under which, as Martin Gilens has shown, policy "outcomes are fairly strongly related to the preferences of the well-to-do ... but wholly unrelated to the preferences of the poor."

Friday, April 01, 2011

Letter to Obama, Boehner, Reid, Pelosi, and McConnell

Yesterday's news included reports (such as this one) that "a powerful group of leaders in the business, academic and economic communities sent letters to the White House and Capitol Hill urging policymakers to work together to reduce the deficit by overhauling government retirement programs and an inefficient federal tax code." I was among the signatories, though I don't purport to have been among the "powerful" ones.

Relevant text of the letter included the following:

--"[C]omprehensive deficit reduction measures are imperative, and ... [we] urge you to work together in support of a broad approach to solving the nation's fiscal problems."

--The Bowles-Simpson Fiscal Commission's work, even if one disagrees with various features, "represents an important foundation to achieve meaningful progress on our debt," and also "underscored the scope and breadth of our nation's long-term fiscal challenges."

--"Beyond FY2011 funding decisions, we urge you to engage in a broader discussion about a comprehensive deficit reduction package. Specifically, we hope that the discussion will include discretionary spending cuts, entitlements changes, and tax reform."

I'll admit I was ambivalent about signing the letter. Reservations or qualifications that I felt - though this is not a dodge; I did in fact voluntarily sign the letter - include the following:

1) I support comprehensive deficit reduction measures, but believe they should address future, not current year, deficits given the ongoing down economy. In other words, I would like to enact changes today but generally limit their effect to future years.

2) A solution to our long-term fiscal ills would require the Democrats and Republicans to work together. But I don't think the Republicans are ready to do so in a serious way, and if I were advising the Democrats I'd tell them to keep this in mind. This is particularly relevant to overhauling government retirement programs, where I disagree with those on the left who tend to see no problem that requires retrenchment, but share their tactical concerns about whether, at this point, the Obama Administration ought to contemplate playing a very tricky game on this front.

3) As my forthcoming (I hope) Tax Notes piece about 1986-style tax reform will say, I disagree with the Bowles-Simpson Fiscal Commission Report in a number of fairly significant ways. A case in point is its proposing to hand back, via lower individual rates, a huge preponderance of the revenue gain from repealing tax expenditures. And I don't like the proposed cap on tax revenues relative to GDP. Even if tax revenues can be defined meaningfully (on which see my 2 preceding posts), I'd be more inclined, against the grim fiscal background and the distressing defects in national budgetary politics, to support a revenues-to-GDP floor than a ceiling.

4) Again, I am generally opposed to discretionary spending cuts right now given the state of the economy. In the longer term, there's certainly plenty of garbage there that ought to be cut. I'd start with things such as farm subsidies. More generally, this really isn't where the big money is, though that of course is no reason to exempt it.

5) As my forthcoming piece will say, tax reform is great, but the time has passed for 1986-style tax reform in which the rates are slashed to eliminate revenue gain from base-broadening. That's not the model we should be using any more. Instead, I favor eliminating bad tax expenditures, addressing horrendously structured areas such as corporate and international, in my ideal world converting the income tax into a progressive consumption tax (but that is probably unrealistic), and finding new revenue sources such as a VAT, carbon tax, and/or a financial activities tax (addressing the egregious heads-we-win, tails-the-taxpayers-lose incentive structure of the financial sector).

All things considered, and in particular given the extreme dangers posed by our long-term fiscal problems, I agreed to sign the letter as my little drop in the ocean towards trying to enhance pressures to move in the right direction. I also think the Fiscal Commission Report has fared a bit worse in public discourse (especially on the left) than it deserved - despite some serious flaws - given, for example, that it appears to be a modestly progressive package overall.

March 31 NYU Tax Policy Colloquium (with Len Burman), part 2: Distribution versus allocation

As this is a follow-up to my prior post, you might want to start by reading Part 1.

The last post ended with the damsel strapped to the railroad tracks, so to speak, in the sense that I believe I had illustrated a flaw in standard tax expenditure (TE) analysis that is as basic as that in the conventional taxes versus spending distinction that David Bradford so nicely illustrated with his "weapons supplier tax credit" example.

The point I made is that looking just at the income tax, and distinguishing its "normal" features from those that are deemed to be "spending," leaves one vulnerable to framing effects, in the sense that identical policies will be described differently - by people typically convinced that the terms "taxes" and "spending" actually matter, and demonstrate something "real" (such as the size of government) - depending purely on the formalities of presentation and perhaps administration.

But there is a better way (to quote Bill McKay from The Candidate). The distinction I offered in my article drew on Richard Musgrave's classic The Theory of Public Finance (1959) to distinguish conceptually between the "distributional" and "allocative" branches of government. The former concerns who gets what, the latter how all assets in the society are used. In short, distribution and efficiency, although the latter term has to be interpreted broadly for this purpose.

When a system mainly serves one purpose and something is smuggled into it that cannot be plausibly rationalized without deploying the other purpose, you have a risk of confusion. For example, the main reason for having an income tax is distributional: we prefer apportioning tax burdens based on some measure of ability to pay to having, say, a uniform head tax. The rationale for a welfare or other transfer system is likewise primarily distributional. By contrast, the weapons supplier tax credit can only be rationalized in allocative terms - someone decided that the Pentagon should have those weapons.

Allocative versus distributional is only one example, but a very helpful one in dealing with the issues posed by TE analysis. By contrast, here's an example where something like TE analysis might help with purely allocative programs. Suppose we enacted a carbon tax, which is clearly an allocative program, but put into it a huge exception for carbon emission by homeowners. Rationale: We Love Home Ownership, it's the American Way, never mind about 2008 and all that. That, too, is an allocative rationale, albeit probably a very stupid one. But it is so clearly distinguishable from the species of allocative rationale that underlies the carbon tax that we can say: it's something separate, interposed into the carbon tax for reasons apart from trying to measure carbon emissions or the harm they cause (which of course is uniform as between carbon atoms).

By making the cut at allocative versus distributional, you can create a structure where program choices that are actually being compared to each other are all within the same analysis. So you address both the weapons supplier tax credit problem and the "distribution policy inside versus outside the income tax" set of problems that I tried to illustrate in my Part 1 post.

So how come no one is game for the enterprise that this suggests? I think I understand that a little better after yesterday's session with Len Burman than I did before. Perhaps I had been lazy about it, although I'd rather call it keeping my focus on issues where I have a comparative advantage. I have noted that step 1 of adopting a more coherent, rather than a less coherent, view of tax expenditure analysis is to make the point that it's basically nonsensical to call, say, the earned income tax credit or child tax credit "tax expenditures." Whether good or bad, they are distributional policies that can easily be done either inside or outside the income tax. They occupy the same policy space as taxing income in the first place, deciding on marginal rates, having a welfare system or not, Food Stamps, etcetera. But I hadn't gone to Step 2, though indicating that I thought it should be done, which might involve more fundamentally redrawing conceptual categories in the budget to feature allocative and distributional policy (including regulatory stuff) rather than, or more likely in addition to, "taxes" and "spending." (Counting up dollar flows is fine - it's just attributing false significance to particular subparts that we need to watch.)

An ambitious rethinking of the budget runs into serious baseline problems - though, then again, what else is new? E.g., allocative and distributional policy, or rather the outcomes produced, compared to what?

But inadequate though it is just to improve tax expenditure analysis, rather than taking on the whole shaggy beast, if one is going to go that far (in order to correct the misperceptions created by even more naive frameworks), then why not go at least one step further and recognize that the "disguised spending" frame that underlies most contemporary uses of tax expenditure analysis becomes more coherent if one interprets it as distribution versus allocation? If we are looking at provisions in the tax code - admittedly an overly narrow focus - then addressing those that advance allocative policies, rather than being aspects of adjusting overall distribution policy, appears to be exactly what people worried about the long-term fiscal situation have in mind when they say that "tax expenditures" should help pay for the needed course correction.

March 31 NYU Tax Policy Colloquium (with Len Burman), part 1: What is "Spending?"

Yesterday Len Burman presented his paper draft (co-authored with Marvin Phaup), Tax Expenditures, the Size and Efficiency of Government, and Implications for Budget Reform. The central is that mislabeling tax expenditures (TEs as tax cuts rather than disguised spending both leads to bad program choices and is a major contributor to the long-term U.S. fiscal gap. In the later part of the paper that is particularly still in progress, it suggests using revised accounting for TEs both to report government operations differently and in designing budget rules that might in principle have some bite.

Obviously I tend to work similar territory part of the time (e.g., when not doing international tax or some such thing), though with less of a focus on budget rules, which I have discussed in a couple of my books (such as this one and that one) but tend to regard both somewhat skeptically and as outside my core expertise.

I guess I need to start by repeating what has become my Standard Tax Expenditures Gripe. (Indeed, I should probably adopt a shorthand and call it, from now on, the STEG.) My personal STEG starts from the following observation: Tax expenditure analysis typically purports to distinguish between the "normal income tax structure" and "spending through the tax code." The idea is fine - leaving aside more fundamental improvements to our fiscal language - but the expression is utterly incoherent. Decades of TE literature have focused on the difficulty of both defining, and motivating reliance on, the concept of the "normal income tax structure." But the other part, as almost no commentators seem to appreciate (David Bradford was of course an early exception) is at least equally problematic - as in, lacking any fundamental meaning.

The STEG consists of my having pointed this out about 8 years ago and proposed a substitute that is conceptually vastly superior. Various individuals have told me they agree, but I am pretty sure that I have never once in print seen anyone shift to using it. Instead (while a cite to my article usually appears, around footnote 83 or so), they keep on writing articles that trot out the old, incoherent structure or else what I consider confusing and jerry-built modifications to it that don't quite do the job either.

So I feel as if I'd invented the washing machine and people kept right on washing dirty underwear by hand in the sink. OK, that's a bit grandiose and overstated. But if my assessment is at all correct, you can appreciate that it would be personally frustrating.

This is obviously turning into a long post, so I will break it into two parts. I will close this one with some content from a little handout that I prepared for the colloquium session, addressing the question of whether "spending" is a meaningful term. In particular, it addresses the muddy line between ostensibly "normal" income tax features and identical features that could be placed outside the income tax system. It shows, no less than David Bradford's famous "weapons supplier tax credit" hypothetical, that we cannot accept form in making the distinction that commonly is called taxes versus spending, unless we are willing to turn the entire exercise into one of pure labeling that lacks broader meaning.


Example 1

Suppose that marginal tax rates are as follows:
0%, 0 - $20,000
20%, $20,000 - $100,000
35%, > $100,000

Astolphe earns $100,000 and pays $16,000 of tax. If not for the two lower rate brackets, however, he would have paid $35,000. Does this mean he got $19,000 worth of "tax expenditures," in the form of having 0% and 20% brackets? No, say TE proponents, because non-linear marginal rates are a "normal" feature of the income tax. I accept the conclusion but not the analysis. A point to note in passing: "normal" as used here has nothing to do with what the U.S. income tax code has ever looked like in its history. For example, a homeowner's imputed rent has never been taxed, yet there is no good argument of income measurement for regarding home mortgage interest deductions as tax expenditures OTHER than as indirect partial denial of the imputed rent exclusion. But there's worse to come regarding reliance on the "normal income tax structure" idea to explain why lower rate brackets aren't tax expenditures.

Example 2

Suppose we repeal the zero bracket. Marginal tax rates are therefore as follows:
20%, 0 - $100,000
35%, > $100,000

In addition to repealing the zero bracket, however, we made a strikingly related change outside the income tax system. Specifically, we have enacted an “earned and investment income transfer charge” (EIITC), equal to 20% of one’s first $20,000 of income, and administered separately from the income tax. Or alternatively, we can administer it through the income tax but call it a "tax expenditure" (like the actual earned income tax credit, or EITC).

The combined repeal of the zero bracket and enactment of the EIITC leaves everyone in the society in exactly the same position as before. For example, Astolphe, instead of paying $16,000 of tax, now pays $20,000 of "tax" and benefits from $4,000 of "spending."

So in substance Example 2 is identical to Example 1. Yet now, proponents of TE analysis as commonly formulated would be forced to say (and indeed might vociferously insist) that both taxes and spending have gone up by $4,000. You're not going to fool them by putting the EIITC into the income tax instead of leaving it to one side! So matters of pure form determine whether they regard lower rate brackets in substance as part of the "normal income tax system" after all.

Better still, we could enact a flat rate 35% tax and expand the EIITC to apply at a 15% rate to income between $20,000 and $100,000. Now Astolphe pays $35,000 tax and gets $19,000 of spending, all within the “normal” structure.

Example 3

Same as Example 1, but now we add a welfare benefit equaling 75% of the amount (if any) by which one’s income falls short of $20,000. Thus, for example, if you earn zero you get $15,000; if you earn $10,000 you get $7,500; if you earn $20,000 or more you get zero.

As all standard TE proponents think they know, this is a "spending" program from which Astolphe, with his $100,000 income, gets zero. Beulah, who earns $12,000, gets $6,000 in government spending.

Example 4

Same as Example 1, except now, in lieu of what we did in Example 3, we add a universal $15,000 demogrant and raise the tax rate on one’s first $20,000 of income from 0 to 75%.

All individuals end up in exactly the same positions as in Example 3, but we have increased both taxes and spending. For example, Astolphe now gets a $15,000 check and pays tax of $31,000, while Beulah gets a $15,000 check and pays tax of $9,000.

Now, you can't fool standard TE proponents. They know their "normal income tax structure," and they know "spending" when they see it. So, even though Examples 3 and 4 are identical, they are forced to agree - and they may indeed vociferously assert - that (considering only Astolphe and Beulah) in Example 3 taxes were $16,000 and spending was $6,000, whereas the completely non-substantive reformulation in Example 4 has raised taxes to $40,000 and spending to $30,000.

What are all these people getting wrong? (Even though, ahem, I thought I had explained all this. albeit evidently not well enough.) Let's leave that for the next post.