Friday, February 06, 2015

That was the week that wasn't: David Kamin article from cancelled NYU Tax Policy Colloquium

A week ago this past Tuesday, due to the blizzard-that-wasn’t, we DIDN’T hold the second session of our Tax Policy Colloquium, featuring my colleague David Kamin’s paper, In Good Times and Bad: Designing LegislationThat Responds to Fiscal Uncertainty. This was really too bad, albeit an increasingly familiar feature of January colloquium sessions, as we had a good discussion planned and expected a good audience.

As it happens, there is an interesting overlap of coverage – albeit from very different perspectives – as between the Kamin article and Eugene Steuerle’s recently published book, Dead Men Ruling: How to Restore Fiscal Freedom and Rescue Our Future, which Steuerle will be presenting at NYU Law School on Monday, February 9, at 2 pm.  I will be offering commentary on the book at this session, and will post my slides afterwards.

A key background point for both Kamin and Steuerle is that Congress passes laws that affect taxes and spending in future years, and that remain in place indefinitely, barring further legislative action, unless they have expressly been given expiration dates.  This is obviously generally true of tax rules, and it also holds for entitlements programs such as Social Security and Medicare.

Inevitably, conditions change over time.  Thus, even if it is hard to specify fully what "current policy" means as applied to future years, probably some nominal change in application is necessary  just to keep that "it," whatever it is, in some relevant sense the same.

Steuerle's take, which I will address on Monday, at the session and then here on the blog, is that the "dead hand" of the past is crowding out "fiscal democracy" because, for example, Social Security, Medicare, and Medicaid are projected to grow vastly, and indeed (it is expected) unsustainably, relative to the rest of the budget.  Kamin's take, by contrast, is that we should consider trying to put current policy on the intended course via pre-adjustments, without needing to wait for future legislation.  He is not opposed to letting future legislators do as they like, and does not expect to deter them - his aim, rather, is simply to prevent artificial crises emerging because one has steered off course in ways that, at a general level, could have been anticipated.

Income tax rate brackets provide a useful illustration.  The 1970s, by reason of featuring both unindexed rate brackets and high levels of inflation, had substantial bracket creep.  People whose incomes were fixed in real terms kept being pushed into higher marginal rate brackets because their nominal incomes were rising with inflation.  While this was fun for a while for Congress, which could keep enacting tax cuts that really (at least in part) just undid the automatic tax increases from bracket creep, Ronald Reagan in 1980 campaigned in favor of indexing the rate brackets for inflation, which Congress then did in 1981.

Clearly, indexing income tax rate brackets for inflation keeps current year policy more in place for future years than it would be if you let inflation change things.  The only good reason for not indexing would be to change the actual rate pattern over time without having to do it quite so openly.  (This, for example, might be a good political reason for not indexing the $1 million cap on home acquisition indebtedness that generates deductible mortgage interest, if one dislikes the home mortgage interest deduction but is leery of challenging it directly.)

But what about "real" bracket creep?  Over time, and despite recent stagnation below the very top, average income levels across the distribution have been rising in real terms, reflecting the real increase over time in per capita GDP.  So the rate structure is changing all by itself.  With enough growth, at some point the top income tax bracket (39.6%, disregarding various other inputs that can move it around) will be applying to a far higher percentage of taxpayers than the tiny slice subject to it today.  

So what is current or constant policy - to let this happen, or to index the 39.6% bracket for real growth, so that it applies to the same percentage of the population as previously?  The answer is: It depends on what you think of as the policy.  I could imagine two supporters of the current rate structure, both of whom want to keep "current policy" in place, who learn that one of them believes this would involve indexing the rate brackets for real growth, while the other one believes the contrary.

In familiar law and economics lingo, this is an "incomplete contracting" problem.

Anyway, we could further.  Several years ago, Len Burman, Jeff Rohaly, and Robert Shiller wrote a paper, entitled The Rising Tide Tax System: Indexing (at Least Partially) for Changes in Inequality, which Burman presented at our colloquium.  It argues for a system under which changes in measured inequality would automatically lead to tax rate changes - for example, to higher tax rates at the top, if high-end inequality kept increasing.  This keeps current policy in place if one defines it in some ways, but not if one defines it in other ways.

You could go even more general in that, in defining current policy.  Suppose our aim is to achieve a particular tradeoff between the efficiency costs of income taxation and the social welfare benefits that one attributes to reducing inequality.  Labor supply elasticity is among the inputs to this calculus.  So you could imagine in theory - though surely not in practice - providing that the rate structure will automatically change to reflect new and more current information about labor supply elasticity and/or any other input into the process.

Kamin, of course, does not propose anything like that - his focus is far more practical.  But consider Social Security.  Its benefits are indexed to inflation, and its benefit formula for age cohorts that newly reach age 60 is indexed for changes in wage levels.  It also has a long-term trigger mechanism that could apply automatically in the future: benefits may get curtailed if the Social Security Trust Fund is deemed to have run out.  One could imagine putting all sorts of other automatic adjustments into the system - e.g., indexing something or other for life expectancy changes, measures of aggregate retirement saving by the members of a given age cohort, etc.

The Kamin paper discusses, at both a general and a program-specific level, how one might want to design automatic adjustments, triggers, alarm bells, etc., generally with the aim of benignly updating current policy without creating needless policy drift that Congress would have to address.  (He rejects the idea that we should want to set off random policy drift, even though some might laud it as a way of refocusing Congress's attention.)

In general, the greater the degree of preexisting policy consensus, the easier this may be to do.  But the proponents of given legislation may want to do all they can to keep current policy, on course without requiring further legislative action, even if the other side dislikes the whole policy.  Nothing wrong with that, I would say.  Once one recognizes that, say, there is no inherent reason not to index for inflation (and that nominal fixity is not a meaningful or attractive baseline), the rest is presumably up for grabs, or fair game, or whichever standard expression one happens to like best here. 

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