Tax Policy

I know, I know, my ongoing beef with Alice Rivlin is starting to get as long in the tooth as the now-settled one between Nas and Jay-Z, but I just realized that I forget to mention her quote in that awful and error-plauged article on the budget in last Saturday's WaPo:

"I suspect that McCain will be more constrained and will have a veto power over the Democratic Congress," said Alice M. Rivlin, who served as the first director of the Congressional Budget Office, as well as one of Clinton's budget directors. "If it's Obama, the Democratic Congress is going to be pushing for spending and it's awfully hard to rein in your own folks. No Democrat is going to want to go to war with Congress."

The Brookings-Urban Tax Policy Center estimates that the McCain tax proposal would increase the national debt by a trillion more dollars over the next 10 years than Obama's plan. Some constraint.

That's Henry Aaron of Brookings who had the best testimony at this week's House Budget Committee meeting on the Pete Peterson-funded jihad against Social Security and legislation that would create a commission to come up with a proposal to cut Social Security. Aaron summarizes the case against this legislation as follows:

The bill mischaracterizes the source of [projected, long-term] deficits. They derive entirely from projected increases in national health care spending, not from problems peculiar to government health care or entitlement spending.

Materially slowing the growth of Medicare and Medicaid apart from general health system reform is impossible, unless the nation reneges on its commitment to assure the elderly, disabled, and poor health care roughly comparable to that available to the rest of the nation.

The specification of 'issues to address' and 'policy solutions' in section 3 of H.R. 3654 is unbalanced. For example, the draft bill specifies as a 'policy solution' limits on entitlement spending, but does not mention as a 'policy solution' curbing in tax expenditures that putatively serve the same general objectives as direct spending, but benefit different groups.

The draft bill virtually invites 'game playing,' as policymakers could avoid hard choices by manipulating long-term projections with artful assumptions, scoring methods, or other tactics for avoiding hard choices. Such practices were used extensively to subvert the Gramm-Rudman-Hollings targets in the 1980s. H.R. 3654 could actually obstruct desirable action to address projected long-term budget deficits.

Commissions never solve complex problems unless members of Congress are prepared to address the underlying source of those problems.

Some concrete examples of the effects of the McCain and Obama tax plans, from modeling by the Tax Policy Center:

A single mom, with one child, making $15,000-a-year (in adjusted gross income) would get a $17 tax cut from the McCain plan, but see a $500 reduction from Obama, thanks to his new work credit.

A newly-married young couple with no kids, making a combined income of $50,000, would get a $36 tax cut from McCain, but a tax reduction of about $1000 from Obama. The big difference again: Obama’s work credit.

By contrast, think about the classic suburban 1950s sitcom family, with two kids but only one wage earner, who makes $75,000. Ward and June Cleaver would do a bit better under McCain, who would cut their taxes by $800, while Obama would trim their taxes by only about $500. McCain’s increased dependent exemption for Wally and the Beave trumps Obama’s work credit.

Now, let’s look at a two-lawyer family, making $200,000, with one child. McCain would give them a tax cut of roughly $7000, while Obama would trim their taxes by about $5000. The big reason: each candidate would patch the Alternative Minimum Tax.

A married baseball player who takes home $2 million and has one child might want to go to bat for McCain, who would give him a tax cut of more than $30,000. Obama would raise his taxes by $135,000.

For seniors, the pattern is a bit more surprising, since Obama has been touting his tax cuts for the elderly. Obama would give an unmarried senior making $35,000 a tax cut of $3000, which would wipe out her tax bill. McCain would give her a tax cut of about $250.

Brad DeLong adds on to the critique of Perry Bacon Jr's abysmal WaPo story on the differences between Obamanomics and McCainonomics:

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To establish tax credits for health insurance requires the creation of a bureaucracy to assess and monitor health insurance plans—somebody has to decide purchase of which health insurance plans qualifies one for the tax credit, and which does not. Regulation via tax expenditures and a bureaucracy to define and monitor them is regulation—a point that eludes Perry Bacon Jr. His example of how McCain is for reducing regulation—well, that dog just won't hunt. And as for job creation—covering the uninsured definitely creates health-care jobs; tax credits to persuade people who almost all already receive employer-sponsored insurance to switch to catastrophic-only coverage is not and is not intended to be a job-creation measure. But Perry Bacon doesn't seem to realize this.

Nor does Bacon appear to realize that a government that spends through tax expenditure creates as many potential distortions as a government that spends through, well, spending—that is why they are called tax expenditures, after all.

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My vote for stupidest individual tax break would probably go to the tax exclusion for employer reimbursed parking expenses, subsidized by the general public at the cost of around $3 billion a year. (There's also a more sensible exclusion for employer-provided transit passes, but that's capped and comes in at under $400 million.) I haven't seen data, but there's little question that most of the benefits go to well-off taxpayers who need the help the least. In a new working paper, Michael Grubb and Paul Oyer provide a new reason for hating the parking tax break: it ends up raising the costs of parking for those who can least afford it. Here's the abstract, an earlier version of the paper is on Grubb's website:

We use university parking permits to study how firms and employees split the value of employee benefit tax subsidies. Starting in 1998, the IRS allowed employees to pay for parking passes with pre-tax income. This subsidized the parking pass purchases of faculty and staff, but did not affect students. We show that the typical university raised its parking rates by 8-10% extra when it implemented a pre-tax payment system, but that this increase was the same for those affected by the tax change and those that were not affected. We conclude that university employees captured much of the new tax benefit, that faculty and staff that purchase permits benefited relative to those that do not purchase permits, and that students that purchase permits were made worse off relative to those that do not buy permits. We discuss what these results suggest about universities' objectives in setting their parking prices and about the demand for university parking.

In an earlier post, I noted that the tax subsidy for employer-sponsored health insurance is strangely absent from the focus of Entitlement Crisis advocates. Over at the OMB Watch Budget Blog, Craig Jennings adds:

... this oversight isn't limited to tax subsidies health insurance. No one seems aware of the other massive entitlement programs like the $100 billion housing subsidy that helps higher-income families buy homes (Filers earning more than $100,000 represent 11% of all filers, but they see 60% of the benefit.).

This general blind spot for tax breaks as subsidies has a deleterious effect on the What To Do About Entitlements conversation, because it disguises the scope of the impending health care crisis. The CBO projects that federal spending on Medicare and Medicaid will be 9 percent of GDP in 2035, causing heart palpitations for the budget-minded. Yet, in that same year all health care spending will capture 31 percent of GDP double today's rate.

Crafting policies aimed at reducing per-unit costs of health care would not only allow all Americans to access more and higher-quality health care, but it would also help avert the a doomsday debt scenario (AKA The Entitlement Crisis®). And as long as we neglect to consider the health insurance subsidy part of the federal health care system, this solution will remain obscured.

Responding to a recent comment by Libertarian Finlander, I noted that I didn't necessarily have any theoretical objections to a national value-added tax, but that I wanted universal health care first. After writing my response, I ran across this interesting post by TPC's Howard Gleckman on some recent proposals to combine a VAT with health care reform:

... Ezekial Emanuel and Victor Fuchs ... [would] create a European-style Value Added Tax and use the huge slug of new revenue for health care vouchers, which people would use to help buy insurance.

My TPC colleague Len Burman, who comes at the problem from the perspective of tax reform as well as health care reform, would go yet another step. He’d create a VAT of about 15 percent to fund these health vouchers. But Burman would also use the VAT revenue to reform and simplify the income tax.

He’d set two individual rates—say, 15 percent and 25 percent—and eliminate the personal exemption, the standard deduction, and most itemized deductions. He’d also dump the exclusion for employer-sponsored health insurance and vastly simplify retirement savings incentives.

Burman’s VAT would not only help pay for private insurance, it would also finance Medicaid, veterans health, and the share of Medicare that is now supported through general revenues (about $200 billion in 2009).

Burman is hardly the first policy maven to push the VAT. Yale professor Michael Graetz backs one of roughly 10 percent to 14 percent. However, Graetz would use the VAT revenue to eliminate the income tax for nearly all taxpayers—those earning less than, say $100,000. The TPC’s Bill Gale has also suggested a VAT, but as an additional source of revenue rather than as a replacement for the income tax.

These proposals are all worth a look, but a U.S. shift to a VAT is a much longer-term proposition than (hopefully) health care reform that gets costs under control and expands coverage to all Americans.

The mortgage interest tax deduction is one of our largest government programs—it will cost almost $100 billion in 2009—contributes significantly to income and wealth inequality, and helped make the housing bubble happen. The time has come to reform it. Via Economist's View, this is a good post by Thomas Palley that includes recommendations on reform:

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First, the capital gains exemption should be abolished for all new home purchases. Instead, the base cost of houses should be indexed to inflation so that homeowners are not taxed on inflation gains. Existing homeowners should be grand-fathered under current law to discourage selling to protect unrealized gains, which would destabilize the housing market.

Second, the ceiling (currently $500,000 per taxpayer) on mortgages qualifying for interest deductibility should be gradually lowered to zero over a ten-year period. Such a gradual phase-out can actually help existing middle-class homeowners because it will make top-end homes relatively less affordable compared to mid-market homes that retain the tax subsidy. That will shift demand toward the mid-market segment, helping maintain mid-market prices and thereby mitigating the housing slump.

Third, since everyone needs housing, the Federal government should phase in a refundable housing cost tax credit available to all, regardless of whether they own or rent. That credit can be financed with revenues generated by phasing out the mortgage interest deduction. During the transition every taxpayer should have the choice between taking either the available mortgage interest deduction or receiving the housing tax credit.

Current tax treatment of housing is intended to benefit working families, but it actually creates bad outcomes. The reality is current tax law distorts the economy, promotes house price speculation, renders households over-indebted and financially vulnerable, and undermines wages and family structure. There is a better way to help working families afford decent housing, and now is a good time for policy to transition in that direction.

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Both the NYT and the WaPo report today on Hillary Clinton's support for the John McCain gas tax suspension. As Dean Baker notes, the WaPo does the best job of debunking the claims made in favor of the proposal.

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Some economists say that a nationwide "gas tax holiday" would have even less impact on gas prices than a moratorium like the one passed by Illinois in 2000. "It's basic economics," said Len Burman, director of the Tax Policy Center, a nonpartisan think tank. "Gas is always in very short supply during the summer, which is why prices go up. In order to reduce the price, you would have to increase supply, but that is difficult over the short term, because the refineries cannot add capacity."

According to James Hamilton, a professor of economics at the University of California at San Diego, the benefits of a temporary tax moratorium would probably go to oil companies rather than consumers. He said states that suspend gas taxes are able to respond to rising demand more efficiently than the country as a whole, because gasoline supplies can be easily transferred from one state to another.

"Prices would certainly rise to the market-clearing level," Hamilton said. "I would expect the price to go back to very close to where it was before, in which case consumers would not see any benefit."

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But the NYT story includes a couple of useful tidbits:

At a meeting with voters in North Carolina on Monday, Mr. Obama said lifting the gas tax for three months would save the average consumer no more than $30, a figure confirmed by Congressional analysts. Mr. Obama has previously dismissed Mr. McCain’s proposal as a “scheme.”

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The highway trust fund that the gas tax finances provides money to states and local governments to pay for road and bridge construction, repair and maintenance. Mr. McCain and Mrs. Clinton propose to suspend the tax from Memorial Day to Labor Day, the peak driving season, which would lower tax receipts by roughly $9 billion and potentially cost 300,000 highway construction jobs, according to state highway officials.

I have to say Clinton's support of the McCain proposal depresses me more than just about anything to happen so far in this election. It's pure Dick-Morris-era Clintonian triangulation of the worst kind. Paul Krugman, we await your outrage.

Update: Krugman weighs in:

John McCain has a really bad idea on gasoline, Hillary Clinton is emulating him (but with a twist that makes her plan pointless rather than evil), and Barack Obama, to his credit, says no.

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The Clinton twist is that she proposes paying for the revenue loss with an excess profits tax on oil companies. In one pocket, out the other. So it’s pointless, not evil. But it is pointless, and disappointing.

Well, not evil maybe as policy, but as politics, which is all this debate is about, it's evil.

Wanted to lift up this good comment from Adam Hughes on my post on McCain's tax and budget proposal:

While there has been pretty good coverage of the insanity of the size of the tax cuts McCain has proposed, there hasn't been quite enough of the fact that he says he'll cut spending to balance out the tax cuts, all the while still providing for the needs of American communities.

McCain was on NPR yesterday afternoon claiming he could cut $100 billion annually very easily just by cutting earmarks and pork spending. Yet even the most broad, generous definition of pork spending show less than a fifth of what McCain is claiming to be able to cut - $17 billion. (See Citizens Against Government Waste estimates here). When asked yesterday on NPR about how he could balance investments in areas like Appalachia and large cuts ($100 billion) a year to many of those same program, McCain got a little testy.

I suppose that because he seems to be talking out of both sides of his mouth on this issue. You can't support investments and services in areas of need and claim you can cut more than a tenth of domestic discretionary spending at the same time and still seem credible. Especially when McCain offers no specifics whatsoever on what would be cut to get up to $100 billion.

The NYT Times reports on John McCain's visit to Appalachia:

Senator John McCain walked in the literal footsteps of President Lyndon B. Johnson on Wednesday as he stood near the now-abandoned Appalachian front porch where Johnson declared a war on poverty. Forty-four years later, Mr. McCain said, “We have a lot to do.”

Mr. McCain, who was on the third day of a weeklong tour of America’s “forgotten places,” held out the promise of better Internet service and job training in community colleges to this economically depressed coal-mining town of less than 650 people.

While he offered few other poverty-fighting specifics in a speech that was largely focused on trying to connect to voters in one of the poorest parts of the United States, he sought to project himself to independents and moderate Democrats across the country as a different kind of Republican.

While McCain is right that "we have a lot to do", it should be noted that his radical, even-crazier-than-Bush-II tax cut plan would leave government bereft of the resources to do any of it. According to the Tax Policy Center, the McCain plan would reduce federal revenues by around $5.7 trillion over ten years and "pare government back to levels not seen since the Eisenhower administration."

In FY 2012, tax revenues would be reduced by about $550 billion compared with current law (with the tax cuts expired). That is roughly equal to CBO’s baseline projection for all nondefense discretionary spending.

McCain’s proposal is $300 billion bigger than all of President Bush’s FY2012 tax cut proposals. Tax revenues would be about 16.8 percent of GDP. By comparison, spending this year is about 20 percent of GDP.

McCain's anti-poverty proposals are notable only for being even less substantive than GW Bush's compassionate conservatism.

Continuing on the theme of how to talk about taxes, here's Kwame Anthohy Appiah in Sunday's WaPo on why it's important to appeal to fairness:

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How, in the first Bush administration, did the movement to repeal the estate tax prevail? Not just because it was craftily renamed the "death tax." The number of Americans who told pollsters that they opposed the "death tax" was just a few percentage points higher than the number who said they opposed the "estate tax." As Yale scholars Michael Graetz and Ian Shapiro have shown, it mattered more that proponents of repeal made a moral argument (however specious): that the tax was unfair because, for one thing, it involved taxing earnings twice.

Defenders of the tax typically countered with an appeal to self-interest: But you're not paying it, because it applies to just 2 percent of households. They didn't quite grasp how powerful appeals to fairness are. In fact, when the barnstorming Teddy Roosevelt proposed the tax a century ago, he made the case for it precisely in terms of fairness: He talked about what the wealthy owe to a nation that made their success possible.

Roosevelt, of course, was one of the great leather-lunged orators. This primary season has seen an ongoing dispute about whether soaring rhetoric of moral uplift has any relevance to the hard work of devising and implementing public policy. But once you start thinking about how powerfully affected we are by our sense of fairness -- and about how powerfully that sense can be affected by the way issues are described to us -- it's hard to dodge the fact that whiffy moral rhetoric can have practical consequences when April 15 rolls around.

At some level, we're those kids with the candy bars. We may change our minds about what's truly just, but not about how much fairness matters. As faltering as our intuitions about fairness in public policy are, success comes to the politician who can enlist them effectively. It's not enough to craft good policies, you have to convince people that they're wise and just. Some individuals, for reasons we grasp only dimly, are a lot better at that than others, however smart, engaged and sensible. Almost doesn't seem fair, does it?

A sensible proposal from Richard Conniff:

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It’s time to take a page from the conservative playbook, the one where they reframe the debate by changing the language — for instance, calling the “estate tax” a “death tax,” or making equal rights for same-sex partners a “protection of marriage” issue. I propose we stop saying “taxes” and start calling them “dues.”

Yes, this is a little sneaky. Some conservatives may even call it Orwellian, and they ought to know. But the word “dues” also plays into the psychology of group identity, and that can work to the benefit of conservatives and liberals alike. Consider that “tax” comes from the Latin for “appraise” with punitive overtones of “censure” or “fault,” as if wage-earners have done something wrong by their labors. “Dues,” in contrast, is rooted in social obligation and duty.

“Look,” I said to a conservative friend, “simply saying ‘hard earned’ every time you say ‘tax dollars’ doesn’t make bureaucrats think twice before spending. But spending other peoples’ dues, now that’s not so easy.” He muttered darkly. With a liberal friend, I mentioned a study showing that words like “social” and “contract” make people more willing to pay their share. “But I probably wouldn’t like paying dues either,” he replied. “The government isn’t my kind of club.”

So this will be an uphill struggle. But we need language to remind us that this is our government, and that we thrive because of the schools and transit systems and 10,000 other services that exist only because we have joined together. Instead of denouncing taxes, politicians would do better to appeal to the patriotic corners of our hearts that warm to phrases like “we the people.” “Taxation” is a throwback to the time when kings picked our pockets. “Paying my dues,” a phrase popularized in the jazz music world, is language by which we can stand together as Americans.

In their classic 1999 book, The Cost of Rights: Why Liberty Depends on Taxes, Stephen Holmes and Cass Sunstein update legal realism to remind us that taxation is a necessity of modern civilization. Here's Sunstein summarizing some of the book's key points:

... we don’t need to celebrate the level of taxes, but we do need to celebrate the fact of taxes. We can’t have freedom and security against violence without taxes. They’re not an obstruction to liberty, but the condition.

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The principal claim in the book is that democratic theory and public finance have more to do with each other than it appears. Rights should be cost-effective, and we should have a theory of who is entitled to what. The big plea is that we should have a democratic discussion of public finance rather than saying that some people depend on government and some people don’t. If you have some property, you depend on the government.

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That liberty depends on taxes is so elementary that there seems to be some hope that some version of it will be accepted. It’s not that the point is so surprising––what’s surprising is that there are arguments to the contrary. No one can say they are antigovernment; it’s ridiculous, unless you’re an anarchist. There are good-faith arguments for a lower tax rate, or for more protection of property and less of social security, or for rights that are more cost-effective. But there’s no reason to say that we should be relying on markets instead of government, as the Russia example shows.

As ... F.A. Hayek, said, you can’t have markets without government. It’s not about big government vs. small government. It’s about where we choose to allocate our resources.

It doesn't happen all that often on economic issues, so it's worth noting that the Washington Post's ed board is right on today:

WE'RE REALISTS. We know that legislation can involve a certain amount of moral and intellectual corner-cutting. But is it too much to ask that a bill called the "Foreclosure Prevention Act of 2008" not contain a provision that might, at the margin, encourage home foreclosures? Apparently so, because the bipartisan Senate housing relief package includes just such a measure.

We refer to a $7,000 tax credit (payable over two years) to anyone who purchases a foreclosed home within a year of the proposal's enactment. Supposedly, this would help clear the nation's swollen inventory of repossessed properties, thus propping up home prices more generally. Here's the catch. For lenders as well as borrowers, foreclosure is an expensive hassle. If at all possible, most banks would rather avoid repossessing a house, which they must then try to resell. But, by making it cheaper to buy a foreclosed house than a comparable unforeclosed property, the tax credit makes it more feasible to sell one. The cost and hassle -- for the lender -- of foreclosure go down, and the benefits go up. Other things being equal, lenders would be that much more likely to foreclose -- rather than to help homeowners stay in their houses on modified terms.

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Perhaps the only provision that's more objectionable is the bill's $6 billion tax break for money-losing home builders -- who threatened not to give any more campaign money when they got shut out of the economic stimulus bill in February.

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.... on the whole, the legislation looks like an election-year turkey, stuffed and cooked to order for lobbyists.

Also on the Senate housing bill, the AP's Andrew Taylor has a good story on opposition to the bill. Taylor notes that House Dems will not include in their package the two worst elements of the Senate bill: the $7,000 credit for buying foreclosed homes, and the business tax break.