The Tax Policy Center’s verdict on Herman Cain’s ‘999’ plan is in, and it’s not pretty for the vast majority. Last Sunday, Cain claimed on Meet the Press that his plan would lower taxes on most Americans. Analysis of the plan proves otherwise. The average household would see an $836 tax increase, with 84 percent of households paying more, relative to current tax policies. In this case, that’s what ‘broadening the base’ entails: more households paying much more in taxes.
Mr. Cain said the elderly wouldn’t be made worse off, because the elimination of capital gains taxes would offset the new taxes levied on their consumption, again a wildly unfounded claim. It turns out that 86 percent of elderly households would see a tax hike, which is unsurprising because fewer than 10 percent of households will even pay capital gains taxes this year, again according to TPC. If the vast majority is getting hosed, who’s reaping the benefit?
I recently characterized the ‘999’ plan as the inverse of the so-called ‘Buffett Rule’ that millionaires and billionaires shouldn’t be paying a lower effective tax rate than middle-class households. TPC’s distributional analysis demonstrates just this. The chart below depicts effective tax rates under current policy (blue) and the ‘999’ plan (red) across various cash income ranges.
Under a progressive tax code, effective tax rates should rise with income. TPC treats the ‘999’ plan effectively as a 23.6 percent flat sales tax, which is in fact the final phase of Mr. Cain’s tax plan (TPC’s wonky explanation here and Howard Gleckman offers a more accessible explanation here). Upper-income households consume less of their income than middle-class families, hence lower effective tax rates and a regressive tax code. (Note: the tax code is less progressive than the blue bars suggest because the federal tax code is layered on top of regressive state and local taxes, as Citizens for Tax Justice notes in this report.)
Under ‘999,’ average tax rates would begin to fall for households with income exceeding $200,000. Households with income exceeding $1 million would see their effective tax rate roughly halved from 32.9 percent to 17.9 percent, for an average tax break of $455,000, relative to current tax policies. The top 0.1 percent of filers—those with incomes of roughly $2.7 million and above—would get an average tax cut of $1.4 million, as Jared Bernstein depicts nicely. This is where the benefit of eliminating wealth taxes (i.e., capital gains, dividends, and estate taxes) really kicks in; the highest-income 0.1 percent will pay 49 percent of all capital gains taxes this year.
The American consumer is in no position to lead the economy to recovery. Lower-income and middle-class Americans are burdened by mortgage debt and lost housing equity, underemployment, and a decade of falling real median income. In this context, I fail to see how jacking up taxes and slashing disposable income for 84 percent of the population constitutes responsible tax reform, much less a jobs plan. It’s more along the lines of kick ‘em when they’re down.
Mr. Cain’s ‘999’ plan amounts to highway robbery, not a jobs plan. It’s simple, all right, simply a massive redistribution of after-tax income up the earnings distribution.
RedState.org blogger Erik Erickson has launched a counterattack to the Occupy Wall Street’s “we are the 99 percent” campaign. Erickson’s retort: “Suck it up you whiners. I am the 53 percent subsidizing you so you can hang out on Wall Street and complain.”
What’s he talking about? This 53 percent figure refers to the share of all households who pay federal income taxes. Far too many people, hearing this statistic, miss the crucially important adjectives “federal” and “income” and take it to mean that nearly half of American households pay no taxes at all. This is clearly wrong. Essentially every adult in the country pays taxes. They pay federal excise taxes when they buy gasoline, they pay state sales taxes when they buy clothes and electronics, they pay local property taxes if they own a house, and they pay federal payroll taxes on every dollar of income they earn – unless they’re lucky enough to earn over $107,000, when Social Security taxes revert to zero.
Federal income taxes, in fact, accounted for only 37 percent of federal taxes and just 20 percent of total federal, state, and local taxes paid in 2010. So why have conservative activists like Erickson tried to privilege the income tax over others? Well, mostly because they’re hoping people think this refers to all taxes. But conservatives particularly dislike the federal income tax because it’s pretty much the only significant part of our tax code that remains progressive – though less so after a decade of Republican-backed tax cuts. (The most progressive federal tax, the tax on large estates and gifts, has been eviscerated over the last decade.)
Most taxes besides federal income taxes are flat or regressive, meaning that lower-income households pay a higher share of their income in these taxes than the rich. Citizens for Tax Justice has a great report that points out that the tax system as a whole is nearly flat – meaning that households across the income distribution are paying about an equal share of their income in taxes.
The 47 percent that pay no federal income tax that Erickson thinks he’s subsidizing are a mix of current taxpayers that just happen to have not made enough income in the current year to have income tax liability, and former income taxpayers (retired households), as explained in this post. Unlike other taxes, the federal income tax intentionally exempts subsistence levels of income from taxation, largely through the standard deduction and personal exemption. The tax code also provides an extra standard deduction for retirees, who face high costs of living, and exempts some Social Security income from taxation. Because of this, and because the effect of the earned income tax credit (EITC – first introduced in the Nixon administration and expanded under both the Clinton and George W. Bush administrations) is to offset payroll tax liability for low-earners, it is true that 18 percent of households (mostly retirees and very low-earning families with children) will face no net federal taxes on income this year. Is it really so offensive that retirees and families with very low incomes are not paying this particular tax?
One wonders where this hilarious attempt to cherry-pick tax stats to divide the world into the virtuous and undeserving will end. According the Tax Policy Center, 90 percent of tax units will pay no capital gains or dividends taxes this year – does this make the rest of us freeloaders? But wait, eliminating all taxes on capital gains and dividends is a prime goal of conservative policymakers – are they trying to replace the undeserving freeloaders with virtuous freeloaders?
Or, are they just trying to mislead people who are angry (with good reason) about the outcomes the economy is producing and threatening to pin some outrage where it actually belongs?
Fiscal year 2012 kicked off on Oct. 1 to an economy roughly $1 trillion (-6.2 percent) below potential economic output—the level of economic activity that would be associated with full employment and industrial capacity utilization. This economic slack has significant consequences for the budget deficit because revenues are lower and more Americans rely on the social safety net.
Recently, the Congressional Budget Office estimated that this portion of the budget deficit attributable to economic weakness is $340 billion this fiscal year (FY2012). In other words, if the unemployment rate were closer to 5 percent, the budget deficit would be around a third lower than its projected level ($973 billion, or 6.2 percent of GDP). CBO’s methodology and older estimates can be found here.
While sizable, these estimates understate the impact of the recession on the budget by only focusing on economic variables and ignoring deliberate legislative efforts to prop up the economy. Objectively stimulative provisions in last December’s tax and insurance compromise added $124 billion to this year’s deficit (in addition to the $299 billion added to the deficit by extending current tax policies), the Recovery Act added $49 billion, and supplemental stimulus extensions (UI, helping states with their Medicaid bills, and a teachers’ jobs fund) added $1 billion. Similarly, tax deal stimulus added $157 billion to last year’s deficit, the Recovery Act added $163 billion (net of the alternative minimum tax patch, which wasn’t stimulus), and supplemental stimulus extensions added roughly $47 billion to last year’s deficit.
Adjusting the budget deficit (less cyclical contributions) for these legislative decisions, the effective impact of the recession is closer to $699 billion last year and $514 billion this year, or about 54 percent of last year’s actual budget deficit and 53 percent of this year’s deficit.
Even adjusting for legislated economic support underestimates the impact of the recession, because many economically sensitive projections, such as decreased revenue from capital gains realizations, show up in CBO’s ‘technical revisions’ rather than the cyclical economic revisions. Technical revisions are residual non-legislative, non-economic changes in projected receipts and mandatory outlays, influenced by factors such as the distribution of tax filers through income brackets or effective tax rates. Kitchen (2003) finds that economic and technical revisions demonstrate a statistically significant and close relationship, particularly with personal income receipts. Since the start of the recession, technical revisions to CBO’s budget outlook have cumulatively added $139 billion to the FY2011 budget deficit and $246 billion to the FY2012 deficit.
Stripping out the combined impact of cyclical economic factors, stimulus legislation, and technical revisions, this year’s structural deficit would be $223 billion, or 1.4 percent of GDP. Last year’s structural deficit would have been $446 billion, or 3.0 percent of GDP. Put differently, a host of recession-related factors account for at minimum half and upwards of 65 percent of last year’s deficit and 77 percent of this year’s deficit.
This analysis shows just how sensitive the budget is to economic activity and employment. Unfortunately, the economy faces a big drop off in deliberate fiscal support between last year and this year. Goldman Sachs recently estimated that under current law, U.S. fiscal policy will shave 1.8 percentage points from GDP growth in calendar year 2012 (or one percentage point even if the payroll tax cut is extended). We estimate that the debt ceiling deal’s initial spending cuts, coupled with failure to extend the payroll tax cut and UI, would shave 1.5 percent off growth and lower employment by 1.8 million jobs in 2012.
Congress needs to change course and enact more economically supportive policy to put millions of Americans back to work and improve the fiscal outlook.
Back when the “Gang of Six” was the fiscal flavor of the week and Sen. Tom Coburn (R-Okla.) was sparring with Grover Norquist over ethanol subsidies, I wrote that Norquist’s Taxpayer Protection Pledge is the height of fiscal irresponsibility. The pledge unconditionally rejects any net reduction in tax credits, deductions, or increase in rates unless matched dollar-for-dollar by some other tax reduction. (The pledge should have lost some of its gravitas when conservatives decided it didn’t apply to the payroll tax cut enacted last December.)
Since then, a rigid refusal to restore any revenues from levels diminished by current tax polices led Republican leadership to repeatedly walk out of debt ceiling negotiations, first with Vice President Biden and then again with President Obama. Instead of a grand bargain containing more desperately needed support for the faltering economy, our political system delivered an eleventh hour debt ceiling deal that prompted a credit rating downgrade from Standard & Poor’s, albeit on specious grounds (they made a $2 trillion baseline error but continued with the downgrade based strictly on political judgments). A stage of Republican presidential candidates unanimously declared that they would oppose a budget deal with 10 dollars in spending cuts for every dollar in new revenue.
Now, an impasse over revenue suggests that the super committee (tasked with negotiating the second phase of the debt ceiling deal) will go down in flames. This would trigger further discretionary spending cuts—the $111 billon cut slated for FY2013 would wallop GDP growth a year from now—and all but rule out more near-term fiscal support (due to limited borrowing headroom). The pledge is also hindering initiatives to put millions of Americans back to work; House Majority Leader Eric Cantor (R-Va.) recently proclaimed the American Jobs Act dead, having objected to its revenue offsets. Advantage Norquist?
Not so fast. Last Tuesday, Rep. Frank Wolf (R-Va.) excoriated Norqusit for guarding spending through the tax code, obstructing tax reform, and thwarting deficit reduction deals. “Have we really reached a point where one person’s demand for ideological purity is paralyzing Congress to the point that even a discussion of tax reform is viewed as breaking a no-tax pledge?” Wolf, who is one of only six House Republicans who have not signed Norquist’s pledge, came to Coburn’s defense a little too late, but this is nonetheless encouraging. Shortly thereafter, Taxpayer Protection Pledge signee Sen. John Thune (R-SD) said that Congress can’t be “bound by” pledges if it wants to enact comprehensive tax reform. Michael Gerson understands that pledge ideology rules out political agreement on long-term deficit reduction, and his attempt to fault the president’s emphasis on tax “fairness” as being equally unproductive is preposterous (he must have repressed all memories of the debt ceiling negotiations, and for good reason).
One by one, conservatives may be coming to the realization that the pledge is incompatible with fiscal responsibility of any form. Perhaps it helped that President Obama threatened to veto any budget deal that cuts Medicare without raising more revenue from upper-income households and businesses. Hopefully a critical mass of conservatives will stray from the herd of deficit peacocks and prioritize reducing the long-term budget deficit rather than blindly obsessing over the level of government spending.
Via Roberton Williams over at TaxVox, I see that House Majority Leader Eric Cantor has a surprising objection to President Obama’s American Jobs Act (AJA) and its pay-fors: it will hurt soup kitchens and Americans living in poverty. How? By taxing upper-income individuals, of course. Thank goodness compassionate conservatism isn’t dead.
As I noted earlier, the largest component of the revenue offsets for the AJA would limit the rate at which itemized deductions and specified above-the-line deductions and exclusions reduce tax liability for households with adjusted gross income above $200,000 ($250,000 for joint-filers). These tax expenditures increase in value with one’s marginal tax rate. The president’s proposal would cap the value at 28 percent, slightly reducing the benefit from 33 percent or 35 percent for these upper-income tax-filers. Cantor objects to the proposal on the grounds that it would further “tax charitable donations to soup kitchens, churches, and cancer research centers.”
Williams makes two excellent points: if the tax policy objective is a higher incentive to charitable giving, Cantor should 1) not object to restoring the top marginal tax rate to 39.6 percent, which he does, and 2) not support lowering the top marginal tax rate to 25 percent, which he also does. Indeed, the House Republican 2012 budget would cut both the corporate tax rate and top individual tax rate to 25 percent at a revenue loss of $2.0 trillion(some of which is theoretically offset by eliminating unspecified tax expenditures—perhaps perennial GOP targets such as the Earned Income Tax Credit), on top of continuing the regressive Bush-era tax cuts to the tune of $3.8 trillion.
But the Republican budget reveals much deeper hypocrisies when it comes to the interests of poor and working families than the marginal tax rate. Bob Greenstein of the Center on Budget and Policy Priorities estimated that two-thirds of the spending cuts in their budget come from programs for lower-income Americans. Food stamps are cut and federal spending on Medicaid—health care for the disabled, poor children, and poor seniors—is slashed in half over the next 20 years. Medicaid alone would be cut by $1.4 trillion this decade.
Broadly speaking, Cantor objects to a revenue offset that would only affect 2.2 percent of the population, according to the Tax Policy Center, most of whom earn at least tenfold the poverty threshold for a family of four. More critically for impoverished Americans, the $447 billion in near-term job creation would boost employment by 1.9 million jobs and reduce the unemployment rate by 1.0 percentage point next year, according to Mark Zandi of Moody’s Analytics. In 2010, the federal poverty threshold for a family of four was $22,113; a family with earned income at this level would receive a payroll tax cut of $686 under the American Jobs Act, but not under the House budget. Unemployment insurance kept 3.2 million Americans out of poverty last year; the American Jobs Act would extend emergency unemployment benefits, but the House budget would not. Soup kitchens aside, putting Americans back to work and strengthening, rather than eviscerating, the social safety net is the way to address rising poverty.
Cantor is correct that the tax incentive for charitable giving would decline, although only for 2.2 percent of households. Expressing this concern in the name of the poor is, however, irreconcilable with the budget he steered through the House of Representatives, which would represent a massive redistribution of wealth from low- and middle-income families to the so-called “job creators.”
Presidential candidate Herman Cain has made quite a splash with his “999” plan, but the catchiness of the proposal’s branding belies a subtle attack on low- and middle-income working families (and a not-so-subtle windfall for financiers and businesses).
Along with efficiency, the core principal behind a progressive tax code is one of equity—that the distribution of the nation’s tax liability should take into account one’s ability to pay. In other words, Americans with higher income should pay a higher share of their income in taxes than those with lower income. Mr. Cain’s plan would radically jettison this principle of equity along with the rest of the code.
Mr. Cain advocates a 9 percent tax on each of earned income, corporate income, and consumption. This would entail two changes: (1) a drastic cut in corporate and individual income taxes for high-earners, and (2) an increase in income and consumption (sales) taxes for low- and some middle-income households. Additionally, the proposal would eliminate all taxes on capital gains, dividends, foreign profits, and large estates and gifts (objectively the most progressive federal tax)—again a boon to the highest-income and/or wealthiest Americans. In a second bait-and-switch, the diminished taxes on earned income and corporate income would eventually be swapped for even higher taxes on consumption (the so-called “fair tax”).
Indeed Mr. Cain’s plan is just about diametrically opposed to Warren Buffett’s plea to stop coddling multi-millionaires and billionaires, many of whom pay lower effective tax rates than middle-class households because of the preferential tax treatment of investment income. It is hard to fathom a hedge fund manager paying a higher effective tax rate than a secretary under Mr. Cain’s plan; financiers would be able to receive all of their compensation as tax-free investment income and taxable consumption presumably accounts for a smaller share of income (certainly a smaller share than that of Mr. Buffett’s secretary). The windfall from eliminating investment income taxes would accrue to the top 1 percent of earners, who will pay over 70 percent of all capital gains and dividends taxes in 2011.
In recent congressional testimony, Syracuse University professor and tax expert Len Burman stated that “the biggest loophole is the lower rate on capital gains” and that “tax breaks on capital gains undermine the progressivity of the tax system.” Rebuilding an equitable tax code necessitates curtailing, rather than exacerbating, the preferential tax treatment of investment income over work income. That does not mean equalizing taxes on investment and work income at zero rates while amplifying a flat consumption tax, which would be even more regressive.
Mr. Cain’s tax proposal only makes sense if you believe that the problem with the current tax code is that low- and middle-income households have it way too good, and they should give more of their income to those poor Americans making more than half a million dollars a year.
While there are numerous job creation proposals that would meaningfully lower unemployment, some lawmakers are pushing counterproductive policies disguised as job creation packages. The proposed repeat of the corporate tax repatriation holiday is one such wolf in sheep’s clothing. The repatriation holiday would allow U.S. multinational companies to return foreign profits at a tax rate of 5.25 percent instead of the 35 percent corporate tax rate, repeating a 2004 corporate tax holiday that failed to produce its intended effects. Today, non-financial U.S. businesses are sitting on over a trillion dollars in cash but still aren’t hiring; increasing aggregate demand, not the supply of corporate cash, is the solution to jobs crisis.
A recent report by the Center on Budget and Policy Priorities details why another repatriation holiday would fail to create jobs, counter-productively push investment and jobs overseas, and add to the long-term budget deficit. Firms used the 2004 tax holiday predominantly to boost share prices,
and many of the firms actually laid-off thousands of American workers shortly after repatriating billions of dollars at the lower rate.
Dharmapala, Foley, and Forbes (2009) estimate that every dollar of repatriated foreign earnings was associated with a 92 cent payout in stock repurchases and dividend payments even though these were explicitly prohibited (money is fungible). Inflating the S&P 500 amounts to corporate welfare, not a jobs program.
So why would lawmakers double-down on this failed experiment in corporate tax policy? A recent report by NDN argues that a repatriation holiday will generate $8.7 billion over the next decade. This finding (and the entirety of the report) rejects the Joint Committee on Taxation’s estimate that a second repatriation holiday would result in $78.7 billion of lost revenue over a decade. The NDN report arrives at a different conclusion by stripping out JCT’s behavioral assumptions that (1) repatriation would fall several years after the holiday, and (2) that firms would reorganize, shifting earnings to foreign markets and patiently waiting for the next repatriation holiday.
Regardless of past evidence related to the 2004 repatriation holiday, you cannot extrapolate behavior from a onetime to repeated event. The 2004 repatriation holiday was sold as a one-time-only event. If companies are now led to believe that every 5-8 years they can bring foreign earnings back at a negligibly low tax rate, they would be foolish to repatriate any income at the 35 percent statutory rate.
The clear impact of another repatriation holiday would reduce the expected effective tax rate for foreign earnings, inducing companies to shift more operations overseas.
Economists care about moral hazard for a reason. The moral hazard associated with repeating the repatriation holiday—leaps and bounds beyond that of the first holiday—risks decreased investment and employment in the United States while exacerbating long-term budget deficits (the ones that matter). JCT’s behavioral concerns are well founded and cannot be ignored. Consequently, this policy would be bad for employment and bad for the federal budget.
The Washington Post’s editorial board was quick to rebuke President Obama’s recommendations to the Select Joint Committee on Deficit Reduction for not going far enough:
“The president’s plan would leave the debt at an unhealthy 73 percent of gross domestic product. The Simpson-Bowles plan would reduce that number to 65 percent, a still high but far less troubling level.”
What is driving this debt target of 65 percent, or 60 percent for that matter? Numerology comes to mind, as does austerity for austerity’s sake.
Let’s be clear – addressing the jobs-crisis is the most important near-term necessity – and if doing so drives the debt to greater than 60, 65 or 73 percent of GDP (or any other magical number), that’s fine.
Over the medium-term, stabilizing the trajectory for the debt-to-GDP ratio is a reasonable goal. But, there is no evidence at all that stabilizing it at 73 percent is more dangerous or troubling than any other number. (Click here for wonky footnote).
Reducing public debt-to-GDP by another 8 percentage points in 2021 would reduce annual debt service by roughly 0.3 percentage points of GDP. On the other hand, the steps required to achieve this fiscal contraction will also reduce economic activity in an economy that is years and years away from full employment. In fact, the economic activity suppressed by a fiscal contraction needed to achieve the Post‘s totally arbitrary target by 2021 would see foregone tax revenues and increased safety spending that would surely lead to a more than 0.3 percent of GDP deterioration in the budget. And millions of job-years lost to unemployment.
Our long-term budget blueprint Investing in America’s Economy, as adapted for the Peter G. Peterson Foundation’s Solutions Initiative, stabilized debt-to-GDP at 77 percent in 2021 and 82 percent by 2035. We thought investing $2.5 trillion over the next decade to put America back to work building a more competitive economy was more important than embracing austerity and targeting an arbitrary debt level. And again, there is no serious evidence that can be brought to bear suggesting that we’re wrong.
Footnote: Much of the policy rationale for targeting a lower debt ratio comes from Carmen Reinhart and Kenneth Rogoff’s paper Growth in a Time of Debt, which argues that economic growth becomes hindered when government debt exceeds 90 percent of GDP, but this research fails to identify causality. Slow growth can just as easily account for higher debt accumulation. And as my colleagues John Irons and Josh Bivens explain in this paper, the Reinhart and Rogoff results are inapplicable to the United States because the data sample is entirely sensitive to the post-war demobilization, in which economic contraction was driven by large spending cuts, not contemporaneously high debt. Stripping out 1945 and 1946 from the sample yields 2.8 percent average growth for all other years in which government debt exceeds 90 percent of GDP. (Note: their specification uses gross government debt rather than the more applicable measure—debt held by the public, which dictates market interest rates and any crowding out effects—so the 90 percent threshold isn’t an apples-to-apples comparison with the public debt levels discussed above.)
Debt hysteria yanked the national policy focus away from the economic recovery, toward the counterproductive debt ceiling debacle. The policy debate is finally pivoting back to job creation, but it should never have strayed, as is demonstrated by the abysmal 0.7 percent growth in the first half of this year and recent jobs reports. When it is time to think about longer-run fiscal problems, solutions should be informed by actual evidence, not hand-waving about debt targets that sound “troubling” for some ill-defined reason.
And how is the austerity camp faring in Europe? This week’s leader in The Economist finally proclaimed austerity a massive failure: “Sharply cutting budget deficits has been the priority—hence the tax rises and spending cuts. But this collectively huge fiscal contraction is self-defeating. By driving enfeebled countries into recession it only increases worries about both government debts and European banks.” This sounds a lot like Reinhart and Rogoff’s causality reversed. Whoops.
President Obama outlined a fairly progressive federal budget proposal for the Super Committee this morning, calling for upfront job creation, more revenue from high-earners, and preserving our commitments to children, the disabled, and the elderly. The proposal represents a balanced and progressive approach that addresses the root causes of our budget deficits, namely the Great Recession, a decade of ineffective and unfair tax cuts, and a decade of unfunded wars. Here’s a quick summary:
— $447 billion for the American Jobs Act
— $1.2 trillion in discretionary cuts (already enacted under the Budget Control Act)
— $1.1 trillion from drawing down troops overseas
— $577 billion from cuts to mandatory programs: about 40 percent are Medicare savings (mostly reducing overpayments), 10 percent are Medicaid/SCHIP savings, and the rest are from agricultural subsidies, federal employee benefits, and recalibrating government fees and program oversight
— $1.6 trillion, including $900 billion from allowing the Bush tax cuts to expire for high-earners and capping tax subsidies
— $436 billion in interest savings
There are many things in here for progressives to like. First, it focuses on job creation, including in the proposal the American Jobs Act that the president released last week. That’s as it should be—a continued downturn makes fiscal balance near impossible. The first step of the Super Committee must be getting the economy back on track, and the AJA is a good start.
Second, the proposal moves toward a more fair and equitable tax code. The guiding principle for reform is the so-called “Warren Buffet rule,” which holds that middle-class Americans shouldn’t be paying a higher tax rate than high-income Americans. Beyond addressing fairness, the proposal acknowledges that considerably more revenue is needed; the alternative spending-cuts-only approach would unacceptably force the brunt of deficit reduction on the backs of poor and working families. Furthermore, the president also issued a veto threat against any legislation that affects Medicare benefits without also including additional tax revenue from high-earners and corporations, a welcome sign that the president actually intends to use his constitutional powers as leverage in the coming negotiations.
Third, the proposal includes savings from winding down the wars in Iraq and Afghanistan. This reflects the fact that the wars in Iraq and Afghanistan are extremely expensive (nearly $1.3 trillion has already been appropriated for these wars over the last decade), and drawing them down entails substantial savings.
Fourth, the proposal generally takes the right approach to reforming health programs, doubling down on the health care reforms in the Affordable Care Act. On Medicare, it focuses on health provider savings while maintaining the commitment to seniors. The Medicaid savings are less positive, as they could shift costs to states and even undermine health care reform. But these proposals stand in stark contrast to the House Republican plan to turn Medicare into a voucher program—leaving seniors to fend for themselves in predatory, broken insurance markets—and cut Medicaid in half over the next two decades.
And fifth, the proposal does not cut Social Security, a recognition of the fact that the program does not impact the deficit over the long run. The president took a firm position that any Social Security reform must be done on a separate legislative track, one that focuses not on deficit reduction but rather on protecting it for future generations.
The outlined budget proposal would provide a counterweight to the lopsided discretionary spending cuts from the Budget Control Act and flip federal fiscal policy from being an obstacle to a force for economic recovery. This budget outline would also stabilize deficits and begin to reduce debt as a share of the economy in a balanced manner consistent with commitments to a fair tax code and economic security programs for children and seniors. Hopefully, the Super Committee will mirror this dual focus of strengthening the economy today and improving the long-term fiscal outlook in a balanced fashion.
Progressives believe the highest-income households should contribute more revenue; conservatives counter that the bottom half of earners should be paying more. When pressed about the need for revenue and shared sacrifice, House Majority Leader Eric Cantor recently lamented that nearly half of Americans don’t pay federal income taxes. Texas Governor Rick Perry went further, decrying this result of the tax code an “injustice.” This is a misleading grievance demonstrating a misunderstanding of the tax code: more than four in five households pay federal taxes and the role of the income tax is to adequately fund government without pushing more families into poverty.
While 46 percent of Americans won’t pay federal income taxes this year, 82 percent of households will pay federal income taxes and/or social insurance payroll taxes—predominantly Social Security and Medicare contributions. Payroll taxes are a tax on earned income and cannot be ignored because they are both regressive and substantial. Lower-income households pay higher average social insurance tax rates than upper-income households and these taxes brought in $865 billion last budget year (40 percent of all revenue).
A recent Tax Policy Center report explains that the basic structure of the tax code accounts for half of the 46 percent of households owing no income tax, while tax expenditures (preferences and credits) eliminate remaining income tax liability for the other half. The income tax code intentionally spares subsistence levels of income from taxation, hence the standard deduction ($5,800 for single filers and $11,600 for married joint filers) and personal exemption ($3,700). Of the households made nontaxable by tax expenditures, 44 percent pay no income tax because of special tax treatment for the elderly and 30 percent pay no income tax because of credits for children and poor workers.
Of the narrow 18 percent of households paying neither income nor payroll taxes, 57 percent are elderly households and 38 percent are non-elderly households with less than $20,000 in income. There simply isn’t much income here for taxes to collect: the lowest earning 20 percent of households (earning under $20,500 in 2007 dollars) received only 4 percent of pre-tax income in 2007, compared with 19 percent captured by the top 1 percent of households (earning above $352,900).
Broadening the tax base so that substantially more tax filers pay income taxes would require reducing the personal exemption, standard deduction, extra standard deduction for the elderly, exclusion of some Social Security benefits from taxation, child tax credit, or earned income tax credit. (Alternatively, higher employment and more evenly shared income gains would raise the number of households paying income taxes).
Forcing a higher tax burden on those with little to live on is a twisted concept of shared sacrifice, particularly when poverty has climbed to a 17-year high and recent income losses have been most pronounced at the bottom of the earnings distribution (see Figure H in this EPI analysis). Tax policy should instead focus on where the income gains have been concentrated over the last three decades.
Earlier this week, Office of Management and Budget Director Jack Lew outlined a package of tax changes to pay for the American Jobs Act. These offsets are generally consistent with our criteria for financing an effective jobs plan: the president’s proposed jobs bill would add to the near-term budget deficit (as it should) and gradually be paid for over the next decade, largely when the economy is stronger and unemployment is lower. Furthermore, the proposed offsets are entirely on the revenue side (also beneficial, as permanent tax changes have substantially less impact on near-term economic activity than spending cuts) and these specific polices would have almost no impact on economic activity.
The White House proposed four policies that would save $467 billion over the next decade, slightly exceeding the $447 billion price tag of the job creation package, which is front loaded over the next two years. Most of these policies were proposed in the president’s 2012 budget and none of the proposals would decrease disposable income for working and middle class families.
At $400 billion, the largest of the proposed offsets would limit the rate at which tax expenditures–such as itemized deductions–reduce tax liability for households with adjusted gross income above $200,000 ($250,000 for joint-filers). The value of most tax expenditures increase with a tax filer’s marginal tax rate; limiting this value would make many preferences less regressive while maintaining incentives embedded in the tax code.
The president’s budget proposed limiting the value of itemized deductions to 28%, which would have only affected 1.8% of tax filers relative to current tax policies, according to the Tax Policy Center. The Joint Committee on Taxation estimated that this would save $293 billion over 2012-21. This policy has been scaled up to also limit the value of specified above-the-line deductions and exclusions for upper-income households. (In our budget blueprint for economic recovery and fiscal responsibility, we proposed limiting the benefit on itemized deductions to 15% for savings of $1.2 trillion over 10 years).
The other offsets include $40 billion from ending subsidies to oil and gas companies, $18 billion from ending the carried interest loophole for investment income, and $3 billion from ending a tax break allowing firms to gradually write off the cost of corporate jets. The carried interest preference, which allows investment bankers to reclassify a portion of their ordinary income as capital gains subject to a 15% tax rate, was recently highlighted when Warren Buffet implored Congress to stop coddling millionaires with lower effective tax rates than those paid by many middle-class families. The oil and gas subsidies are prime examples of corporate welfare embedded in the tax code benefiting a particularly profitable industry. Repealing these carve outs will have a negligible impact on employment; further, all pass muster as progressive improvements to the tax code.
Beyond picking offsets that would have little impact on economic activity, the timing seems appropriate. The budgetary offsets would be delayed until Jan. 2013, and the offsets combined with the jobs package would almost certainly increase the budget deficit for the next two years (the timing of infrastructure outlays is somewhat uncertain).
Budgetary offsets focused more heavily on spending cuts or the near-term deficit would compromise the positive employment impact of the American Jobs Bill, but these progressive revenue changes would have a negligible impact on employment. Allowing the near-term budget deficit to rise and at the same time putting the country on a stable fiscal path over the long run isn’t just possible, it’s necessary.