The Truth About Taxes: What are Our Choices


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The truth is that taxes are both too high, and at the same time, too low. What we need is tax reform.

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The Truth About Taxes: What are Our Choices

  1. 1. The Truth About Taxes What are Our Choices? Presentation to the San Juan County League of Women Voters September 12, 2011 Terms of Use: These slides are made available under Creative Commons License Attribution—Share Alike 3.0 . You are free to use these slides as a resource for your economics classes together with whatever textbook you are using. If you like the slides, you may also want to take a look at my textbook, Introduction to Economics , from BVT Publishers. Another slideshow from Ed Dolan’s Econ Blog
  2. 2. The Truth about Taxes <ul><li>Here are the questions most often asked about taxes: </li></ul><ul><li>Are taxes too high? </li></ul><ul><li>Are taxes too low? </li></ul>YES! YES! Posted Sept. 12, 2011 to Ed Dolan’s Econ Blog
  3. 3. The Choice We Do Not Have: Do Nothing <ul><li>We do not have the choice of doing nothing about the federal budget. </li></ul><ul><li>If we do nothing, government debt will grow out of control and we will end up like Greece, or worse </li></ul>Posted Sept. 5, 2011 on Ed Dolan’s Econ Blog
  4. 4. How Do We Know if the Debt and Deficit are Sustainable? <ul><li>Whether or not the national debt is sustainable in the long run is a matter of simple arithmetic </li></ul><ul><li>Start with the ordinary balance (surplus or deficit) as a percent of GDP </li></ul><ul><li>Adjust the balance for effects of the business cycle: </li></ul><ul><ul><li>The budget should be allowed to move into deficit during a recession </li></ul></ul><ul><ul><li>It should move into surplus during an expansion </li></ul></ul><ul><ul><li>The average balance over the cycle is called the cyclically adjusted balance </li></ul></ul><ul><li>Subtract interest payments to get the cyclically adjusted primary balance </li></ul><ul><li>For the national debt to be sustainable in the long run, the cyclically adjusted primary balance must be near zero, or in slight surplus </li></ul>Posted Sept. 5, 2011 on Ed Dolan’s Econ Blog
  5. 5. The US Budget Deficit: An International Comparison <ul><li>The cyclically adjusted primary deficit for the United States is about 6.8% of GDP </li></ul><ul><li>That is the worst number among all industrialized countries </li></ul><ul><li>To avoid budget disaster, the US needs to reduce the deficit </li></ul><ul><ul><li>by about 7% of GDP </li></ul></ul><ul><ul><li>by about $1 trillion per year </li></ul></ul><ul><ul><li>by more than ¼ of the current size of the federal budget </li></ul></ul>Posted Sept. 5, 2011 on Ed Dolan’s Econ Blog
  6. 6. Now for The Choices We Do Have <ul><li>The first choice is to decide what level of government services we really want </li></ul><ul><li>The amount of government spending determines the amount of taxes we need </li></ul><ul><li>When we know that, we can choose a tax system that collects enough revenue to pay for the services we want </li></ul> Posted Sept. 5, 2011 on Ed Dolan’s Econ Blog
  7. 7. How Large are Expenditures? Historical Comparisons <ul><li>Total federal expenditures since 2008 have been high in relation to GDP, mostly because of the deep recession </li></ul><ul><li>Cyclically adjusted expenditures are now about the same as in the 1980s </li></ul><ul><li>For comparison, the balanced budget amendment proposed by House Republicans would cap total spending at 18% of GDP, about where they were in Eisenhower’s last year in office </li></ul>Posted Sept. 5, 2011 on Ed Dolan’s Econ Blog
  8. 8. How Large are Expenditures? International Comparisons <ul><li>Combined US government expenditures are among the lowest of developed countries, although some countries do seem to get along well with even less </li></ul><ul><li>For accurate international comparison, the totals shown here include all levels of government—federal, state and local </li></ul><ul><li>Federal expenditures are about 60% of the total for the United States </li></ul>Posted Sept. 5, 2011 on Ed Dolan’s Econ Blog
  9. 9. Composition of Expenditures <ul><li>When many people think of government, they think of schools, parks, and fire fighters </li></ul><ul><li>However, the federal government more accurately described as an insurance company with an army attached </li></ul><ul><li>All other government functions (nondefense discretionary) are less than a fifth of federal spending </li></ul>Posted Sept. 5, 2011 on Ed Dolan’s Econ Blog
  10. 10. Cutting Spending Involves Hard Choices <ul><li>To make the budget sustainable without new taxes would require spending cuts of about 7 percent of GDP </li></ul><ul><li>Cutting defense spending in half would save 2.4% of GDP </li></ul><ul><li>Cutting nondefense discretionary spending in half would save another 2.4% of GDP </li></ul><ul><li>Even after those reductions, 2.2% of GDP would have to be cut from entitlements </li></ul>Posted Sept. 5, 2011 on Ed Dolan’s Econ Blog
  11. 11. Why Cutting Entitlements is Hard <ul><li>The US old age dependency ratio will rise sharply in coming decades </li></ul><ul><li>Even holding total entitlement spending constant, let alone cutting it, would require far lower benefits per person than in recent decades </li></ul><ul><li>The bottom line: Yes, it would be possible to cut federal spending to 18% of GDP but doing so would leave us with a lower level of government services and benefits than at any time in the post-World War II period </li></ul>Posted Sept. 5, 2011 on Ed Dolan’s Econ Blog
  12. 12. What Choices do We Have for Tax Revenue? <ul><li>After deciding how much government we want, we need to find enough tax revenue to pay for it </li></ul><ul><li>Income taxes are now the biggest source of federal revenue </li></ul><ul><li>Payroll taxes (social security and Medicare) have grown over time </li></ul><ul><li>Corporate income taxes are much less important than they were at one time </li></ul>Chart source: Posted Sept. 5, 2011 on Ed Dolan’s Econ Blog
  13. 13. The Case for Tax Reform <ul><li>Earlier we said that taxes were both too high AND too low </li></ul><ul><li>Are taxes too high? Yes, in the sense that high tax rates distort economic decisions of businesses and families </li></ul><ul><li>Are taxes too low? Yes, in the sense that our current tax system does not produce enough revenue to pay for the services people want and vote for </li></ul><ul><li>What we need are not higher taxes or lower taxes, but tax reform </li></ul><ul><li>Broaden the base by closing loopholes </li></ul><ul><li>Lower marginal tax rates </li></ul><ul><li>Switch to taxes that have fewer perverse incentive effects </li></ul>Posted Sept. 5, 2011 on Ed Dolan’s Econ Blog
  14. 14. The Dirty Dozen Tax Loopholes <ul><li>The 12 biggest tax expenditures amounted to more than $600 billion in 2008, nearly one fourth of federal revenue that year </li></ul><ul><li>If all or most of these loopholes were eliminated, everyone’s tax rates could be cut while still increasing taxes by enough to help balance the budget </li></ul><ul><li>Value of tax expenditures in 2008 ($ billions) </li></ul><ul><li>Employer-paid health care (131) </li></ul><ul><li>Pension contributions and earnings (117) </li></ul><ul><li>Mortgage interest deduction (89) </li></ul><ul><li>Accelerated depreciation (56) </li></ul><ul><li>State and local tax deduction, other than property taxes (49) </li></ul><ul><li>Charitable contributions (47) </li></ul><ul><li>Deferral of income from foreign corporations (31) </li></ul><ul><li>Exclusion of capital gains on sale of homes (30) </li></ul><ul><li>Property tax deduction on homes (29) </li></ul><ul><li>Child credit (28) </li></ul><ul><li>Capital gains rate (24) </li></ul><ul><li>Capital gains basis step-up at death (22) </li></ul><ul><li>Data source: </li></ul>Posted Sept. 5, 2011 on Ed Dolan’s Econ Blog
  15. 15. Who Benefits? Example: Mortgage Interest Deductions <ul><li>The benefits of many tax loopholes are concentrated on a small minority of the population </li></ul><ul><li>Example: The mortgage interest deduction has the greatest value for high-income families that are more likely to itemize deductions, own larger homes, and are in higher tax brackets </li></ul><ul><li>The average value of the deduction to lower-income groups is very small </li></ul>Posted Sept. 5, 2011 on Ed Dolan’s Econ Blog
  16. 16. What Taxes Are Too High? <ul><li>Payroll taxes (social security and Medicare) </li></ul><ul><ul><li>Increase cost of hiring </li></ul></ul><ul><ul><li>Highly regressive—heavy burden on low- and middle-income workers </li></ul></ul><ul><li>Personal income taxes </li></ul><ul><ul><li>Discourage work effort </li></ul></ul><ul><ul><li>Discourage saving </li></ul></ul><ul><li>Corporate income taxes </li></ul><ul><ul><li>US has close to the world’s highest rates but collects very little revenue </li></ul></ul><ul><ul><li>High rates + loopholes distort business decisions </li></ul></ul><ul><ul><ul><li>Encourage businesses to move money and jobs offshore </li></ul></ul></ul><ul><ul><ul><li>Encourage excessive corporate debt </li></ul></ul></ul>Posted Sept. 5, 2011 on Ed Dolan’s Econ Blog
  17. 17. New tax ideas: Energy taxes <ul><li>Another path to tax reform is to replace existing taxes with new kinds of broad-based taxes </li></ul><ul><li>Advantages of energy taxes </li></ul><ul><ul><li>Discourage excessive energy use that contributes to climate change and local pollution </li></ul></ul><ul><ul><li>Reduce national security risks associated with excessive US dependence on oil from unfriendly governments </li></ul></ul><ul><ul><li>Can take many forms: Gasoline tax, carbon tax, cap-and-trade, or other </li></ul></ul>Posted Sept. 5, 2011 on Ed Dolan’s Econ Blog
  18. 18. New tax ideas: Value Added Taxes <ul><li>Value added taxes (similar to sales taxes) are the biggest source of revenue in most other countries </li></ul><ul><li>Advantages of VAT </li></ul><ul><ul><li>Taxes consumption, encourages saving </li></ul></ul><ul><ul><li>Broad tax base with fewer special-interest loopholes </li></ul></ul><ul><ul><li>5% VAT in US could raise about 2.5% of GDP, enough to completely eliminate the corporate tax and reduce other rates, too </li></ul></ul>Posted Sept. 5, 2011 on Ed Dolan’s Econ Blog
  19. 19. Why Everyone Should Support Tax Reform <ul><li>Tax reform for Liberals . . . </li></ul><ul><li>Raise enough tax revenue to balance the budget and support total government spending around 23% of GDP </li></ul><ul><li>Close special interest loopholes for corporations and wealthy individuals </li></ul><ul><li>Introduce VAT and energy taxes </li></ul><ul><li>Sharply cut payroll taxes to encourage hiring </li></ul><ul><li>Moderately reduce income tax rates for everyone </li></ul><ul><li>Tax reform for Conservatives . . . </li></ul><ul><li>Bring in enough tax revenue to balance the budget and support total government spending around 18% of GDP </li></ul><ul><li>Close special interest loopholes while cutting income tax rates for everyone </li></ul><ul><li>Eliminate corporate income tax altogether, replacing it with VAT </li></ul>Posted Sept. 5, 2011 on Ed Dolan’s Econ Blog
  20. 20. The Bottom Line <ul><li>The truth about taxes is that we need tax reform that broadens the tax base and reduces marginal tax rates for everyone </li></ul><ul><li>Choices we have: </li></ul><ul><ul><li>What level of services do we want? </li></ul></ul><ul><ul><li>What kind of tax system will best raise the revenue needed to pay for them? </li></ul></ul><ul><li>The choice we do not have: continue our current level of services without the taxes we need to pay for them </li></ul>Posted Sept. 5, 2011 on Ed Dolan’s Econ Blog
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