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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.

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