Testimony -taxreform--pres budget commission5
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Testimony -taxreform--pres budget commission5 Testimony -taxreform--pres budget commission5 Presentation Transcript

  • Reforming Taxes as Part of Budget Reform Testimony before the National Commission on Fiscal Responsibility and Reform June 23, 2010 C. Eugene Steuerle Institute Fellow & Richard B. Fisher Chair The Urban Institute
  • Outline
    • Taxes & the Budget
    • Principles of Public Finance
    • More on Tax Subsidies & “Expenditures”
    • Tax Gap & Tax Havens
    • Thinking Comprehensively & Lessons from Past Tax Reform
    2
  • Taxes & the Budget
    • Reforming taxes involves dealing with:
      • Entire revenue side of budget, including special taxes for:
        • Social Security & Medicare & highways
      • Complex measurement issues (e.g., cost of business)
      • Incentives for work & saving (which affect future revenues)
      • Tax rates
      • About 1/4 to 1/3 of all “spending” or subsidies
        • More housing subsidies (e.g., mortgage interest) than HUD
        • A larger low-income subsidy (EITC) than welfare (TANF)
    • Thousands of provisions
      • Like expenditures, each provision a different rationale
    3
  • Relationship Between Tax & Budget Reform
    • Four ways to reduce deficits
      • (1) Reduce direct spending
      • (2) Raise tax rates
      • (3) Spend less on tax subsidies
      • (4) Work more (& save more)
        • Example: Raise early retirement age
          • Biggest budget effect: income tax revenues
          • Actually increases Social Security benefits
    • All except (1) related to taxes
    4
  • Taxes & Spending per Household ($2010) Source: S. Rennane and C. E. Steuerle, the Urban Institute, 2010. CBO Alternative Baseline, with author adjustments for health reform. 5 2011 2020 Taxes per household $ 20,000 $ 26,000 Total Spending per household $ 30,000 $ 35,000 Tax Expenditures per household $ 9,600 $ 12,400 Interest Spending per Household $ 2,000 $ 7,000
  • Relationship Between Tax & Budget Reform
    • A common problem: permanent built-in growth
      • Many mandatory spending (entitlement) programs
      • Most tax programs
    • Throughout all U.S. history until today, the long-term budget under current law was in surplus
      • E.g., huge 1980 surpluses under 1970 law
      • E.g., huge 1954 surpluses under 1944 law
    • Today, revenues spent before new Congress assembles
    6
  • Steuerle-Roeper Index of Fiscal Democracy: -- % of Revenues Not Yet Committed to Permanent (Mandatory) Programs-- Source: S. Rennane, T. Roeper and C. E. Steuerle, 2010. Data from OMB and CBO, with author adjustments for health reform. Excludes TARP. 7
  • Principles of Public Finance --Apply to Taxes & Expenditures--
    • Equal Justice (equal treatment of equals)
    • Efficiency (competitiveness, growth, bang per buck, no special favors)
    • Progressivity (e.g., don’t tax those who can’t pay; subsidize needs, not everyone)
    • Simplicity (includes transparency, ability to administer)
    • Individual Equity (entitled to rewards from own efforts)
    8
  • Opportunities for Reform: Adhering to & Balancing Principles
    • (1) Special candidates for reform: a principle violated
        • without furthering other principles
        • Preferences by industry, consumption, taxpayer
    • (2) Check for balance
      • How strong is policy rationale for intervention?
      • How much can base broadening deter rate increases?
      • What are the real marginal tax rates—direct & indirect?
      • What are the error rates?
      • Do we need multiple “programs” for education, capital gains rates, etc.?
      • What is the evidence for effectiveness?
      • Who really benefits?
      • Does form (e.g., credit or deduction) matter?
      • Are floors or caps reasonable?
    9
  • Tax Expenditures
    • Expenditure-like preferences in tax code
    • Exclusions, deductions, credits, special rates, timing shifts
    • Goals: social, economic, redistributive
      • Usually targeted at specific groups or for specific activities
    • Other Issues
      • Accounting for them doesn’t make them good or bad per se
        • Like expenditures, do affect behavior
      • Often not “neutral” or efficient
        • E.g., favor one form of energy production over another
        • E.g., favor one form of saving over another
      • Some controversy over which to count
        • Most conflicts over capital income taxation
        • For example, should base be income or consumption?
    10
  • How Tax Expenditures Differ From Direct Spending
    • Enactments show up as tax cuts, not spending increases
    • Removals show up as tax increases, not spending cuts
    • Administered by IRS, not spending agencies
    • Other Considerations
      • “ Authorized” by tax-writing committees
      • Most are permanent (“tax entitlements”) and many intended to be permanent (“tax extenders”)
      • Use annual accounting period (e.g., EITC based on annual wages, welfare based on monthly income)
      • Most (other than EITC and child credits) not “refundable”
    11
  • Income & Corporate Tax Expenditures: Comparison to Income Tax and Total Revenues (2010, $ billions) *Percentages especially high in 2010 due to recession Source: Urban-Brookings Tax Policy Center, 2010. 12 Total Income Tax Expenditures 1,099 Total Income Tax 1,093 Total Revenues 2,126 Income Tax Expenditures as % of Total Income Tax 101%* Income Tax Expenditures as % of Total Revenues 52%*
  • Tax Expenditures: Largest in 2009 (Billions, $2009) Source: OMB Analytical Perspectives. Income Tax Expenditures only. 13 Employer contributions to health insurance* 144 Exclusion for pensions & retirement plans (income tax only) 85 Deductibility of mortgage interest 79 Accelerated depreciation-machinery & equipment 57 Capital gains 53 Earned income tax credit 49 Deductibility of non-business state and local taxes 45 Child credit 45 Step-up basis of capital gains at death 41 *Income tax only. At least $60 billion more in Social Security tax expenditures (own estimates).
  • Tax Expenditures: Some Comparisons to Spending by Function, 2009 ($, billions) Source: Center for a Responsible Federal Budget. Tax Expenditure calculations do not include interaction effects. 14   Outlays Tax Expenditures* Total National defense 661 12 673 International affairs 38 46 83 General science, space and technology 29 12 41 Energy 5 5 10 Natural resources and environment 36 2 37 Agriculture 22 1 23 Commerce and housing 292 385 677 Transportation 84 4 88 Community and regional development 28 3 31 Educ., training, emp., and social services 80 109 188 Health 334 168 502 Medicare 430 430 Income security 533 130 664 Social Security 678 31 709 Veterans benefits and services 95 4 100 Other 168 175 343 Total 3,513 1,087 4,600
  • Distribution of Major Tax Expenditures Source: Burman, L., E. Toder and C. Geissler, 2008. Urban-Brookings Tax Policy Center. 15 Percent Reduction in After-Tax Income: Eliminating Major Individual Income Tax Expenditures, by Income Quintile   Bottom Quintile 2 nd Quintile Middle Quintile 4 th Quintile Top Quintile Without interactions 5.6% 8.0% 6.8% 6.5% 10.7% With interactions 6.5% 8.2% 6.8% 6.8% 11.4%
  • Distribution of Tax Expenditures Throughout the Income Scale
    • Benefits from high- to low-income taxpayers:
    • Lower rates on capital gains and dividends
    • Itemized deductions
    • Exclusions for pension & health insurance
    • Student loans & higher education subsidies
    • Above-the-line deductions
    • Child-care expenses & tuition credits
    • Child Credit (partially refundable)
    • Earned Income Credit (fully refundable)
    Source: Burman, L., E. Toder and C. Geissler, 2008. Urban-Brookings Tax Policy Center. 16
  • Examples of Issues Throughout Income Distribution
    • High income : zero taxes or multiple taxes?
      • Much income accrued & never taxed or taxed at capital gains rates
      • But also multiple taxation:
        • individual, corporate, estate
    • Middle income : are adjustments appropriate & by how much?
      • Housing, pensions
      • Adjustments for family size—too little or too much?
        • Example: family of 4 & family of 2, each making $50,000
    • Low income : who should administer and how?
      • Earned income tax credit
        • Alternative to welfare
        • But leaves out singles, particularly low-earning males
    17
  • Sources of Tax Gap, 2001 ($ billions) Source: Toder, E. 2007. “What is the Tax Gap?” Tax Analysts. 18 Tax Sources Non-filing Under-reporting Under-payment Total Individual Income Tax 25 197 23.4 245 Non-business income   56     Business income   109     Adjustments, deductions, exemptions   15     Credits   17     Corporation Income Tax   30 2.3 32 Employment Tax (e.g., Social Security)   54 5 59 Estate Tax 2 4 2.1 8 Excise Tax     0.5 0.5 All Taxes 27 285 33.3 345 Memo: Taxes paid by individuals 27 240 25.5 293 Memo2: Taxes on business income of individuals   148     Source: Internal Revenue Service, "Tax Gap for Tax Year 2001", in Mark J. Mazur and Alan H. Plumley (2007)
  • Tax Gap & Tax Havens: Opportunities
    • Moderate saving relative to deficit, BUT …
    • Tax Gap
      • Simplification & lower rates = less tax gap
      • More IRS enforcement/resources
        • Direct effects: about $4 per $1 of spending
        • Indirect effects: deterrence
      • More information reporting + withholding
      • Greater equity, but labor switched out of “productive” activities
    • Tax Havens
        • Both evasion (cheating) and legal avoidance (income shifting)
        • Business income shifting perhaps costs $20 billion to $60 billion
          • Includes large interest deductions where few assets
          • Disputes over “transfer pricing” & location of intangibles
        • Financial capital extremely mobile
    Sources: E. Toder & R. Altshuler, Urban-Brookings Tax Policy Center; H.Grubert, Treasury; IRS; C. E. Steuerle 19
  • Thinking Comprehensively
    • Inevitable controversy over cuts in spending & tax increases
      • Headlines same for attacking 5 or 500 special interests
      • Controversy already assured over renewal of Bush tax cuts
      • Might as well claim some major achievement
    • Lesson from 1984-86 tax reform effort
      • Burden of proof under narrow reform:
        • Special interest argue they have been “picked on” unfairly”
      • Switch in burden of proof under broad reform:
        • Special interests must argue why principles don’t apply to them
    • Precedent very important
      • Congress facing fiscal huge challenges for many years
    20
  • Opportunities: Interactive Tax & Budget Issues
    • Work longer: more revenues at any given tax rate
    • Combined private pension & Social Security reform
      • Recent British example
    • Employee benefit reform: affect income taxes & Soc Sec solvency
    • Financial reform: tax-induced leverage
      • Corporate debt preferred to equity
      • Individual borrowing for larger houses & second homes
      • Interest deductions, yet excluding interest in 401 (k) plans
    • Unprecedented opportunity to combine direct spending & tax subsidies (not possible even in 1986 tax reform)
    21
  • Consider Broad Rules & Criteria for Action
    • Limit automatic growth in all mandatory programs
    • Remove special preferences for particular types of industry, consumption or taxpayer
    • Trigger action for excessive growth or fiscal imbalance
      • Goal is to encourage action
    • Remove needless duplication (& combine programs)
      • Education, capital gains, housing , urban, etc.
    22
  • Real Budget Reform Means Lower Taxes & Better Spending
    • Over long-run, taxes = spending
      • Current spending = revenues collected today + revenues collected tomorrow
      • Bills don’t go away because paid with credit
      • Interest costs reduce funds for alternatives
    23