Reforming Taxes as Part of  Budget Reform Testimony before the National Commission on Fiscal Responsibility and Reform  Ju...
Outline <ul><li>Taxes & the Budget </li></ul><ul><li>Principles of Public Finance  </li></ul><ul><li>More on Tax Subsidies...
Taxes & the Budget <ul><li>Reforming taxes involves dealing with: </li></ul><ul><ul><li>Entire revenue side of budget, inc...
Relationship Between Tax & Budget Reform <ul><li>Four ways to reduce deficits </li></ul><ul><ul><li>(1) Reduce direct spen...
Taxes & Spending per Household ($2010) Source: S. Rennane and C. E. Steuerle, the Urban Institute, 2010.  CBO Alternative ...
Relationship Between Tax & Budget Reform <ul><li>A common problem: permanent built-in growth </li></ul><ul><ul><li>Many ma...
Steuerle-Roeper Index of Fiscal Democracy: -- % of Revenues Not Yet Committed to Permanent (Mandatory) Programs--  Source:...
Principles of Public Finance --Apply to Taxes & Expenditures-- <ul><li>Equal Justice  (equal treatment of equals) </li></u...
Opportunities for Reform: Adhering to & Balancing Principles <ul><li>(1)   Special candidates for reform: a principle viol...
Tax Expenditures <ul><li>Expenditure-like preferences in tax code </li></ul><ul><li>Exclusions, deductions, credits, speci...
How Tax Expenditures Differ  From  Direct  Spending <ul><li>Enactments show up as tax cuts, not spending increases </li></...
Income & Corporate Tax Expenditures:  Comparison to Income Tax and Total Revenues   (2010, $ billions) *Percentages especi...
Tax Expenditures: Largest in 2009 (Billions, $2009) Source: OMB Analytical Perspectives. Income Tax Expenditures only. 13 ...
Tax Expenditures: Some Comparisons to  Spending by Function, 2009  ($, billions) Source: Center for a Responsible Federal ...
Distribution of Major Tax Expenditures Source: Burman, L., E. Toder and C. Geissler, 2008. Urban-Brookings Tax Policy Cent...
Distribution of Tax Expenditures  Throughout the Income Scale <ul><li>Benefits from high- to low-income taxpayers: </li></...
Examples of Issues  Throughout Income Distribution <ul><li>High income : zero taxes or multiple taxes? </li></ul><ul><ul><...
Sources of Tax Gap, 2001  ($ billions) Source: Toder, E.  2007. “What is the Tax Gap?” Tax Analysts. 18 Tax Sources Non-fi...
Tax Gap & Tax Havens: Opportunities <ul><li>Moderate saving relative to deficit, BUT …  </li></ul><ul><li>Tax Gap </li></u...
Thinking Comprehensively <ul><li>Inevitable controversy over cuts in spending & tax increases </li></ul><ul><ul><li>Headli...
Opportunities:  Interactive Tax & Budget Issues <ul><li>Work longer: more revenues at any given tax rate </li></ul><ul><li...
Consider Broad Rules & Criteria for Action <ul><li>Limit automatic growth in all mandatory programs </li></ul><ul><li>Remo...
Real Budget Reform Means Lower Taxes & Better Spending <ul><li>Over long-run, taxes = spending </li></ul><ul><ul><li>Curre...
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Testimony -taxreform--pres budget commission5

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Testimony -taxreform--pres budget commission5

  1. 1. 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
  2. 2. Outline <ul><li>Taxes & the Budget </li></ul><ul><li>Principles of Public Finance </li></ul><ul><li>More on Tax Subsidies & “Expenditures” </li></ul><ul><li>Tax Gap & Tax Havens </li></ul><ul><li>Thinking Comprehensively & Lessons from Past Tax Reform </li></ul>2
  3. 3. Taxes & the Budget <ul><li>Reforming taxes involves dealing with: </li></ul><ul><ul><li>Entire revenue side of budget, including special taxes for: </li></ul></ul><ul><ul><ul><li>Social Security & Medicare & highways </li></ul></ul></ul><ul><ul><li>Complex measurement issues (e.g., cost of business) </li></ul></ul><ul><ul><li>Incentives for work & saving (which affect future revenues) </li></ul></ul><ul><ul><li>Tax rates </li></ul></ul><ul><ul><li>About 1/4 to 1/3 of all “spending” or subsidies </li></ul></ul><ul><ul><ul><li>More housing subsidies (e.g., mortgage interest) than HUD </li></ul></ul></ul><ul><ul><ul><li>A larger low-income subsidy (EITC) than welfare (TANF) </li></ul></ul></ul><ul><li>Thousands of provisions </li></ul><ul><ul><li>Like expenditures, each provision a different rationale </li></ul></ul>3
  4. 4. Relationship Between Tax & Budget Reform <ul><li>Four ways to reduce deficits </li></ul><ul><ul><li>(1) Reduce direct spending </li></ul></ul><ul><ul><li>(2) Raise tax rates </li></ul></ul><ul><ul><li>(3) Spend less on tax subsidies </li></ul></ul><ul><ul><li>(4) Work more (& save more) </li></ul></ul><ul><ul><ul><li>Example: Raise early retirement age </li></ul></ul></ul><ul><ul><ul><ul><li>Biggest budget effect: income tax revenues </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Actually increases Social Security benefits </li></ul></ul></ul></ul><ul><li>All except (1) related to taxes </li></ul>4
  5. 5. 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
  6. 6. Relationship Between Tax & Budget Reform <ul><li>A common problem: permanent built-in growth </li></ul><ul><ul><li>Many mandatory spending (entitlement) programs </li></ul></ul><ul><ul><li>Most tax programs </li></ul></ul><ul><li>Throughout all U.S. history until today, the long-term budget under current law was in surplus </li></ul><ul><ul><li>E.g., huge 1980 surpluses under 1970 law </li></ul></ul><ul><ul><li>E.g., huge 1954 surpluses under 1944 law </li></ul></ul><ul><li>Today, revenues spent before new Congress assembles </li></ul>6
  7. 7. 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
  8. 8. Principles of Public Finance --Apply to Taxes & Expenditures-- <ul><li>Equal Justice (equal treatment of equals) </li></ul><ul><li>Efficiency (competitiveness, growth, bang per buck, no special favors) </li></ul><ul><li>Progressivity (e.g., don’t tax those who can’t pay; subsidize needs, not everyone) </li></ul><ul><li>Simplicity (includes transparency, ability to administer) </li></ul><ul><li>Individual Equity (entitled to rewards from own efforts) </li></ul>8
  9. 9. Opportunities for Reform: Adhering to & Balancing Principles <ul><li>(1) Special candidates for reform: a principle violated </li></ul><ul><ul><ul><li>without furthering other principles </li></ul></ul></ul><ul><ul><ul><li>Preferences by industry, consumption, taxpayer </li></ul></ul></ul><ul><li>(2) Check for balance </li></ul><ul><ul><li>How strong is policy rationale for intervention? </li></ul></ul><ul><ul><li>How much can base broadening deter rate increases? </li></ul></ul><ul><ul><li>What are the real marginal tax rates—direct & indirect? </li></ul></ul><ul><ul><li>What are the error rates? </li></ul></ul><ul><ul><li>Do we need multiple “programs” for education, capital gains rates, etc.? </li></ul></ul><ul><ul><li>What is the evidence for effectiveness? </li></ul></ul><ul><ul><li>Who really benefits? </li></ul></ul><ul><ul><li>Does form (e.g., credit or deduction) matter? </li></ul></ul><ul><ul><li>Are floors or caps reasonable? </li></ul></ul>9
  10. 10. Tax Expenditures <ul><li>Expenditure-like preferences in tax code </li></ul><ul><li>Exclusions, deductions, credits, special rates, timing shifts </li></ul><ul><li>Goals: social, economic, redistributive </li></ul><ul><ul><li>Usually targeted at specific groups or for specific activities </li></ul></ul><ul><li>Other Issues </li></ul><ul><ul><li>Accounting for them doesn’t make them good or bad per se </li></ul></ul><ul><ul><ul><li>Like expenditures, do affect behavior </li></ul></ul></ul><ul><ul><li>Often not “neutral” or efficient </li></ul></ul><ul><ul><ul><li>E.g., favor one form of energy production over another </li></ul></ul></ul><ul><ul><ul><li>E.g., favor one form of saving over another </li></ul></ul></ul><ul><ul><li>Some controversy over which to count </li></ul></ul><ul><ul><ul><li>Most conflicts over capital income taxation </li></ul></ul></ul><ul><ul><ul><li>For example, should base be income or consumption? </li></ul></ul></ul>10
  11. 11. How Tax Expenditures Differ From Direct Spending <ul><li>Enactments show up as tax cuts, not spending increases </li></ul><ul><li>Removals show up as tax increases, not spending cuts </li></ul><ul><li>Administered by IRS, not spending agencies </li></ul><ul><li>Other Considerations </li></ul><ul><ul><li>“ Authorized” by tax-writing committees </li></ul></ul><ul><ul><li>Most are permanent (“tax entitlements”) and many intended to be permanent (“tax extenders”) </li></ul></ul><ul><ul><li>Use annual accounting period (e.g., EITC based on annual wages, welfare based on monthly income) </li></ul></ul><ul><ul><li>Most (other than EITC and child credits) not “refundable” </li></ul></ul>11
  12. 12. 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%*
  13. 13. 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 $60 billion more in Social Security tax expenditures (own estimates).
  14. 14. Tax Expenditures: Some Comparisons to Spending by Function, 2009 ($, 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
  15. 15. 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%
  16. 16. Distribution of Tax Expenditures Throughout the Income Scale <ul><li>Benefits from high- to low-income taxpayers: </li></ul><ul><li>Lower rates on capital gains and dividends </li></ul><ul><li>Itemized deductions </li></ul><ul><li>Exclusions for pension & health insurance </li></ul><ul><li>Student loans & higher education subsidies </li></ul><ul><li>Above-the-line deductions </li></ul><ul><li>Child-care expenses & tuition credits </li></ul><ul><li>Child Credit (partially refundable) </li></ul><ul><li>Earned Income Credit (fully refundable) </li></ul>Source: Burman, L., E. Toder and C. Geissler, 2008. Urban-Brookings Tax Policy Center. 16
  17. 17. Examples of Issues Throughout Income Distribution <ul><li>High income : zero taxes or multiple taxes? </li></ul><ul><ul><li>Much income accrued & never taxed or taxed at capital gains rates </li></ul></ul><ul><ul><li>But also multiple taxation: </li></ul></ul><ul><ul><ul><li>individual, corporate, estate </li></ul></ul></ul><ul><li>Middle income : are adjustments appropriate & by how much? </li></ul><ul><ul><li>Housing, pensions </li></ul></ul><ul><ul><li>Adjustments for family size—too little or too much? </li></ul></ul><ul><ul><ul><li>Example: family of 4 & family of 2, each making $50,000 </li></ul></ul></ul><ul><li>Low income : who should administer and how? </li></ul><ul><ul><li>Earned income tax credit </li></ul></ul><ul><ul><ul><li>Alternative to welfare </li></ul></ul></ul><ul><ul><ul><li>But leaves out singles, particularly low-earning males </li></ul></ul></ul>17
  18. 18. Sources of Tax Gap, 2001 ($ 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, &quot;Tax Gap for Tax Year 2001&quot;, in Mark J. Mazur and Alan H. Plumley (2007)
  19. 19. Tax Gap & Tax Havens: Opportunities <ul><li>Moderate saving relative to deficit, BUT … </li></ul><ul><li>Tax Gap </li></ul><ul><ul><li>Simplification & lower rates = less tax gap </li></ul></ul><ul><ul><li>More IRS enforcement/resources </li></ul></ul><ul><ul><ul><li>Direct effects: about $4 per $1 of spending </li></ul></ul></ul><ul><ul><ul><li>Indirect effects: deterrence </li></ul></ul></ul><ul><ul><li>More information reporting + withholding </li></ul></ul><ul><ul><li>Greater equity, but labor switched out of “productive” activities </li></ul></ul><ul><li>Tax Havens </li></ul><ul><ul><ul><li>Both evasion (cheating) and legal avoidance (income shifting) </li></ul></ul></ul><ul><ul><ul><li>Business income shifting perhaps costs $20 billion to $60 billion </li></ul></ul></ul><ul><ul><ul><ul><li>Includes large interest deductions where few assets </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Disputes over “transfer pricing” & location of intangibles </li></ul></ul></ul></ul><ul><ul><ul><li>Financial capital extremely mobile </li></ul></ul></ul>Sources: E. Toder & R. Altshuler, Urban-Brookings Tax Policy Center; H.Grubert, Treasury; IRS; C. E. Steuerle 19
  20. 20. Thinking Comprehensively <ul><li>Inevitable controversy over cuts in spending & tax increases </li></ul><ul><ul><li>Headlines same for attacking 5 or 500 special interests </li></ul></ul><ul><ul><li>Controversy already assured over renewal of Bush tax cuts </li></ul></ul><ul><ul><li>Might as well claim some major achievement </li></ul></ul><ul><li>Lesson from 1984-86 tax reform effort </li></ul><ul><ul><li>Burden of proof under narrow reform: </li></ul></ul><ul><ul><ul><li>Special interest argue they have been “picked on” unfairly” </li></ul></ul></ul><ul><ul><li>Switch in burden of proof under broad reform: </li></ul></ul><ul><ul><ul><li>Special interests must argue why principles don’t apply to them </li></ul></ul></ul><ul><li>Precedent very important </li></ul><ul><ul><li>Congress facing fiscal huge challenges for many years </li></ul></ul>20
  21. 21. Opportunities: Interactive Tax & Budget Issues <ul><li>Work longer: more revenues at any given tax rate </li></ul><ul><li>Combined private pension & Social Security reform </li></ul><ul><ul><li>Recent British example </li></ul></ul><ul><li>Employee benefit reform: affect income taxes & Soc Sec solvency </li></ul><ul><li>Financial reform: tax-induced leverage </li></ul><ul><ul><li>Corporate debt preferred to equity </li></ul></ul><ul><ul><li>Individual borrowing for larger houses & second homes </li></ul></ul><ul><ul><li>Interest deductions, yet excluding interest in 401 (k) plans </li></ul></ul><ul><li>Unprecedented opportunity to combine direct spending & tax subsidies (not possible even in 1986 tax reform) </li></ul>21
  22. 22. Consider Broad Rules & Criteria for Action <ul><li>Limit automatic growth in all mandatory programs </li></ul><ul><li>Remove special preferences for particular types of industry, consumption or taxpayer </li></ul><ul><li>Trigger action for excessive growth or fiscal imbalance </li></ul><ul><ul><li>Goal is to encourage action </li></ul></ul><ul><li>Remove needless duplication (& combine programs) </li></ul><ul><ul><li>Education, capital gains, housing , urban, etc. </li></ul></ul>22
  23. 23. Real Budget Reform Means Lower Taxes & Better Spending <ul><li>Over long-run, taxes = spending </li></ul><ul><ul><li>Current spending = revenues collected today + revenues collected tomorrow </li></ul></ul><ul><ul><li>Bills don’t go away because paid with credit </li></ul></ul><ul><ul><li>Interest costs reduce funds for alternatives </li></ul></ul>23
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