Reforming Taxes as Part of Budget Reform


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Reforming Taxes as Part of Budget Reform

  1. 1. Reforming Taxes as Part of Budget Reform<br />Testimony before the National Commission on Fiscal Responsibility and Reform <br />June 23, 2010<br />C. Eugene Steuerle<br />Institute Fellow & Richard B. Fisher Chair<br />The Urban Institute<br />
  2. 2. Outline<br />Taxes & the Budget<br />Principles of Public Finance <br />More on Tax Subsidies & “Expenditures”<br />Tax Gap & Tax Havens <br />Thinking Comprehensively & Lessons from Past Tax Reform <br />2<br />
  3. 3. Taxes & the Budget<br />Reforming taxes involves dealing with:<br />Entire revenue side of budget, including special taxes for:<br />Social Security & Medicare & highways <br />Complex measurement issues (e.g., cost of business)<br />Incentives for work & saving (which affect future revenues)<br />Tax rates<br />About 1/4 to 1/3 of all “spending” or subsidies<br />More housing subsidies (e.g., mortgage interest) than HUD<br />A larger low-income subsidy (EITC) than welfare (TANF) <br />Thousands of provisions<br />Like expenditures, each provision a different rationale<br />3<br />
  4. 4. Relationship Between Tax &Budget Reform<br />Four ways to reduce deficits<br />(1) Reduce direct spending <br />(2) Raise tax rates <br />(3) Spend less on tax subsidies<br />(4) Work more (& save more)<br />Example: Raise early retirement age <br />Biggest budget effect: income tax revenues<br />Actually increases Social Security benefits<br />All except (1) related to taxes<br />4<br />
  5. 5. Taxes & Spending per Household($2010)<br />5<br />Source: S. Rennane and C. E. Steuerle, the Urban Institute, 2010. CBO Alternative Baseline, with author adjustments for health reform.<br />
  6. 6. Relationship Between Tax &Budget Reform<br />A common problem: permanent built-in growth<br />Many mandatory spending (entitlement) programs<br />Most tax programs <br />Throughout all U.S. history until today, the long-term budget under current law was in surplus<br />E.g., huge 1980 surpluses under 1970 law<br />E.g., huge 1954 surpluses under 1944 law<br />Today, revenues spent before new Congress assembles<br />6<br />
  7. 7. Steuerle-Roeper Index of Fiscal Democracy:-- % of Revenues Not Yet Committed toPermanent (Mandatory) Programs-- <br /> 7<br />Source: S. Rennane, T. Roeper and C. E. Steuerle, 2010. Data from OMB and CBO, with author adjustments for health reform. Excludes TARP.<br />
  8. 8. Principles of Public Finance--Apply to Taxes & Expenditures--<br />Equal Justice (equal treatment of equals)<br />Efficiency (competitiveness, growth, bang per buck, no special favors)<br />Progressivity (e.g., don’t tax those who can’t pay; subsidize needs, not everyone)<br />Simplicity (includes transparency, ability to administer)<br />Individual Equity (entitled to rewards from own efforts)<br />8<br />
  9. 9. Opportunities for Reform:Adhering to & Balancing Principles<br />(1)Special candidates for reform: a principle violated<br />without furthering other principles<br />Preferences by industry, consumption, taxpayer<br />(2)Check for balance<br />How strong is policy rationale for intervention?<br />How much can base broadening deter rate increases?<br />What are the real marginal tax rates—direct & indirect?<br />What are the error rates?<br />Do we need multiple “programs” for education, capital gains rates, etc.? <br />What is the evidence for effectiveness?<br />Who really benefits?<br />Does form (e.g., credit or deduction) matter?<br />Are floors or caps reasonable?<br />9<br />
  10. 10. Tax Expenditures<br />Expenditure-like preferences in tax code<br />Exclusions, deductions, credits, special rates, timing shifts<br />Goals: social, economic, redistributive<br />Usually targeted at specific groups or for specific activities<br />Other Issues<br />Accounting for them doesn’t make them good or bad per se<br />Like expenditures, do affect behavior<br />Often not “neutral” or efficient<br />E.g., favor one form of energy production over another<br />E.g., favor one form of saving over another <br />Some controversy over which to count <br />Most conflicts over capital income taxation<br />For example, should base be income or consumption?<br />10<br />
  11. 11. How Tax Expenditures Differ From Direct Spending<br />Enactments show up as tax cuts, not spending increases<br />Removals show up as tax increases, not spending cuts<br />Administered by IRS, not spending agencies<br />Other Considerations<br />“Authorized” by tax-writing committees<br />Most are permanent (“tax entitlements”) and many intended to be permanent (“tax extenders”)<br />Use annual accounting period (e.g., EITC based on annual wages, welfare based on monthly income)<br />Most (other than EITC and child credits) not “refundable”<br />11<br />
  12. 12. Income & Corporate Tax Expenditures: Comparison to Income Tax and Total Revenues(2010, $ billions)<br />*Percentages especially high in 2010 due to recession<br />Source: Urban-Brookings Tax Policy Center, 2010.<br />12<br />
  13. 13. Tax Expenditures: Largest in 2009(Billions, $2009)<br />13<br />Source: OMB Analytical Perspectives. Income Tax Expenditures only.<br />
  14. 14. Tax Expenditures: Some Comparisons to Spending by Function, 2009 ($, billions)<br />14<br />Source: Center for a Responsible Federal Budget. Tax Expenditure calculations do not include interaction effects.<br />
  15. 15. Distribution of Major Tax Expenditures<br />15<br />Source: Burman, L., E. Toder and C. Geissler, 2008. Urban-Brookings Tax Policy Center.<br />
  16. 16. Distribution of Tax Expenditures Throughout the Income Scale<br />Benefits from high- to low-income taxpayers:<br />Lower rates on capital gains and dividends<br />Itemized deductions<br />Exclusions for pension & health insurance <br />Student loans & higher education subsidies<br />Above-the-line deductions<br />Child-care expenses & tuition credits<br />Child Credit (partially refundable)<br />Earned Income Credit (fully refundable)<br />16<br />Source: Burman, L., E. Toder and C. Geissler, 2008. Urban-Brookings Tax Policy Center.<br />
  17. 17. Examples of Issues Throughout Income Distribution<br />High income: zero taxes or multiple taxes?<br />Much income accrued & never taxed or taxed at capital gains rates<br />But also multiple taxation: <br />individual, corporate, estate<br />Middle income: are adjustments appropriate & by how much?<br />Housing, pensions<br />Adjustments for family size—too little or too much? <br />Example: family of 4 & family of 2, each making $50,000<br />Low income: who should administer and how? <br />Earned income tax credit <br />Alternative to welfare<br />But leaves out singles, particularly low-earning males<br />17<br />
  18. 18. Sources of Tax Gap, 2001 ($ billions)<br />18<br />Source: Toder, E. 2007. “What is the Tax Gap?” Tax Analysts.<br />
  19. 19. Tax Gap & Tax Havens: Opportunities<br />Moderate saving relative to deficit, BUT… <br />Tax Gap<br />Simplification & lower rates = less tax gap<br />More IRS enforcement/resources<br />Direct effects: about $4 per $1 of spending<br />Indirect effects: deterrence<br />More information reporting + withholding<br />Greater equity, but labor switched out of “productive” activities<br />Tax Havens<br />Both evasion (cheating) and legal avoidance (income shifting)<br />Business income shifting perhaps costs $20 billion to $60 billion<br />Includes large interest deductions where few assets<br />Disputes over “transfer pricing” & location of intangibles<br />Financial capital extremely mobile<br />19<br />Sources: E. Toder & R. Altshuler, Urban-Brookings Tax Policy Center; H.Grubert, Treasury; IRS; C. E. Steuerle<br />
  20. 20. Thinking Comprehensively<br />Inevitable controversy over cuts in spending & tax increases<br />Headlines same for attacking 5 or 500 special interests<br />Controversy already assured over renewal of Bush tax cuts<br />Might as well claim some major achievement <br />Lesson from 1984-86 tax reform effort <br />Burden of proof under narrow reform: <br />Special interest argue they have been “picked on” unfairly”<br />Switch in burden of proof under broad reform: <br />Special interests must argue why principles don’t apply to them<br />Precedent very important<br />Congress facing fiscal huge challenges for many years<br />20<br />
  21. 21. Opportunities: Interactive Tax & Budget Issues<br />Work longer: more revenues at any given tax rate<br />Combined private pension & Social Security reform<br />Recent British example<br />Employee benefit reform: affect income taxes & Soc Sec solvency<br />Financial reform: tax-induced leverage<br />Corporate debt preferred to equity<br />Individual borrowing for larger houses & second homes<br />Interest deductions, yet excluding interest in 401 (k) plans<br />Unprecedented opportunity to combine direct spending & tax subsidies (not possible even in 1986 tax reform) <br />21<br />
  22. 22. Consider Broad Rules & Criteria for Action<br />Limit automatic growth in all mandatory programs<br />Remove special preferences for particular types of industry, consumption or taxpayer<br />Trigger action for excessive growth or fiscal imbalance <br />Goal is to encourage action<br />Remove needless duplication (& combine programs)<br />Education, capital gains, housing, urban, etc.<br />22<br />
  23. 23. Real Budget Reform MeansLower Taxes & Better Spending<br />Over long-run, taxes = spending<br />Current spending = revenues collected today + revenues collected tomorrow<br />Bills don’t go away because paid with credit <br />Interest costs reduce funds for alternatives<br />23<br />