Brookings: Topics - Tax Cuts

Tax Policy and U.S. Manufacturing in a Global Economy

Fri, 15 Mar 2013 08:50:00 -0400

Event Information

March 15, 2013
8:50 AM - 12:30 PM EDT

Falk Auditorium
Brookings Institution
1775 Massachusetts Avenue NW
Washington, DC 20036

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In his 2013 State of the Union address, President Obama stated "Our first priority is making America a magnet for new jobs and manufacturing." His “Framework for Business Tax Reform” would support this priority by focusing and deepening the existing tax deduction for domestic manufacturing activities. Others, including Senator Orrin Hatch, ranking minority member of the Finance Committee, are cool to the idea, saying, "We're starting to come back in manufacturing, and I don't think you need the government to show the way for them."

On March 15, the Urban-BrookingsTax Policy Center and the International Tax Policy Forum hosted a conference to assess the current state of U.S. manufacturing, its contribution to U.S. economic growth, and whether tax reform should maintain, deepen, or eliminate preferential income tax treatment of manufacturing income.

Brookings Co-Director of the Tax Policy Center William Gale gave introductory remarks and moderated the first panel with Brookings Director of the Initiative on Business and Public Policy Martin Baily, and Tax Policy Center Director Donald Marron served as a panelist. Former member of the Council of Economic Advisers Laura D’Andrea Tyson delivered the keynote address. After each panel, speakers took questions from the audience.

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Tax Policy and U.S. Manufacturing in a Global Economy

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A Win-Win: Compromise on Foreign Profits

Robert C. Pozen — Thu, 07 Feb 2013 00:00:00 -0500

In last year’s State of the Union, President Obama argued in favor of reforming how the U.S. taxes the foreign profits of U.S. corporations: “From now on, every multinational company should have to pay a basic minimum tax.” While an international minimum tax is a sound idea, it should be part of a broader effort to fix our dysfunctional system for taxing foreign profits.

Currently, foreign profits of U.S. corporations are subject to a Hobson’s choice. Such profits are subject to a 35 percent tax rate if repatriated to the U.S. parent company. But if a corporation keeps that money permanently outside of the U.S., it typically owes no U.S. tax on those profits.

This bifurcated tax treatment leads to two related economic problems. First, corporations can reduce their tax burden by artificially shifting their profits from the U.S. to a tax haven, such as Bermuda or the Cayman Islands. Because highly mobile intellectual property (such as patents, brand names, and the like) has become an increasingly important driver of corporate profits, corporations have been able to shift more and more of their profits to tax havens. In 2008, U.S. corporations reported profits in Bermuda over 1000% of that island’s GDP.

Second, U.S. corporations have a huge disincentive to bring any profits earned in a foreign country back to the U.S. If a corporation did repatriate those profits, it would owe the difference between the 35 percent U.S. corporate tax rate and the local corporate tax rate. As a result, trillions of dollars in cash is currently being held by overseas affiliates of U.S. corporations—cash that cannot be invested in the U.S. by the parent company.

An international minimum tax, as President Obama has proposed, is a smart way to reduce profit-shifting—the first problem. Such a minimum tax should allow a credit for foreign taxes paid (as allowed under the current system); if the minimum tax were 17 percent and the local tax rate were 5 percent, the U.S. would impose an immediate tax equal to the difference between the two rates (12 percent in this case).

However, the international minimum tax would not address the second problem of today’s system: the incentive for U.S. corporations to keep their cash in the hands of their foreign affiliates. The U.S. could fix this second problem if it taxed foreign profits at 35 percent regardless of whether they were repatriated. But such a “worldwide system” of taxation would put U.S. corporations at a significant disadvantage to their foreign competitors. For instance, McDonald’s would face a 35 percent tax rate on the profits they earn in their restaurants in the United Kingdom, while a U.K.-based competitor (say, Harry Ramsden’s) would pay the U.K. rate of 24 percent.

Most jurisdictions take the opposite approach, taxing only those profits earned within their borders (with limited modifications to try to prevent egregious forms of profit-shifting). This system, known as the “territorial system” of taxation, is also the proposed solution of the GOP. If Congress enacted a territorial system, it would essentially remove the tax-related barriers blocking corporations from using foreign profits to invest in the United States. However, it would also strongly encourage the transfer of corporate profits to tax havens—especially income attributable to intellectual property or mobile investments.

Fortunately, there is a sensible compromise in the offing: policymakers could combine President Obama’s proposed international minimum tax with the GOP’s proposed territorial system. Here’s how this combination could work:

First, there would be an international minimum tax rate equal to, say, 17 percent. If a corporation paid less than 17 percent to a foreign government, it would immediately owe the difference to the U.S.—reducing the incentive to artificially shift profits to tax havens.

Second, if a corporation paid more than 17 percent in taxes to a foreign country, it would be allowed to repatriate that income freely to the United States and owe no (or minimal) taxes. This would substantially reduce the incentive to keep cash in the hands of overseas affiliates.

By imposing an international minimum tax, this combination would ensure that all corporate profits were taxed at some reasonable rate by some government. And by allowing corporations to easily repatriate profits earned in most foreign countries, this combination would strengthen the competitive position of multinational corporations based in the United States. President Obama proposed the first half of this combination in last year’s State of the Union; I hope he finishes the job in this year’s speech.

Authors

Robert C. Pozen

Image Source: © Darley Shen / Reuters

The Downside of States as Laboratories for Tax Reform

Tracy Gordon — Tue, 05 Feb 2013 10:35:00 -0500

With state finances gradually improving, some Republican governors are turning their attention to fundamental tax reform. Louisiana Governor Bobby Jindal has proposed replacing his state’s personal and corporate income taxes with higher sales taxes. Nebraska’s Dave Heineman and North Carolina’s Pat McCrory would do the same, broadening the sales tax base and perhaps including some previously tax-exempt services.

With Washington apparently stuck in gear on taxes among other issues, it may be tempting to see the states as leading a way to reform. Unfortunately, some of the proposals currently circulating—and the idea of states as laboratories for a fundamental federal tax reform—are fundamentally flawed.

First, as my Tax Policy Center colleague Ben Harris has noted, income-sales tax swaps would be regressive—or hit low income household the hardest. This is because low income households must dedicate a greater share of their income to consumption to achieve a basic standard of living and more of their consumption tends to go toward goods (which are taxed) versus services (which are typically not). These households also often benefit from income tax rebates which presumably would be wiped out along with the tax.

Another key issue is whether states would go after currently untaxed services. Most states have already picked off easy targets like tuxedo rentals and tattoo parlors. As pointed out by the Tax Foundation’s Joe Henchman, it’s a much heavier lift politically to tax professional services of lawyers, accountants, and real estate agents. Just ask lawmakers in Maryland, Michigan, and Florida who enacted new sales taxes on some services but were forced to repeal the levies in the face of industry backlash.

It is unclear whether states without an income tax would be able to raise adequate revenue to provide the services that individuals and businesses value. Proponents of tax swaps often point to modestly higher growth in states without a personal income tax. But these comparisons are misleading. States without income taxes usually have strong alternative tax bases like energy (Texas, Alaska, and Wyoming) or gambling (Nevada).

More broadly, states are not the federal government. The usual argument for a federal consumption tax—that it would spur investment by reducing future tax penalties on savings—does not apply in an open economy where people may respond to higher sales taxes by doing more shopping online or in neighboring states. The federal government can afford to worry less about tax flight. It is simply much easier to cross state rather than national borders to avoid taxes unless you're a professional athlete or, well, Gerard Depardieu. At both government levels, higher rates can also prompt flat out tax avoidance or cheating.

Proponents of sales-income tax swaps are correct in noting the income tax’s one major flaw: volatility. An overreliance on income taxes can put states on a revenue rollercoaster and make them very sensitive to economic downturns. This is a particular problem in states where income tax rates rise sharply with income or where individuals get more income from variable sources like stock options and capital gains.

However, states can address these problems by doing a better job managing their budgets. For example, they could improve their rainy day funds and park more money there when times are good. They might also reconsider rules that make it prohibitively costly to raid these funds in a bad economy.

In other words, state tax reform may be a good idea, but no tax cut in history has ever paid for itself. Switching from income to consumption taxes may sound like music to federal policymakers’ and some economists’ ears. But another equally resonant sentiment, especially among the latter group, is to upgrade fiscal infrastructure when the opportunity cost is low. Translation: fix the roof when it’s not raining.

Authors

Tracy Gordon

Publication: Real Clear Markets

Image Source: © Jessica Rinaldi / Reuters

35 Percent Is Way Too High For Corporate Taxes

Robert C. Pozen — Tue, 29 Jan 2013 10:53:00 -0500

If there's one policy agreement between Republicans and Democrats, it's that the 35% corporate tax rate in the United States should be reduced to 28% or 25%. The current rate, highest in the advanced industrial world, disincentivizes investment and encourages corporations to relocate overseas.

Unfortunately, the deficit is a major hurdle facing any proposal to reduce the corporate tax rate. Because of the fiscal pressures facing the government, most politicians recognize that any corporate tax rate cut must be paid for by eliminating tax preferences and "loopholes." But few politicians have identified enough revenue-raising measures to offset the cost of a significant reduction of the corporate tax rate-cutting the rate from 35% to 25% would cost roughly $1.2 trillion over ten years.

I believe that there is a sensible answer: a modest limit to the deductions that corporations claim for the interest they pay on their bonds and other debt.

Admittedly, interest deductions probably won't be the first target for politicians. Most likely, politicians will first take a close look at the myriad of provisions designed to benefit specific industries. For instance, the fiscal cliff deal extended tax benefits for car racing facilities, railroads, mining companies, and various alternative energy companies. Indeed, many of these preferences have highly suspect economic justifications; unfortunately, these special deals are too small for their repeal to raise a significant amount of revenue.

Politicians might then turn to some of the larger tax preferences that corporations enjoy, collectively known as "tax expenditures." However, they will likely find it unwise, or politically infeasible, to repeal any of these large tax expenditures, such as accelerated depreciation or the research and development credit. Most Democrats and Republicans view these policies as being essential to economic growth. In any case, the bipartisan Joint Committee on Taxation has estimated that the elimination of virtually all corporate tax expenditures would not be sufficient to reduce the corporate tax rate to 25%.

Another approach would be to change how the U.S. taxes the foreign profits of U.S. corporations. Currently, U.S. corporations can avoid paying U.S. tax on foreign profits so long as they keep those profits overseas. Congress could raise a significant amount of revenue if it required U.S. corporations to immediately pay U.S. taxes on their foreign profits-beyond the foreign taxes that they already pay. However, this change would make our corporate tax system even more out of step with the rest of the world; most foreign countries require corporations to pay tax only on profits that were earned in that country (with exceptions designed to prevent abusive tax-shifting).

Thus, if policymakers are serious about reducing the corporate tax rate, they will need to consider other revenue-raising measures. To merit serious consideration, such reforms should offer the potential for meaningful new revenue, and they should also make sense from a policy standpoint.

My proposed limits to interest deductions (which I call the "interest cap") would meet both criteria. Currently, corporations may fully deduct the interest they pay on their bonds and other forms of debt. This deduction costs the Treasury a significant amount of money, and encourages corporations to take on too much debt, increasing the fragility of the economy.

Using data from 2000 to 2009 (the most recent available), I estimate that a 65% cap on deductions for gross interest would have paid for a reduction in the corporate tax rate from 35% to 25% over those ten years. In other words, corporations would be able to deduct 65% of their gross interest expense, rather than 100%; from 2000 to 2009, this modest restriction would have been enough to finance the entire rate reduction to 25%.

My proposed "interest cap" would also reduce a significant distortion in the tax code. Currently, if a corporation finances an investment with debt, it can deduct the interest that it pays on that debt. If a corporation finances an investment by issuing new shares of stock, or by using money in the bank, there is no equivalent deduction. As a result, the tax code effectively encourages corporations to load up on debt. This makes companies more vulnerable to downturns-exposing their employees to a greater risk of layoffs and prolonging recessions in the broader economy.

I acknowledge that the treatment of financial institutions under my proposal is a tricky issue. Financial institutions typically borrow significant amounts of money in their daily operations. On the one hand, a vibrant financial sector is a critical component of a healthy, growing economy, and the "interest cap" could constrain these daily operations. On the other hand, excess debt within the financial sector can be especially damaging, as it has the potential to increase the severity of financial crises.

To balance these competing demands, my proposal would apply the interest cap to financial institutions, but at a lower rate. They would be allowed to deduct 79% of their interest expense-less than the 100% that they may deduct currently, but more than the 65% that nonfinancial corporations could deduct.

Undoubtedly, certain debt-intensive industries will lobby against my proposed cap on interest deductions. But policymakers should resist such pressure: any revenue-neutral tax reform must necessarily create winners and losers. Instead, policymakers should focus on setting the stage for broad-based economic growth by reducing the distortions in favor of debt-finance, and by bringing our corporate tax rate in line with the rest of the world.

Authors

Robert C. Pozen

Publication: Real Clear Markets

Image Source: © Robert Galbraith / Reuters

Tax Reform? Between a Rock and a Hard Place

Henry J. Aaron — Mon, 14 Jan 2013 16:12:00 -0500

During the political knife-fight known as the 'fiscal cliff debate,' there was one topic on which virtually everyone seemed to agree -- that the income tax is a mess and needs reform. The idea on tax reform was straightforward. Broaden the tax base by curbing what are variously called tax expenditures, loopholes, special breaks, or simply deductions, credits, and allowances. Then, use the resulting revenues in part to lower rates and in part to lower deficits. The template for such reform was the Tax Reform Act of 1986 when Congress broadened the tax base and cut rates. We did it then, and we could do it again.

Now that most of the Bush tax cuts have been made as permanent as anything in the tax code can be, interest in tax reform has abated somewhat. But, the income tax remains a mess and still needs reform. So, it would be worth understanding why reform succeeded in 1986 -- if only barely -- and what it will take for it to succeed in the future. Unfortunately, the job will be even harder this time.

The key to success in 1986 was that Congress cut personal income tax collections. Although overall tax collections were to remain unchanged, tax burdens were supposed to be moved from individuals to corporations. The shift was large, equivalent to moving about $1 trillion in taxes in today's economy from individuals to corporations over ten years.

Cutting taxes always makes reform easier. Tax reform is income redistribution. Tax breaks are of value to some people, rate cuts to others. Some gain, some lose. Of course, reform advocates always promise that everyone will gain because economic growth will increase and tax simplification will spare everyone needless hassle and compliance expense. But people know that some of these promises are not true and that even when they are true, the benefits take time to materialize. But who pays more and who pays less when tax breaks are ended is instantly clear once the legislative specifics are known.

Cutting personal income taxes greatly increased the appeal of reform. It reduced the number of people were net losers and the amounts they would lose, and it raised the number who were net gainers and the amounts they would gain. Nonetheless the Tax Reform Act of 1986 almost died several times and the outcome was in doubt until the very end. Many regarded its ultimate enactment as something of a political miracle.

Today, the job is even harder. Shifting taxes from individuals to corporations is now out of the question. The increased international mobility of capital and the proliferation of multinational corporations means that any attempt to raise business taxes will be largely frustrated by companies that can readily transfer profits to low-tax jurisdictions. Even worse, the need to narrow projected budget deficits means that taxes have to be increased.

To be sure, there are other ways to raise revenues. A new tax could be levied on energy or on value-added -- a sort of national sales tax -- and some of the resulting revenue could be used to cut the deficit and some to lower personal income taxes. But opposition to a new tax on energy or on value-added is currently fierce and unbending. New taxes of this sort are politically fanciful in the current environment.

Or the nation could avoid the need to raise taxes by walking away from its commitment to provide basic income and health care support to America's elderly, disabled, and poor. But a majority of members of both parties opposes cutting Social Security or Medicare.

All this means that successful tax reform today will be tied to raising personal income tax revenue, not, as in 1986, to cutting it. Until such time as the nation is prepared to entertain a new tax on energy or value-added, tax reform means that most filers will see themselves as losers. Even if the partisan divide were not as wide and deep as it is today, there would be little chance that serious reform of the personal income tax could get through Congress without some way of lowering total personal income taxes to lessen the opposition from those who would lose the special tax breaks. With partisanship at current pathological levels, the chances are nil. A rock and a hard place, indeed!

Authors

Henry J. Aaron

Publication: Huffington Post

Image Source: © Mary Calvert / Reuters

To Fathom the Fiscal Fix, Look in the Mirror

Pietro S. Nivola — Mon, 07 Jan 2013 11:00:00 -0500

No one particularly liked the way Congress and the president resolved their “fiscal cliff” dilemma. The outcome, and the petty haggling that led up to it, was disparaged by commentators of opposite persuasions. But as last week’s dust settles, it is time to take a break from hyper-ventilating about how “dysfunctional” and out-of-touch the government is, and face an inconvenient truth: Actually, decisions like the fiscal deal pretty much mirror what most of the American public has indicated it prefers.

If that proposition seems perverse, consider these simple facts. Whatever else Americans say about the country’s soaring and unsupportable debt, clear majorities have expressed two sentiments: (1) If taxes are to increase, the burden should fall on “the rich.” Fully 64 percent favored higher taxes on households earning above $250,000, according to a Pew poll taken in October. (2) Serious spending reductions are mostly anathema. The resistance to changes in Social Security and Medicare is strong. The same Pew survey found 57 percent opposed to raising the amount Medicare recipients contribute to their health care; 56 percent disapproved of gradually raising the Social Security retirement age.

So, there you have it. The fiscal deal duly followed both of these popular mandates; it raised taxes on the wealthy, and then predictably kicked the can of spending cuts, and entitlement reform, down the road.

One can denigrate this answer ad nauseam. It raises too little revenue for the long haul. (Hiking income tax rates only on the rich, while permanently letting 99 percent of us off the hook, is a sure recipe for an enduring revenue shortfall.) Ducking an imperative to rein in entitlement spending is an especially unsustainable policy for the long term. It is easy to bemoan the way Democrats seem unprepared to face up to those issues. It is equally easy to pan Republicans for not really having the courage of their convictions—that is, for having flirted with meaningful entitlement reforms (such as increases in eligibility age, means-testing, altering cost-of-living adjustments, or Ryan’s premium-support idea), but then in essence waiting for the president to buy in first, to provide them with bullet-proof political cover. It is easy to chastise both political parties for, ever so opportunistically, shirking responsibility.

But without popular consent, it is also utopian to expect elected politicians to be casting heroic profiles in courage. They are, after all, representatives of the people, not Platonic philosopher kings. This is true in any democracy, but particularly in this one. With its system of exceptionally frequent elections (and almost continuous electioneering), America’s regime is keenly sensitive to public opinion. Hence, like it or not, until the voters send a very different message—one that asserts, in effect, “We are finally ready to share the pain of higher taxes, and of lower spending!”—the political process is, at best, likely to keep grinding out sausages like last week’s.

And, by the way, that’s not all bad. Look on the bright side; thanks to the public’s misgivings—and, yes, some helpful “gridlock”—at least the compromise that was reached avoided the clearest, most present danger: a draconian lurch toward precipitous austerity measures and broad tax increases that would run the economy back into a ditch. At least for the time being, let’s just breathe a sigh of relief.

Authors

Pietro S. Nivola

Image Source: © Joshua Roberts / Reuters

How the Fiscal Cliff Deal Cured Washington's Fuzzy Math Epidemic

William A. Galston — Thu, 03 Jan 2013 00:00:00 -0500

As public policy, the fiscal cliff deal has few merits to recommend it. But it does have one positive political consequence that has mostly gone overlooked: It substantially narrows the gap between the policy commitments we have made and the way the budget process officially presents them. Americans can finally have a cleaner—if not necessarily more productive—debate over what to do.

Understanding why is somewhat complicated, but worth the effort. The Congressional Budget Office is required to prepare “baseline projections” that reflect the provisions in current law, some of which are permanent, others which are time-limited. This procedure works reasonably well as long as the temporary portions of current law can reasonably be expected to expire on schedule. In recent years, however, that condition has been violated: Congress has treated many tax and spending provisions as temporary while fully intending to extend them before they lapse, generating a yawning chasm between the baseline budget and political reality. This increasingly pervasive strategy has enabled all sides to conceal the long-term costs of their commitments, enabling them to postpone tough choices.

In response, CBO has taken to preparing what it delicately calls an “alternative fiscal scenario,” based on the assumption that many allegedly temporary policies will continue indefinitely. Take, as an example, the CBO's most recent budget and economic outlook for the coming decade. In addition to considering the consequences of current law, it lists existing policies that are scheduled to be phased out, but whose continuation would most affect the budget and the economy: the ensemble of laws, including the Bush tax cuts, that were temporarily renewed after the 2010 mid-term elections; the sharp reductions in Medicare payment rates for physicians (the annual fiscal remedy for which is known as the “doc fix”); emergency extended unemployment benefits; and the 2 percent Social Security payroll tax holiday. It also took into account the automatic cuts (i.e., “sequestration”) created by the Budget Control Act enacted in response to the 2011 confrontation over the debt ceiling;

The baseline projections and alternative fiscal scenario generated sharply contrasting estimates for the next decade. Under the baseline projection, which assumes a return to Clinton-era tax rates for everyone and the implementation of sequestration, the budget deficit declines sharply from $1.1 trillion in 2012 to $213 billion by 2015, the cumulative deficit between 2012 and 2022 is only $2.3 trillion, and the ratio of debt held by the public to GDP falls during that decade from 72.8 percent to 58.5 percent. Under the alternative fiscal scenario, by contrast, the budget deficit would dip only slightly by 2015 before resuming an inexorable rise; the cumulative deficit would amount to $10 trillion; and the debt to GDP ratio would soar to about 90 percent.

The bottom line is this: the features of the tax code that the fiscal cliff deal makes permanent closely mirror the assumptions at the heart of the alternative scenario. That means that in the future, the baseline projections will be much closer to political reality, and every new proposal will be judged against a single standard that will be much harder to challenge. The accounting gamesmanship that made so much of the recent budget discussion impenetrable to the public will subside. Congressional hearings will spend less time jousting over dueling baselines. Participants may be no readier than ever to agree about whether we should increase or cut spending and taxes, but it will be clearer whether a proposal represents an increase or a cut. Politicians will be forced to spend more time debating substance rather than shadows. (The dispute that broke out between the White House and CBO as to whether the fiscal cliff agreement increases or decreases the budget deficit is a timely example of the obfuscation dueling baselines can create.)

The agreement averting the fiscal cliff renders the basic reality of our situation clear enough for busy non-experts to understand. Without substantial tax increases and spending cuts, the annual budget deficit will average $1 trillion during the next decade, and our debt burden will move into what many (but certainly not all) economists regard as the danger-zone. Congress and the people will have to weigh these consequences against the sacrifices required to avert them.

One thing is clear: this debate is just beginning, and it won’t end anytime soon. The fiscal cliff agreement does nothing about the debt ceiling, delays sequestration for only two months, and leaves the impasse over appropriations where it was. Republicans who found themselves on the defensive after November see an opportunity to regain the advantage in February. They will insist on deep spending cuts in return for an increase in the debt ceiling, while President Obama has sworn never again to negotiate under the threat of default. But if our leaders in Washington now fail to make progress, it will be harder to blame the failure on fuzzy math.

Authors

William A. Galston

Publication: The New Republic

Image Source: © Mary Calvert / Reuters

The Fiscal Cliff Has Been Avoided, But at What Cost?

William G. Gale — Wed, 02 Jan 2013 00:00:00 -0500

Some thoughts on the new fiscal agreement:

The economy needs a stimulus, but under the agreement, taxes will go up in 2013 relative to 2012 -- not only on high-income households, as widely discussed, but also on every working man and woman in the country, via the end of the payroll tax cut. For most households, the payroll tax takes a far bigger bite than the income tax does, and the payroll tax cut therefore -- as CBO and others have shown -- was a more effective stimulus than income tax cuts were, because the payroll tax cuts hit lower in the income distribution and hence were more likely to be spent.
The economy faces a long-term budget problem, but the bill substantially reduces future tax revenue relative to current law. Going over the cliff would have put us on a better budget path, but in fell swoop Congress and the Administration put us right back on the worse budget path, less than 24 hours after we had moved to the new path.
This is another “kick the can down the road” event. It is a huge missed opportunity. Two things about this are worth noting. First, it is a really big can. The bill will cost about $4 trillion, not counting the added interest on the debt that will have to be paid. Second, it didn’t get kicked very far. The bill did not address the debt ceiling and it pushed the sequester -- which neither party wants to be implemented -- back to March 1. So, we are back at another cliff-hanger in a couple of months.
The timing of the votes in the Senate and the House -- in 2013, rather than in 2012 -- confirms the notion that the No New Taxes pledge is still a binding commitment on Republicans. Because taxes had already gone up at 12:01 AM on January 1, no Republican violated the NNT pledge by voting for the new agreement. Some of the press has reported the bill as a tax increase on high-income households. It is not a legislated tax increase on high-income households. The tax increase occurred automatically at the beginning of the year, due to the expiration of previous cuts.

Authors

William G. Gale

Let’s All Jump Off the Fiscal Cliff

Bradley Belt, Jared Bernstein, William G. Gale and Phillip Swagel — Fri, 07 Dec 2012 00:00:00 -0500

With less than four weeks left, reaching an agreement to avoid the negative short-term economic impact of the so-called fiscal cliff might be beyond the ability of the strained U.S. political system.

Just kicking the can down the road, averting the more than $600 billion in automatic spending cuts and tax increases scheduled to take effect in January, requires one side to give ground on a core belief: either for Democrats to allow an extension of lower tax rates on top earners or for Republicans to accept a return to higher rates for those taxpayers. It is time to consider a backup plan.

Both parties agree that any deal will include increased revenue. They disagree over the form of that revenue.

Republicans look to limit deductions that mainly benefit people with high incomes, while extending the current 35 percent top income-tax rate. This could raise about $800 billion over 10 years if the deduction cap is broadly applied, but considerably less if tax breaks such as for charitable giving are left untouched or if the cap is phased in gradually to avoid a huge penalty for couples crossing the $250,000 income threshold.

President Barack Obama’s plan raises twice that much through higher tax rates and limits on deductions for households with the top 2 percent of incomes. He would extend current tax rates for lower-income groups.

Democrats and Republicans know that the U.S. fiscal position is unsustainable and that reforms are needed of the tax code and entitlements, yet there is no consensus on which programs should be on the table.

Two Tracks

Our view is that fiscal policy must operate on two time tracks: providing near-term support for the still-fragile recovery, while driving the political system to address the long-term imbalance. We propose to let all tax cuts expire and temporarily offset the negative economic impact.

The changes involved are unsatisfactory to all. Increased revenue comes mainly from higher tax rates rather than from a broader tax base; the higher rates affect all income levels; the alternative-minimum tax hits millions it was never intended to reach; and spending cuts are focused on discretionary programs rather than the entitlements that drive the long-term fiscal imbalance.

To avoid a recession, we propose temporary tax and spending measures to boost near-term demand without making choices between the agendas of the two parties. We see this last point as essential. Getting past the cliff with the least damage to the economy requires not making choices about fundamental long- term issues in a lame-duck setting. This means that our proposal doesn’t separate upper-income tax brackets from other tax rates as sought by President Obama, but neither does it extend all rate cuts as sought by Republicans. Instead, all tax rates go up.

Our proposals are explicitly temporary. We propose a one- year, $200 billion tax refund to support household spending, with rebate checks of about $1,200 for a couple and an additional $600 a child sent out in the first half of 2013. As with a similar measure enacted with bipartisan support in 2008, the tax rebates would phase out for higher-income households, focusing the cash on low- and middle-income households.

We would add $50 billion for spending to rebuild roads, repair and modernize public schools, and fund scientific research. We see a need for a sustained increase in infrastructure spending, even in the face of the long-term fiscal adjustment. This amount is meant as a start, and in recognition that only so many high-quality projects can be initiated in 2013.

Keep Patches

An additional $50 billion would go to fiscal relief for states. This would offset some of the economic drag from their cuts but not erase all budget gaps or remove state governments’ incentives to reach sustainable levels of spending and revenue.

Finally, we propose to extend the legislative patch that prevents the alternative-minimum tax from hitting tens of millions of households and the Medicare “doc fix” that averts sharp cuts in payments to doctors serving senior citizens. We also advocate turning off the sequester put in place in August 2011 that means some $100 billion in automatic spending cuts.

The AMT patch and the doc fix both will be extended under any future fiscal package and aren’t entangled in political conflicts. The spending sequester likewise is opposed by all sides. We think it can be turned off without taking a position on the disagreement over tax rates.

All of these proposals together reduce the contraction from the cliff by $300 billion and add $300 billion to offset the rest of the fiscal tightening and provide the economy with a near-term stimulus. We look to support the recovery and to provide time for a grand bargain to be negotiated on taxes and spending to ensure long-term fiscal sustainability.

At the same time, this isn’t a “least common denominator” approach; the fiscal cliff isn’t avoided, as tax rates rise and expenditures decrease in ways that are painful for people of all political persuasions.

This is an outcome preferred by none. Yet it is better than a stalemate that threatens recession.

Authors

Bradley Belt
Jared Bernstein
William G. Gale
Phillip Swagel

Publication: Bloomberg

Image Source: © Charles Platiau / Reuters

Keep the Recovery Going with a Temporary Super Deduction for Charitable Giving

Isabel V. Sawhill — Wed, 28 Nov 2012 00:00:00 -0500

With the fiscal cliff looming, there is a risk that even a partial slide off the cliff will slow or reverse the recovery. One way to cope with such a risk is to provide a temporary or accelerated deduction for charitable giving. The basic idea is to provide a large incentive for people to spend money now rather than later, thereby creating jobs, but in a way that would be acceptable to both political parties.

The President has proposed that current tax rates be extended for the middle class but allowed to expire for the wealthy. Republicans are arguing that any tax increase at this time is unacceptable. Even though estimates suggest that no more than 2 percent of all households and 3 percent of all small businesses would be affected by allowing tax cuts for the wealthy to expire, the Republican concern is that this would retard economic recovery.

There are any number of possible compromises that might split the difference between these two partisan views. One would be to change the definition of “wealthy” to include just those with incomes over $500,000 or even $1,000,000. Another would be to raise revenues not by changing rates but instead by limiting deductions for those in the higher brackets as the President himself has proposed in recent budgets.

I want to propose still another idea that has the potential to help break the political gridlock. It would allow rates on the wealthy to rise as they are scheduled to do in January but include a new but temporarily higher deductions for charitable giving.

The new deduction for charitable giving would only be in effect for one or two years but it would be substantial. For example, a gift of $1,000 that would reduce a high-income household’s taxes by almost $400 under the new top marginal rate, might be increased by 50 percent, bringing it to $600. The incentive to give now rather than later would be correspondingly heightened. Based on evidence on the responsiveness of donations to the price of giving, charitable giving might rise by as much as 50 percent as a result (although much less than this over the longer-run).

The rationale for this proposal is threefold. First, it would create jobs. The recovery is still very fragile and by increasing the value of the charitable deduction but making it temporary we would move a lot of charitable giving into a period when increased spending is needed. The nonprofit sector is much larger than most people realize, accounting for 1 out of every 10 jobs in the economy. Under my proposal, the affluent would have less after-tax income as their taxes rose but they would also have a much bigger incentive to spend rather than save out of all of their income as well as their wealth over the next year or two. Under some reasonable assumptions the net effect on jobs and the economy would be positive.

Second, the option of keeping their taxes low by increasing their charitable giving would take some of the sting out of higher tax rates on the wealthy. If they hate seeing more of their money going to Uncle Sam, they have a new way to avoid paying taxes. Although the super-deduction for charitable giving would not last forever, it might encourage some affluent households to get off the sidelines and help to establish the philanthropic habit that has always distinguished the United States from other countries.

Third, the nonprofit sector would benefit. Given the need for major spending cuts over the next decade, the voluntary sector is going to need to fill some big holes in everything from the social safety net to community services. Charitable organizations vary enormously from those that support the arts, education, and health to those that provide assistance to the poor and to local community organizations of all kinds. Healthy competition among all of these organizations insures that the money is spent in line with public preferences and not according to bureaucratic dictates from Washington.

Some careful thought would need to be devoted to the details of such a plan. Would faith-based organizations that claim about a third of total charitable giving be eligible? Would there be limits on the amount going to endowments versus operating expenses in the affected nonprofits? Should the types of charitable entities as opposed to all 501(c)3 organizations be specified in the law? These decisions could be negotiated along with the size and timing of the super-deduction.

To be clear, this proposal is no substitute for a broader effort to reform the tax system which will likely move in the direction of limiting most, if not all, deductions. It is a short-term measure that deals with some of the fiscal drag associated with the cliff, makes raising taxes on the wealthy more palatable, and temporarily boosts the health of the voluntary sector. Over the longer term, it might be combined with a hard cap of $35,000 on deductions starting in 2014, but a cap that excludes charitable giving as proposed by the think tank, Third Way.

Authors

Isabel V. Sawhill

Publication: Yahoo! Finance

Image Source: © Kevin Lamarque / Reuters

The Tax Policy Center's Analysis of Governor Romney’s Tax Proposals: A Follow-up Discussion

Samuel Brown, William G. Gale and Adam Looney — Wed, 07 Nov 2012 13:29:00 -0500

ABSTRACT

Tax reform ideas played an important role in the recent Presidential election. Republican candidate Mitt Romney proposed large tax cuts and other changes that he said could be part of a revenue-neutral tax reform that also retained low rates on savings and investment and would not raise taxes on the middle class. In an earlier analysis, we showed that it was not possible to achieve all of Romney’s stated goals simultaneously. This paper reviews that analysis and critiques several responses to our analysis. Legislating realistic tax reform will require recognition of the difficult trade-offs among these competing goals.

I. Introduction

In February, 2012, Republican presidential candidate Mitt Romney laid out a four-part agenda for tax reform that featured cutting income tax rates by 20 percent from today’s levels, promoting “savings and investment for the American people,” repealing the estate tax, and repealing the alternative minimum tax.[1] He also proposed a variety of additional tax cuts, including a 29 percent reduction in the corporate tax rate. Taken together, the proposed tax cuts would reduce revenues by roughly $456 billion in 2015 or about $5 trillion over the next decade.[2] Governor Romney said that the changes would be part of a revenue-neutral reform that would offset the cost of the cuts by eliminating tax breaks and not raise taxes on the middle class, but he did not specify which tax breaks would be eliminated.

In August, the Tax Policy Center (TPC) published a paper we co-authored that analyzed these economic and policy goals.[3] As an illustration of the difficulty inherent in implementing such a substantial tax reform, our paper showed that achieving all of the goals listed above would, under reasonable assumptions about what tax breaks might be on the table, result in tax cuts for households with income above $200,000. Given the goal of revenue neutrality, this would seem to require tax increases on households with income below $200,000, something that Governor Romney has said he does not want to happen.

This conclusion was a mathematical demonstration of the difficulty of accomplishing simultaneously all of the goals Romney had laid out. It was neither a statement of Romney’s intentions nor a political prediction of what he would actually do if elected president. Indeed, Romney had also indicated that he did not want to cut taxes on high-income tax payers and that he wanted to reduce the burden for middle-income households.[4] Thus, our results demonstrated the more general conclusion that something would have to give: Romney’s proposals would fall short on at least one of the goals he had set out. Any practical reform based on his proposals would entail some combination of reduced revenues, tax increases on households with income below $200,000, higher taxes on saving and investment, smaller reductions in income tax rates, or other changes.

Our conclusions held even though we imposed the base-broadening measures in the most progressive manner possible, eliminating them for the highest-income households first before affecting anyone else. This was intended to place an upper bound on what the plan could achieve in terms of progressivity. Our analysis noted that, in reality, practical and administrative challenges of implementing the base-broadening reforms in this manner would mean that any realistic effort to close tax expenditures consistent with Romney’s goals would require higher effective tax rates and would yield even less progressivity, lower revenues, and more tax complexity than we had modeled. Furthermore, we excluded the effects of the corporate tax cuts, despite evidence that these provisions would also result in lower revenues.

Our results held even when we incorporated revenue feedback, not just according to the standard “microdynamic” effects used by TPC, Treasury, and the Joint Committee on Taxation, but also additional feedback effects from potential economic growth, based on estimates from a Romney adviser, even though we believe those estimates are overly optimistic.

In light of several responses to our work, some recent suggestions by Romney on how to finance part of his proposed tax cuts, and ongoing interest in tax reform, this paper reviews the discussion and to respond to various issues that have arisen in response to our paper.[5]

We offer several conclusions. First, we continue to stand by our original results. Although some media outlets and individuals have interpreted a second document that we published as somehow walking back or disavowing our earlier results, that is simply a misinterpretation on their part.[6]

Second, after reviewing several responses to our study, we note that even with the freedom to choose from a much larger set of “pay-fors,” not a single author has offered a plan that generates sufficient revenue to pay for all of Romney’s (non-corporate) tax cuts, exempts households with income below $200,000 from higher taxation, and is administratively feasible. None of the responses actually refutes our study – that is, none of them shows that our conclusions are wrong, given what Romney laid out as goals. Rather, the responses either shift the goal posts – by focusing on tax increases on different households or changing the baseline –

fail to raise sufficient revenue to offset all the tax cuts Romney has proposed; raise taxes on saving and investment, in violation of Romney’s goal of promoting these activities; or do a combination of these things.

Third, Romney subsequently described several ideas to help pay for some of his proposed tax cuts. This was a welcome update to the discussion, but the ideas (which Romney described but did not formally endorse) would not generate sufficient revenue to pay for the tax cuts.

Our paper proceeds as follows: Section II describes Romney’s proposals. Section III summarizes our earlier analysis. Section IV discusses and critiques the responses to our work. Section V discusses Romney’s recent ideas for paying for his proposals. Section VI concludes. An Appendix provides a detailed response to Rosen (2012).

II. Romney’s Proposals

In the Wall Street Journal on February 23, 2012, Romney published an op-ed laying out his economic plan, focused on four items:[7]

Cutting income tax rates by 20 percent below their 2012 level,
Promoting saving and investment (including eliminating taxes on capital gains, qualified dividends and interest incomes for households with income below $200,000; and retaining the current 15 percent top rates on capital gains and dividends for high-income households),
Repealing the estate tax, and
Repealing the alternative minimum tax.

He also proposed a series of other tax changes over the course of the campaign, including:

Repealing the surtaxes on investment and earnings of upper-income taxpayers that were enacted in the Affordable Care Act,
Extending all of the 2001/03 tax cuts,
Allowing the 2009/10 tax cuts to expire, and
Reducing the corporate tax rate to 25 percent from 35 percent.[8]

III. Our Analysis

The purpose of our analysis was to examine the trade-offs inherent in tax reform.[9] We drew on the Tax Policy Center microsimulation model, which was developed to provide revenue and distributional estimates of tax policies that had otherwise only been available from government sources, like the Joint Committee on Taxation (JCT) or the Department of the Treasury.

Much like the models used at these government agencies, the TPC model uses large samples of individual households from multiple data sources, projects the income and other tax-related variables of these households over the budget window, and estimates the taxes owed by each sample household under a specified proposal. The model includes estimates of the ‘microdynamic’ effects on revenues that occur when, for example taxpayers increase reported taxable income or capital gains in response to tax rate cuts, but not ‘macrodynamic’ effects of faster economic growth. (Our paper, however, discussed potential macrodynamic effects of the Romney proposal.)

While using a microsimulation model is more complex than using published tables from the IRS, estimates based on a large sample of individual income tax returns are capable of assessing the interaction of different tax provisions (for example, between changes to the AMT and to the regular income tax), and determining tax liability for households with different levels and sources of income, uses of funds, and family circumstances. This is the reason federal agencies and some private groups (including TPC and the National Bureau of Economic Research) use this type of model to estimate revenue and distributional effects of tax reform proposals. In short, by drawing on the TPC model, we can provide timely analysis of important policy-relevant issues using the basic methods of tax analysis used by the government agencies that provide the official scores of tax proposals.[10]

Regarding Romney’s proposals, TPC estimated in March that, in addition to extending the entirety of the Bush tax cuts, Romney’s explicit proposals would reduce revenues in 2015 by $481 billion on a static basis and by $456 billion after accounting for microdynamic behavioral responses.[11] (The commonly cited figure that Romney proposed $5 trillion in gross tax cuts, with unspecified revenue raisers, is based on the $456 billion estimate for 2015, adjusted for projected baseline growth in the size of the economy over the next decade.[12])

In our paper, we compared the Romney proposals to a current policy baseline and did not aim to finance the corporate tax cuts -- we only included the tax cuts listed in the first five bullets above. With these parameters, we estimated that Romney’s proposed cuts would reduce revenues by $360 billion in 2015, after including microbehavioral responses.

A key consideration of our analysis was how such cuts would be financed. In the absence of any specific proposals from the Romney campaign, we looked to existing tax expenditures that could be closed in order to raise revenues. Similar to a previous TPC study, we divided tax preferences into several groups: (1) exclusions of income from sources that are administratively difficult to tax; (2) tax preferences for saving and investment; and (3) all other tax expenditures.[13]

Of these possible revenue-raisers, we excluded tax expenditures in the first group. These preferences--including imputed rent from owner-occupied housing, and other items--are typically excluded from tax reform proposals due to their administrative complexities (and sometimes for other reasons as well). We also excluded consideration of closing preferences aimed at saving and investment, because of the prominence of promoting saving and investment in Romney’s economic proposals. (We discuss this further in the next section.) We considered all other tax expenditures (including those related to itemized deductions for mortgage interest, charitable contributions, and state and local taxes; the exemption of employee income in the form of health insurance; various other exclusions, above the line-deductions, and tax credits) fair game to pay for the proposed tax cuts.

A key aspect of our analysis is that we closed the available tax expenditures “from the top down.” That is, we offset revenue losses from tax rate reductions by first eliminating tax expenditures for the highest-income groups. If that did not generate enough revenue to pay for the tax cuts, we then closed all available tax expenditures of the next highest-income group and so on. Although it would be both administratively and politically impractical as well as economically damaging (because of the high marginal tax spike it would create) to eliminate all tax expenditures only above a given income threshold, it made the financing of the tax proposals as progressive as could be, for those tax expenditures.

The central results are summarized in Figure 2 from our paper, reproduced below. Among households with income above $1,000,000, Romney’s tax cut proposals (again, ignoring the corporate tax) would reduce tax payments by $106 billion. However, even the complete elimination of all the available tax expenditures (i.e., excluding those administratively difficult to tax or those affecting saving and investment) would only raise $54 billion in revenue from this group. As a result, they would receive a net tax cut of $52 billion. Likewise, each group of households with income of $200,000 or above would receive a net tax cut under Romney’s proposals, even if all available tax expenditures were eliminated from the top down. In total, households with income above $200,000 would receive a net tax cut of $86 billion (consisting of a gross tax cut of $251 billion, partially offset by base-broadeners of $165 billion) even if all of their available tax expenditures were closed.

As a matter of arithmetic, in order for the overall tax package to be revenue neutral and preserve incentives for saving and investment, the $86 billion in lower taxes paid by those with income above $200,000 would require a $86 billion tax increase that would be spread out in some fashion over the 95 percent of the population with income below $200,000. This would require a 58 percent reduction in the value of tax expenditures that go to these households. We did not specify how this burden would be distributed among households with income below $200,000. We did note that if the increased burden were shared equally (as a percentage of income) among all households in this group, after-tax income would fall by an average of 1.2 percent. (The average tax increase would need to be about $500 per household, and about $2,000 for households with children.[14])

This conclusion is mathematical in nature – it is what the analysis shows would have to happen to meet Romney’s stated goals. It was not a prediction of Romney’s actions, were he elected, and Romney has said, before and since, that he does not want to raise taxes on the middle class. That implies an inherent mathematical contradiction between the goals of his proposals: one or more of those goals would have to be compromised.

Finally, we included an analysis of the potential revenue feedback effects from economic growth. We used a model that was developed by Romney advisor Greg Mankiw, and included a significant feedback effect that allowed 15 percent of the tax cut to be paid for through higher economic growth.[15] This implies that the $360 billion cost would fall to about $307 billion. It is not clear how to allocate the increase in income, and hence the added tax payments, across income groups, but it is highly likely that income gains from faster economic growth would increase revenues from both high- and low-income taxpayers. What is clear is that, under any allocation of the changes across income classes, households with income above $200,000 would still receive a large tax cut that would require tax increases on households with income below $200,000 in order to maintain revenue neutrality.

IV. Responses

Since the publication of our paper, several responses have been issued. None of the analyses contradict the results in our study – that is, none shows that our results do not hold, given the goals laid out by the candidate. Moreover, none of the authors of the responses argues that the alternatives they considered would be desirable economic policy. The authors are focused instead on attempting to generate the existence of a plan that could meet all of Romney’s goals. Even so, none of the responses offers a plan that generates sufficient revenue to pay for all of Romney’s (non-corporate) tax cuts, exempts households with income below $200,000 from higher taxation, and is administratively feasible.

We divide our discussion of the responses into three subsections. First, we discuss two overarching issues in the responses: raising taxes on the return to saving and the impact of the Romney proposals on economic growth. Second, we discuss three responses that build directly off of the TPC results. Third, we discuss three responses that use 2009 IRS data to examine the issues.[16]

A. Overarching Issues in the Responses

1. Taxing saving and investment

As noted above, Romney made promoting saving and investment one of his four main planks for pro-growth tax reform, on a par with the income tax cuts and repeal of the estate tax and AMT. In Believe in America: Mitt Romney’s Plan for Jobs and Economic Growth, the major heading for the tax policy section is “Mitt Romney’s Plan: Promote Savings and Investment.”[17]

The claim of promoting savings and investment is an imprecise policy goal and is therefore open to interpretation. It could mean to preserve every incentive for savings and investment or it could mean on net to preserve broad incentives while leaving open the possibility of eliminating more targeted incentives. In the Wall Street Journal op-ed, Romney wrote that “I will promote savings and investment by maintaining the low 15% rate on capital gains, interest [sic] and qualified dividends, and eliminate the tax entirely for those with annual income below $200,000. These low tax rates will create powerful incentives for Americans to save and invest, while encouraging business investment and economic growth.”[18] This does not rule out imposing new taxes on some forms of saving.

Nevertheless, we did not impose new taxes on saving in our calculations because his language and goals do not seem consistent with the idea of raising taxes on any specific types of saving. Specifically, we do not see how raising taxes on various forms of saving is consistent with the goal of promoting saving.

In contrast, all of the authors who have criticized us have suggested including revenue raised from subjecting some forms of saving and investment to higher taxes – either ending the exclusion of interest on state and local bonds, eliminating the tax deferral on long-term saving in life insurance products (often referred to as taxing the inside build-up); or changing the treatment of capital gains on assets that are transferred at death. Including new taxes on forms of saving as a way to pay for the Romney proposals seems to imply either that (a) the authors are ignoring Romney’s goal of promoting saving and investment, or (b) the authors believe that taxing a particular form of saving will not reduce saving and investment.

2. Effects of tax reform on economic growth

We included a discussion of how economic growth would affect our results and we showed that our central results do not change even after accounting for revenue feedback using growth effects taken from Mankiw and Weinzierl.[19]

However, we are skeptical that the growth effects of tax rate cuts – whether taken in isolation or as part of a revenue-neutral package – are as large as is sometimes claimed. While a full debate about taxes and economic growth is beyond the scope of this paper, it is worth noting that estimates that do incorporate macro adjustments by the Congressional Budget Office (CBO) and JCT show smaller effects than Mankiw and Weinzierl.[20] Recent papers by analysts at the Congressional Research Service also highlights a weak relation between lower tax rates and economic growth.[21]

Moreover, history has not been as kind to the verdict that tax cuts generate economic growth as substantial as the campaign’s rhetoric would suggest. For example, the massive and permanent tax increases associated with World War II do not appear to have had an impact on U.S. economic growth rates.[22] Likewise, the 1981 tax cuts, which cut the top rate from 70 percent to 50 percent, accounted for only a very small share of the growth of the economy between 1981 and 1986, according to Martin Feldstein, who advises the Romney campaign today and who was Chair of the Council of Economic Advisers under Reagan.[23] Feldstein and now-CBO director Douglas Elmendorf analyzed the 1981 tax cut and concluded that:

“Our evidence contradicts the popular view that the [early 1980s] recovery was the result of a consumer boom financed by reductions in the personal income tax. We also find no support for the proposition that the recovery reflected an increase in the supply of labor induced by the reduction in personal marginal income tax rates. … The driving force behind the recovery of nominal demand was the shift to an expansionary monetary policy. The rapid response in nominal GDP can be explained by monetary policy without any reference to changes in fiscal and tax policy.”[24]

The 1986 tax act is the most recent example of base-broadening, tax-rate reducing, revenue-neutral reform. In that act, the top personal income tax rate fell by 44 percent and the corporate rate fell by 26 percent. Auerbach and Slemrod document tepid economic growth responses to the 1986 tax act.[25]

Most recently, the 1993 hike of 8.6 percentage points in the top income tax rate did not stop a remarkably strong decade of economic expansion and budget balancing from occurring. The 2001 tax cuts had no appreciable impact on growth during the rest of the decade – through most of the decade (before the Great Recession) growth occurred mainly in housing and finance, two sectors that were not favored by the cuts. Gale and Potter estimate that the deficit-increasing effects of the 2001 tax cut, which reduced long-term economic growth, outweighed the marginal-tax-rate-cut effects, which increased growth, so that the net impact of the tax cut on long-term growth was negative.[26] It is difficult to translate this result, however, into an analysis of the effects of revenue-neutral reform without knowing how the base-broadeners needed to generate revenue-neutrality would affect incentives.

B. Discussion of Studies that build off of the TPC results

Three authors presented responses that start with the estimates we obtained, described above, and modify the results in different ways.

1. Jensen

Jensen suggested that eliminating the exclusion of interest on state and local bonds and the exclusion of inside-buildup on life insurance vehicles could raise “upwards of $90 billion” in 2015.[27] In response, we showed that an upper bound on the revenue obtained from eliminating these two exclusions is on the order of $49 billion ($29 billion for tax-exempt interest, $20 billion for life insurance), at least $4 billion of which would come from families with income under $200,000.[28] Jensen obtained a much higher estimate by including corporate changes and by confusing the tax expenditure estimates for these items with revenue estimates of repealing the provisions. In fact, because taxpayers respond to such changes, the tax expenditure estimates are significantly larger than the revenue implications of repeal.[29]

2. Dubay

Dubay argues that the $86 billion shortfall could be made up by a combination of taxing municipal bond income, taxing the inside build-up in life insurance vehicles, ending the step-up of basis on assets with capital gains that are transferred at death, and incorporating the effects of economic growth.[30]

The novel factor in this study relative to the others is the notion of ending basis step-up on capital gains transferred at death and replacing it with basis carry-forward. He uses the tax expenditure estimate from the fiscal year 2013 Federal Budget that suggests eliminating step up in basis would yield $19 billion.[31] However, Dubay overestimates the revenue that could be collected from this policy, for two reasons. First, the tax expenditure figure he cites comes from a comparison of basis step-up and full taxation of capital gains at death. Replacing basis step-up with basis carryover (under which the tax basis does not get changed, but taxes are not due at the transfer at death – they are due only if and when the asset is sold) would generate significantly less revenue.[32]

Second, the figure he cites is based on current-law projections of tax rates, which for long-term capital gains are more than 50 percent higher than they would be under Romney’s proposals (23.8 percent under current law compared to 15 percent under Romney’s proposals), thus inflating the tax expenditure estimates relative to what they would be under Romney’s proposals.

3. Brill

Brill argues that the $86 billion shortfall could be made up by a combination of taxing interest income from municipal bonds, taxing the inside buildup in life insurance, dropping Romney’s proposal to repeal health care reform from the baseline, and accounting for economic growth.[33] Relative to the other responses, the novel aspect of Brill’s response is his choice to omit health care taxes from the baseline. This raises several issues.

First, Brill suggests that Romney’s tax proposals should be evaluated relative to a baseline that excludes revenues from the ACA taxes—revenues which are highly progressive.

We believe that modifying the baseline to reduce overall revenue and progressivity amounts to moving up the goal line to make the goals artificially easier to achieve. Describing a policy as “revenue neutral” or suggesting that high-income households will pay the same share of taxes implies a commonly accepted baseline. (It’s not “revenue neutral except for those revenues.”) Our analysis draws on the same assumptions for the current policy baseline used by the Congressional Budget Office (whose “current policy” baseline is called the “alternative fiscal scenario”) and by other groups (e.g., Bowles-Simpson and Domenici-Rivlin). The ACA taxes are scheduled to begin on January 1, 2013. Those taxes will thus be in effect when the next president is inaugurated and are rightly considered not only part of “current law” (which takes the law as written) but also “current policy” (which attempts to reflect the trajectory of existing policies—including the likely extension of many expiring tax cuts—and is the baseline we used to analyze Romney’s proposals). Like them or not, the ACA taxes are now part of existing tax policy, and repealing them would be a tax cut—one that particularly benefits high-income taxpayers. More generally, selectively omitting certain disadvantageous features of the baseline to make a policy look better undermines the stated goals of revenue neutrality and the credibility of an analysis.

Second, Brill also suggests that the budget effect of repealing ACA taxes “should be analyzed in the context of the repeal of the various other health care provisions.” Romney wants to repeal the health care reform act (ACA), which is approximately revenue-neutral and very progressive.[34] ACA raises coverage for low- and middle-income households and raises taxes for higher-income households. Both individual elements are progressive. Repealing each provision would thus be unambiguously regressive. We are unable to include repeal of the coverage/spending changes in the tax model, which therefore leads us to understate the regressivity of Romney’s proposals in our model. Removing the revenue portions of Romney’s ACA-repeal proposal, as Brill would like to do, simply leads to a further understatement of the regressivity of Romney’s stated proposals.

From the perspective of households’ wallets, it is a matter of semantics whether ACA repeal is considered “tax policy” or “health policy.” (Similarly, whether curtailing the tax preference for health insurance is “tax reform” or “health reform” is a semantic issue not a substantive one.) What matters is that Romney proposed ACA repeal and doing so would be roughly revenue-neutral but would hurt middle- and low-income households and help high-income households. Hence, we believe that if there is a shortcoming of our analysis of Romney’s proposal to repeal ACA, it is not the inclusion of the revenue changes, but the inability (because we are using a tax model) to incorporate the spending/coverage changes. Had we been able to do so, our analysis would have shown it to be even more difficult to meet Romney’s stated goals.

Finally, for Brill’s plan (or Jensen’s or Dubay’s) to work, of course, one would have to eliminate all tax expenditures for people with income above $200,000 and this would require an enormous spike in the marginal tax rate at that income level. (We know this because Brill worked off of our analysis, and as noted above, our analysis was meant to provide an upper bound on the progressivity of the base broadeners, not an implementable version of tax reform. The same issue applies to Jensen’s and Dubay’s analysis.) That is, a household with income of $200,000 would receive all of its deductions, exclusions, exemptions, etc. But if the household members earned one more dollar, they would immediately lose all of their itemized deductions, their health insurance would be fully taxed, and so on. This would create a massive marginal tax rate at the $200,000 level. We believe it is fair to say that every sensible economist (and we include Brill in this category) would say that such a spike is a bad idea, is probably not administratively feasible, and would generate significant responses in terms of tax avoidance and labor supply. Fixing this problem to reduce the spike would inevitably either reduce revenues or raise middle-class tax burdens. Martin Feldstein has suggested that a phase-in of a cap on itemized deductions would cost about $15 billion.[35]

C. Responses to Feldstein and Rosen, which use 2009 Aggregate IRS data

Two responses by Feldstein and one by Rosen are based on 2009 aggregate IRS data.[36] These responses have several features in common. First, by using data from 2009, they understate the cost of tax cuts (relative to the revenue available from closing deductions), since the economy was so weak that year, and taxable income fell more than itemized deductions.[37] Second, neither author provides financing for estate tax repeal; Rosen does not even cover the costs of AMT repeal. As a result, their efforts at best only show that the policies they do consider could be financed, they do not show that the collection of Romney’s non-corporate tax cuts could be financed. In addition, both authors include substantial revenues from eliminating the standard deduction for individuals who have enough itemized deductions to itemize under current law, but not eliminating the standard deduction for individuals that do not have enough deductions to itemize under current law. This is a bizarre and unenforceable policy; any realistic implementation of a reduction in the standard deduction would either result in higher taxes on lower-income households (violating one goal of the proposal), or would require higher statutory tax rates on ordinary income (violating the stated 20 percent tax cut).

1. Feldstein

Feldstein first attempted to contradict our findings in an op-ed in the Wall Street Journal.[38] Instead, his analysis actually confirmed our central result. As we discuss in a response, under Feldstein’s suggested approach to financing Romney’s proposals, there would be significant tax increases on households with income between $100,000 and $200,000.[39] This is perfectly consistent with our initial conclusion, since (at the risk of stating the obvious) households with income between $100,000 and $200,000 fall in the category of “households with income under $200,000,” the group that we had indicated would have to face higher taxes if the Romney proposals were implemented and the group that Romney has said he considers to be part of the middle class.[40]

We also showed that Feldstein’s method of financing Romney’s proposals made a number of specific omissions and inappropriate assumptions (regarding the estate tax, the standard deduction, and the effective marginal tax rate) that implied that his plan would lose at least $90 billion per year and so wasn’t even close to revenue neutral.

In a response to our comments and that of others, Feldstein corrects a technical error regarding the effective marginal tax rate (which has the effect of reducing revenues), and so he adds new taxes on saving and investment to try (i.e., on the interest income from municipal bonds and inside build-up in life insurance policies) to offset this.[41] Because of the new taxes on saving and investment, his revised proposal imposes even larger tax increases on households with income between $100,000 and $200,000 than his original proposal. In addition, his revised proposal fails to provide a standard deduction for most high-income households and fails to specify financing of the estate tax repeal. Correcting for these factors implies that even his revised proposal is not revenue neutral, contradicting one of the other goals Romney laid out.

2. Rosen

Rosen examined similar issues and concluded that -- under his version of what constituted Romney’s proposals -- incorporating the effects of lower tax rates on economic growth, in combination with aggressive base broadening, could raise taxes on high-income households and hence avoid a middle- or lower-income tax increase in a revenue-neutral plan.[42] But Rosen overstates the case and adjusting for several factors turns his tax increase for high-income households into a tax cut (which would then have to be financed by households with income below $200,000) even if we grant his growth assumptions.

First, the biggest problem is simply that Rosen doesn’t finance all of the Romney proposed tax cuts; he finances only the 20 percent income tax rate reduction. He ignores estate tax repeal and AMT repeal, both of which would provide large tax cuts for high-income households.[43] Thus, although he claims that his analysis shows that taxes on high-income households would rise, he is omitting two major tax cuts that would primarily affect high-income households.

Second, he uses data from 2009, a year when the recession was in full swing and revenues were particularly low relative to itemized deductions (See the Appendix for documentation), thus overstating the revenue gain from eliminating itemized deductions relative to the revenue loss from cutting tax rates.

Third, the analysis assumes that high-income households who currently itemize would not benefit from the standard deduction. Ordinarily in the current system individuals whose itemized deductions fall below the value of the standard deduction simply choose to take the standard deduction. One interpretation is simply that Rosen (and Feldstein) have ignored this behavioral response, and that they have therefore incorrectly assumed too much additional tax revenues. A second interpretation is that this is a deliberate policy choice to eliminate the standard deduction, but only from former itemizers. However, this leads to a bizarre situation where people who would not have enough itemized deductions to itemize in the current system could take the standard deduction in Rosen’s system, but people who did have enough itemized deductions to itemize in the current system would receive neither the standard deduction nor itemized deductions in Rosen’s system. There is no precedent for such a policy, and it would be difficult to enforce if enacted. It is certainly possible to eliminate the standard deduction for all taxpayers, or to recover forgone revenue equal to the value of the standard deduction from higher-income taxpayers, but doing so would either result in a tax increase on low- and middle-income taxpayers, or would require higher statutory tax bracket rates, contravening the pledge to reduce those rates by 20 percent..

Fourth, he imposes new taxes on saving and investment (municipal bonds and inside build-up), which we would argue is not consistent with Romney’s stated objectives.

Adjusting for these factors (see the Appendix) -- that is, estimating what we feel is an reasonable interpretation of Romney’s proposals and goals -- takes what Rosen estimates as a $29 billion tax increase for households with income above $200,000 and turns it into a $41 billion tax cut for those same households, even if we grant the growth effects that Rosen assumes. Thus, high-income households would be receiving a tax cut, which would then have to be financed with higher taxes on other households or running a deficit or compromising some other element of Romney’s proposals.

Even if one allows the tax increases on saving to occur and even if one grants Rosen’s assumptions about economic growth, there would still be a net tax cut of $19 billion on households with income above $200,000, which would require tax increases on the rest of the population.

Also, for a number of reasons, we (and many other economists) believe that Rosen overstates the growth effects of Romney’s proposals. Adjusting that effect downward would further increase the size of the tax cut for households above $200,000 and thus imply even higher required tax increases on others. (See the Appendix for further discussion.)

V. Financing the tax cuts

Recently, Governor Romney mentioned some ways to finance at least some of the proposed tax cuts. He floated the idea of putting a cap on itemized deductions.[44] He suggested that possible levels of the cap could be $17,000, $25,000 or $50,000 and that the cap could phase out to zero at higher income levels.[45] An analysis by the Tax Policy Center shows that a $17,000 cap would raise $1.7 trillion over the next decade, a $25,000 cap would raise $1.3 trillion, and a $50,000 cap would raise $760 billion, if income tax rates were cut by 20 percent from current levels and the AMT were repealed.[46] Romney campaign staff also floated the idea of imposing a tax on health insurance or pulling back on personal exemptions but specifics do not appear to be available.[47]

Thinking about how to finance the tax cuts is a step in the right direction. However, capping itemized deductions falls far short of financing his proposed tax cuts. It is also interesting to note that, consistent with TPC’s assumptions, Romney did not propose new taxes on any form of saving.

VI. Conclusion

By now, there is overwhelming evidence and widespread understanding that Governor Romney overpromised on the tax side. Alan Viard, an economist at the American Enterprise noted in the New York Times that Romney is “going to need to cut rates significantly less than 20 percent if he wants to honor his other goals.”[48] Dan Shaviro, a lawyer and tax expert at New York University has said of the Romney proposals: “There really is no serious dispute that the parameters of their plan can’t be met... There’s just no way to make the numbers add up.”[49] Josh Barro – a Bloomberg columnist and former senior fellow at the Manhattan Institute – has said “There you have the six “studies” on which the Romney campaign has based its defense of Romney’s tax plan. Individually and collectively they fail the task.” [50] The Economist magazine writes that “The same calculations the Tax Policy Center made in August still hold” and that “[Romney’s] response is an acknowledgement that he can’t make his numbers add up.”[51] Martin Sullivan, an economist and journalist for Tax Notes said that “I like tax reform. I want to broaden the base. It’s something I’ve devoted my life to. And I welcome Governor Romney and the Republicans’ strong push, but the plan doesn’t work out. It’s not mathematically possible.”[52]

Tax reform is a difficult task, but not impossible. The parameters that Governor Romney offered are significantly different from previous tax reform proposals and efforts. For example, the Tax Reform Act of 1986 was able to reduce rates and remain revenue- and distributionally-neutral by taxing capital gains as ordinary income, eliminating many then-existing tax shelters for non-corporate investors, and increasing corporate taxes substantially. Similarly, the plan of the co-chairs of the National Commission on Fiscal Responsibility and Reform (Erskine Bowles and Alan Simpson) and the proposals submitted by Bipartisan Policy Center’s Debt Reduction Task Force (under the leadership of Pete Domenici and Alice Rivlin) helped to finance their proposed rate reductions by including among their base-broadening measures the taxation of capital gains and dividends as ordinary income.[53] But these are precisely the proposals that Romney has sworn off.

Romney is not the first politician to overpromise on the tax side and won’t be the last. As discussions about tax reform move from the campaign trail to (we hope) the halls of Congress, realistic recognition of the trade-offs would be a huge step in the right direction.

Appendix: Discussion of Rosen (2012)

(1) Use of 2009 data will understate the revenue losses from tax cuts, relative to the revenue gained from closing itemized deductions. Due to the Great Recession and other factors, 2009 was an unusual year in tax terms, with particularly low taxable income and low tax revenue. (If there is little revenue to begin with, cutting taxes doesn’t cost very much). For example, a key measure in thinking about Rosen’s (and Feldstein’s) analysis is the ratio of taxes paid to the size of itemized deductions (since he reduces tax rates and then eliminates itemized deductions). For different measures of itemized deductions employed (all, or just the ones that Rosen eliminates) and the income group used (over $100,000 or over $200,000), that ratio was about 15 percent higher in 2006, a normal tax and economic year that predates the Great Recession than it was in 2009.[54] The result is that Rosen’s analysis significantly understates the revenue lost from tax cuts and/or overstates the revenue gained from eliminating itemized deductions in a year that is more normal than 2009.

(2) Rosen understates revenue losses by ignoring the cost of repeal of the estate tax. The estate tax is the single most progressive tax in the entire federal system and because it raised $21 billion in 2009. JCT, CBO, and Treasury consistently estimate that repeal would not only lose revenue but could actually lose more revenue than the estate tax collects because it would create opportunities for tax avoidance.

(3) Rosen understates revenue losses by ignoring the repeal of the AMT. This cost is partly mitigated by the fact that Rosen only reduces the deductions for state and local taxes by half.

(4) Rosen’s analysis removes itemized deductions for high-income households, but does not offer those households the option to use the standard deduction. Normally, taxpayers have the choice of itemized or standard deductions, and the standard deduction is not considered a tax expenditure. Under the proposal examined by Rosen, taxpayers with income above $100,000 who had previously taken the standard deduction would continue to take the standard deduction, but taxpayers with income above $100,000 who had taken itemized deductions would be granted neither the itemized deduction or a standard deduction.

(5) Rosen raises revenue from taxing the return to saving – in particular, by taxing the interest income on municipal bonds and taxing inside build-up in life-insurance vehicles.

A Recalculation

What do these assumptions and features imply? It is beyond the scope of this short piece to fully estimate the various changes involved. But here are some rough calculations that suggest how the analysis would change, for some of the issues raised above.

Rosen argues that households with income above $200,000 would receive a $81 billion tax cut from Romney’s various tax cut proposals, that broadening the base would raise $95 billion in taxes from these households, and that supply responses would generate another $15 billion, for a total tax increase of $29 billion (-81+95+15).

Including estate tax repeal would provide an additional tax cut of about $21 billion. Since about 94 percent of the elimination of the estate tax would benefit households in the top 5%, eliminating it would provide a tax cut of around $20 billion to those making more than $200,000.[55]
Including AMT repeal would reduce revenues by $20 billion among those with income above $200,000. Eliminating the remaining state and local tax deductions that Rosen did not repeal would raise about $15 billion in the same income group, so the net reduction in revenue would be $5 billion.
Allowing for a more normal revenue year would raise pre-tax-cut revenues by 15 percent relative to itemized deductions and thus raise the cost of tax cuts relative to itemized deductions by 15 percent. This would increase the revenue loss among high-income taxpayers by about $12 billion.

Thus, the tax cut for households with income above $200,000 would be more like $118 billion ( = 81 + 20 + 5 + 12)

The tax cut for high-income households would be $10 billion larger if we allowed for standard deductions for households that lose itemized deductions (assuming a 24 percent effective rate under Romney’s proposals).
Not eliminating the tax preferences on saving (municipal bonds and inside-build up on life insurance) would reduce revenue from base broadening by about $22 billion (assuming a 24 percent tax rate under Romney’s proposals -- $14 billion for inside build up and $8 billion for municipal bonds).

As a result, the base broadening measures for households with income above $200,000 would raise about $63 billion ( = 95 – 22 – 10). This implies that the net tax cut for households with income above $200,000 would be $40 billion (118 – 63 – 15), even if we grant the growth effects that Rosen assumes.

Additional Issues

Several other issues are hard to quantify precisely but worth noting. First, Rosen overstates the revenue gain by ignoring the micro-behavioral responses to base-broadening. Rosen discusses and includes the effects of how taxpayers adjust their activities in response to lower tax rates (“micro behavioral” responses to tax rate cuts, which tend to reduce the revenue loss) but he neglects to include similar effects for how taxpayers respond to base-broadening measures. For example, he does not allow for the possibility that taxpayers with mortgages would likely choose to pay down their mortgages with taxable assets (and thus reduce taxable investment income) if the mortgage interest deduction were removed. Accurate scoring that includes such effects suggests that the revenue available from base-broadening is significantly smaller than Rosen’s static estimates (or base-broadening) would suggest. The tax cut for high-income households would rise further if one adjusted for individual taxpayer micro-behavioral responses to base- broadening (like reducing mortgage interest payments).[56]

Second, Rosen overstates the revenue gain by ignoring the macro-behavioral responses to base-broadening. If tax reform is truly going to be revenue-neutral and distributionally-neutral then effective marginal tax rates that take into account both the sources and uses of funds would not change very much if at all and certainly the reduction in marginal income tax rates alone -- ignoring the base-broadening -- would overstate the decline in effective marginal tax rates.[57] Brill and Viard (2011) provide further discussion of this point.

Third. Rosen does not incorporate the effects of the increase in the effective marginal tax rate that his proposal would create by eliminating itemized deductions and the exclusion of health insurance. If these tax expenditures were completely removed for all households, there would a large increase in low- and middle-class taxes even under Romney’s tax cut proposals. If the tax expenditure cuts are phased in as income rises (or introduced as a spike at $200,000), then they will increase effective marginal tax rates. Rosen’s analysis ignores these issues.

Finally, even ignoring the issues noted above, Rosen’s growth effects seem too large relative to the literature. He acknowledges that 3 percent growth (based on comparisons to current policy) is an educated guess, not the result of a rigorous proof. But 3 percent growth generates a 17.3 percent revenue feedback (24.9/143.9) for households with income above $100,000 and an 18.2 percent feedback for households with income above $200,000. Estimates by Mankiw and Weinzierl generate only a 15 percent feedback and that is in a model that cuts all capital and labor income taxes and where the response to capital income taxes is larger than labor income taxes.[58] In contrast, Governor Romney’s stated proposals do not cut capital gains and dividends tax rates for households above $200,000 (and these households receive a large share of aggregate capital gains and dividends). To be clear, we believe that JCT and CBO estimates support lower feedback mechanisms than Mankiw and Weinzierl. Our point is just that Rosen’s feedbacks are even higher than those presented by Mankiw and Weinzierl but the tax cuts proposed by Romney are less expansive, especially with respect to capital income, than the ones evaluated in Mankiw and Weinzierl.

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Footnotes

[1] Romney (2012a) and Romney (2012b).

[2] The $5 trillion figure is not a formal estimate. For a discussion of its derivation, see Marron (2012b).

[3] Brown, Gale, and Looney (2012a).

[4] Romney (2012b), Situation Room with Wolf Blitzer (2012), and CNN Political Unit (2012).

[5] For other reviews of the various critiques and issues see: Barro (2012), Greenberg (2012), Khimm (2012), and Matthews (2012).

[6] Our second paper is Brown, Gale, and Looney (2012b). For one example of the incorrect claim that we ”downgraded” our estimate, see Brill (2012). Brill and others appear to have confused our providing an estimate of two policies that they advocated (taxing municipal bond interest and taxing inside build-up in life insurance plans) with our endorsing those policies as consistent with Romney’s stated goals.

[7] Romney (2012b).

[8] Tax Policy Center (2012a).

[9] For related discussion, see Marron (2012a) and Nguyen et al. (2012).

[10] A detailed description of TPC’s microsimulation model is available at http://taxpolicycenter.org/taxtopics/TPC-Model-Overview-2012.cfm.

[11] Tax Policy Center (2012a).

[12] Marron (2012b).

[13] Nguyen et al. (2012).

[14] We are using the more familiar term “household,” instead of the technically accurate “tax unit.” A tax unit is an individual who files a tax return, or a married couple who file a tax return jointly, along with all dependents of that individual or married couple. A tax unit is technically different than a family or a household in certain situations: two persons cohabiting would be considered one household but if they were not legally married, they would file separate tax returns and thus be considered two tax units.

[15] Mankiw and Weinzierl (2006).

[16] Although there is no Romney tax plan, only a set of proposals for tax cuts coupled with unspecified base-broadening, some authors have nevertheless attempted to estimate the effects of what they see as a plan. Diamond (2012) estimates that “the Romney tax plan” would have favorable economic effects. He assumes that the tax cuts are paid for on a static basis, but he does not specify how the base-broadening occurs. Entin and McBride (2012) also estimate favorable economic effects of “Romney’s tax plan” but they do not specify offsets at all and they include revenue feedbacks that are about four times as large as those in Mankiw and Weinzierl (2006).

[17] Romney (2011), page 40.

[18] Romney (2012b).

[19] Mankiw and Weinzierl (2006).

[20] CBO (2003), CBO (2005), and JCT (2005).

[21] Hungerford (2012), Gravelle and Marples (2011).

[22] Stokey and Rebelo (1995).

[23] Feldstein (1986).

[24] Feldstein and Elmendorf (1989).

[25] Auerbach and Slemrod (1997).

[26] Gale and Potter (2002).

[27] Jensen (2012).

[28] Brown, Gale, and Looney (2012b).

[29] It is also worth noting that the estimates above refer to removing the tax exemption on all state and local bonds and taxing the inside build-up on all existing life insurance contracts. Changing the tax treatment only of new bond issues or new insurance contracts would raise far less revenue. Barthold (2012).

[30] Dubay (2012).

[31] OMB (2012).

[32] OMB (2012), page 273.

[33] Brill (2012).

[34] Romney (2011), page 59.

[35] Feldstein (2012b).

[36] IRS (2012).

[37] In 2009, itemized deductions for tax filers making more than $200,000 AGI were 6 percent lower than 2006, a normal economic and tax year. Taxable income for these filers, however, was almost 25 percent lower.

[38] Feldstein (2012a).

[39] Brown, Gale, and Looney (2012c). The income measures that we and Feldstein use differ somewhat. Feldstein uses adjusted gross income, whereas we use cash income, a more comprehensive measure (for a description of the cash income measure, see http://www.taxpolicycenter.org/numbers/displayatab.cfm?DocID=574). In 2009, 2.8 percent of households had AGI above $200,000 (in 2009 dollars), compared to 5.2 percent with cash income above $200,000 (in 2011 dollars) for our estimates for 2015.

[40] Stephanopolous (2012).

[41] Feldstein (2012b).

[42] Rosen (2012).

[43] Rosen also ignores the capital income tax cuts for households with income below $200,000. Since we focus on his results for households above $200,000, we do not address that issue here.

[44] Krieg (2012).

[45] Gabriel and Cooper (2012).

[46] Tax Policy Center (2012c).

[47] Rubin (2012).

[48] Lowrey and Kocieniewski (2012).

[49] Rubin and Przybyla (2012).

[50] Barro (2012).

[51] Democracy in America. (2012).

[52] Quoted in Lowrey (2012).

[53] National Commission on Fiscal Responsibility and Reform (2010) and Debt Reduction Task Force (2010).

[54] For taxable returns with AGI greater than $200,000, the ratio of income tax before credits to itemized deductions was 1.73 in 2006. By 2009, the ratio had decreased to 1.50. SOI (2012).

[55] Tax Policy Center (2012b).

[56] For example, see Poterba and Sinai (2008).

[57] For example, someone who faces a 35 percent statutory tax rate but exempts 20 percent of their income from tax using itemized deductions and other tax preferences actually faces an effective marginal tax rate of 28 percent (80 percent of 35 percent). If the statutory rate were reduced to 28 percent and the itemized deductions and other tax preferences were removed, the taxpayer would continue to face an effective marginal tax rate of 28 percent, so no change would be expected in their labor supply from the “20 percent marginal tax rate cut.”

[58] Mankiw and Weinzierl (2006).

Downloads

TPC’s Analysis of Governor Romney’s Tax Proposals: A Follow-up Discussion

Authors

Samuel Brown
William G. Gale
Adam Looney

Image Source: © Brian Snyder / Reuters

Why Voters Should Fear Romney’s Tax Plan

Betsey Stevenson and Justin Wolfers — Tue, 06 Nov 2012 11:59:00 -0500

Republican presidential candidate Mitt Romney has been strategically slippery about his tax plan, largely refusing to explain how he would pay for the sweeping tax cuts that represent his primary promise to voters.

In the second debate, though, he offered just enough detail for us to sketch the outlines of his program. If you’re poor or worried about the state of the U.S. government’s finances, the picture is not pretty.

The first course in Romney’s plan is dessert: Tax breaks for everyone! He would start by extending the tax cuts put in place by former President George W. Bush. He would then cut everyone’s rates by another 20 percent, repeal the alternative minimum tax, and get rid of the estate tax.

How would he pay for this? Mainly by limiting the amount people can deduct from their taxable income. Here’s the most detailed statement Romney has made: “One way of doing that would be say everybody gets—I’ll pick a number—$25,000 of deductions and credits, and you can decide which ones to use. Your home mortgage interest deduction, charity, child tax credit and so forth, you can use those as part of filling that bucket, if you will, of deductions.”

Big Shortfall

Putting both halves of Romney’s plan together, we compared the impact of the tax cuts with the offsetting effect of limiting itemized deductions. The result: While a cap on deductions is an interesting idea, it couldn’t possibly raise enough revenue to make up for the big tax giveaways Romney has promised. The shortfall would be a whopping $3.7 trillion over the next decade. Lowering the deduction limit to, say, $17,000 wouldn’t much change the math. The gap would still be $3.4 trillion.

Romney’s plan is most striking in its distributional implications (see chart). The greatest benefit would go to the rich. The top one-fifth of households would enjoy a staggering $16,000 average tax cut, offset by a tax increase of $4,000 due to the deduction cap. Net gain: $12,000. Actually, though, most of this group wouldn’t see that large of a benefit. About half of the spoils would go directly to the top 1 percent, which would get an average net tax cut of $100,000 a year.

The further one goes down the income scale, the worse Romney’s plan looks. The average household in the middle of the income distribution—the heart of the middle class—would get a cut of a little more than $800, which wouldn’t be much changed by the limit on deductions. The poor would actually pay slightly more tax, because Romney would end stimulus-related measures—such as an expansion of the Earned Income Tax Credit—that have benefited them.

True, any across-the-board tax cut would give more money to the rich in dollar terms, because they pay most of the taxes in the first place. But Romney’s plan goes further. It would reduce the amount the richest Americans pay relative to their income more than for anyone else. Specifically, the richest fifth would go from paying 26 percent of their income in taxes to 22 percent. The middle fifth would go from 16 percent to 15 percent. The tax burden on the poor would rise.

Romney has explicitly denied that his tax plan would favor the rich: “I will not, under any circumstances, reduce the share that’s being paid by the highest-income taxpayers.”

If this was truly his intention, he could have proposed tax cuts that were proportional to income—say, by offering simply to cut everyone’s tax rates by a few percentage points, rather than by a certain percentage. This would give the rich a bigger tax cut in dollar terms while preserving the distributional structure of our tax system.

Benefit Distribution

As it stands, Romney’s plan would result in 48 percent of the net tax cut going to the richest 1 percent (see pie chart). Another 32 percent would go to the next richest 4 percent of the population. All told, 94 percent of the benefit would go to the top 10 percent of the income distribution, leaving only 6 percent for the rest.

Many of Romney’s biggest boosters argue that he would be a more moderate president than he has been a candidate. Perhaps that’s plausible. On taxes, though, he has left himself little room to maneuver. His constituency would expect him to deliver on the very specific tax cuts he has promised. Meanwhile, his vagueness on the offsetting deduction limits would leave him with no mandate to get rid of the most popular tax breaks, such as those for charitable giving, mortgage interest or health insurance.

Hence, the most probable outcome would be a tax system that is radically less progressive, achieved through cuts that would create a much larger long-run budget deficit. Both outcomes would be colossal failures at a time in which true tax reform is greatly needed.

Authors

Betsey Stevenson
Justin Wolfers

Publication: Bloomberg

An Alternative to Norquist’s Tax Pledge

Philip A. Wallach — Tue, 09 Oct 2012 00:00:00 -0400

Grover Norquist’s Americans for Tax Reform asks prospective Members of the House of Representatives to sign this pledge:

I, ____, pledge to the taxpayers of the ____ district of the state of ____, and to the American people that I will:

ONE, oppose any and all efforts to increase the marginal income tax rates for individuals and/or businesses; and

TWO, oppose any net reduction or elimination of deductions and credits, unless matched dollar for dollar by further reducing tax rates.

The vast majority of Republican officeholders take Norquist’s pledge, which, they say, shows their constituents that they are committed to smaller government. Instead, it encourages Americans to think primarily about their distaste for taxes even as they reject the need for spending cuts that affect their own families.

What began as a dream of delivering small government through low taxes transforms into a rallying cry for not having to pay the bills, the very opposite of fiscal responsibility.

Norquist’s grand strategic plan envisions reduced revenues eventually necessitating serious spending cuts, but his pledge does none of the rhetorical work necessary to bring this about. Though principled small-government visionaries of the recent past have recognized this flaw, abandoning their hopes of “starving the beast,” both the mainstream and the grass roots of the Republican Party have doubled down on their anti-tax mantra. In doing so, their rhetoric veers into the realm of fantasy, and we can only hope that they “face up to big government” as a reality that must be paid for soon.

By making just one party credible on one side of the fiscal equation, Norquist’s pledge creates a profoundly unsustainable political equilibrium, ending in fiscal ruin if unsupported by a rapidly growing economy (as the 1990s provided). The Republican Party becomes an engine of deficits, as the experience under President George W. Bush shows.

If voters really care about halting the growth of America’s debt, shouldn’t they ask for a different pledge? It would go something like this:

I, _____, pledge to the taxpayers of the ____ district of the state of ____, and to the American people, that I will:

Oppose any and all bills that would result in an increase in America’s debt burden, including insisting that cuts in marginal tax rates be matched with cuts in spending, elimination of tax expenditures, or compensating revenue increases of other forms.

If anti-tax voters are real deficit hawks (as many tea partyers claim to be), they ought to demand that prospective officeholders either take this pledge or refrain from taking Norquist’s. If they are unwilling to, but remain happy to accept Norquist’s anti-tax pledge, they fairly decisively reveal that they are not deficit hawks at all.

To be clear, I do not believe that elected representatives should be making pledges at all. I believe that a responsible (fiscally and otherwise) officeholder should reject both of these pledges — pledges are fundamentally grounded on a notion of corrupt and faithless representatives.

Ironically, voters’ distrust of their own elected representatives leads those representatives to conduct themselves in a less trustworthy manner, refusing to exercise real leadership whenever it would upset a faction of their constituents.

But if one insists on a pledge and demands real fiscal responsibility, the pledge should be the one proposed here rather than Norquist’s. Voters who are actually committed fiscal hawks must reject the destabilizing asymmetry inherent in Norquist’s pledge — and those who favor Norquist’s pledge must explain why and how they believe it is going to deliver balanced budgets in the future, despite the contrary experience of the last decade.

If our elected officials were to honor the pay-as-you-go pledge proposed here, our national debt would stabilize. No doubt that following this path to achieve a rapid narrowing of the federal deficit would be painful.

But more painful in the long run would be a continuation of the status quo: just enough bipartisan “compromise” to repeatedly worsen our fiscal trajectory, with Norquist-inspired reductions in revenues unmatched by comparable decreases in spending.

Pledges aside, if all politicians can do in coming years is make the long-term budget picture worse, it will be long past time for voters to adopt a far more heavy-handed approach to their leaders: Get new ones.

This piece originally appeared at Roll Call>>

Authors

Philip A. Wallach

Publication: Roll Call

Mitt Romney's Tax Proposals: Understanding the Debate

William G. Gale — Mon, 08 Oct 2012 11:27:00 -0400

For months, Mitt Romney had been advocating tax cut proposals that would reduce revenues by about $5 trillion over the next decade, and that were heavily tilted toward the rich. Yet he did not explain how he would pay for these cuts, just that he somehow would.

In a recent paper I wrote with two colleagues, we showed that a revenue-neutral plan that met five specific goals that Governor Romney had put forth (reducing income tax rates by 20 percent, repealing the estate tax, the alternative minimum tax, and capital income taxes for middle class households, and enhancing saving and investment) would cut taxes for households with income above $200,000, and—as a result of revenue-neutrality—would therefore necessarily have to raise taxes on taxpayers below $200,000.

This was true even when we bent over backwards to make the plan as favorable to Romney as possible. We considered an unrealistically progressive way of financing the specified tax reductions. We accounted for revenue feedback coming from potential economic growth estimates as estimated by Romney advisor Greg Mankiw. We even ignored the need to finance about a trillion dollars in Romney's proposed corporate cuts.

Our conclusion was not a prediction about Governor Romney would do as president, it was an arithmetic calculation: all of the promises couldn't be met simultaneously without resorting to tax increases on households with income below $200,000.

With both candidates referring to the study in the first debate, several responses to the study having been published, new proposals from Governor Romney on the table, and confusing and misleading partisan jabs on both sides of the aisle, it is time to take a new look at this discussion and help readers understand what is going on.

To do that, let's get out of the hyper-charged world of tax policy for a second.

Suppose Governor Romney said that he wants to drive a car from Boston to Los Angeles in 15 hours. And suppose some analysts employed tools of arithmetic to conclude that "If Governor Romney wants to drive from Boston to LA in 15 hours, it is mathematically impossible to avoid speeding." After all, the drive from LA to Boston is about 3,000 miles, so to take only 15 hours would require an average of 200 miles per hour. Certainly other road trips are possible—but the particular one proposed here is not.

(Note: this is just an example that uses the logic to be employed; I am not suggesting that Romney has in any way broken a law.)

Especially in this inflamed campaign environment, one can imagine the frenzied responses. The Obama campaign might put ads out that say Romney wants to speed or is going to speed. Romney's campaign might respond by saying the study is a "joke" and "partisan," that he supports speeding laws and would never, ever speed, and it is ridiculous to suggest that he would. The Romney campaign and its surrogates might say that the analysts must be wrong because they don't even know what his road plan is or which car he would drive. Besides, Romney never really said he wanted to go LA, he might want to go somewhere closer; he could get to LA without speeding if he took more than 15 hours; he could get somewhere else in 15 hours without speeding. And so on.

With a few substitutions, this is almost exactly how the tax debate has evolved. Substitute "the various tax cuts Romney has proposed" for "driving from Boston to LA;" substitute revenue-neutrality for "in 15 hours;" substitute "tax increases on households with income below 200k and tax cuts for higher income households" for "speeding" and you have the basic story: Romney can't do all of the tax cut proposals he has advocated, remain revenue neutral, and avoid taxing households with income below $200,000 or cutting taxes for higher income households.

Substitute "the full Romney tax plan" (which, by the way, does not exist) for the choice or road plan or car and you have the common complaint, "how can you evaluate the specific proposals when the overall tax plan is not even fully specified?" The answer to which is that even with incomplete information, there is enough to understand some of the implications.

Most obviously, despite all of the hoopla and name-calling, no one has proved or really even tried to prove that the analysts' original calculation was wrong—the proposed trip would require speeding, and Romney's original tax proposals would require tax increases on households below $200,000.

Romney has now also said that he does not want to raise taxes on the middle class and does not want to cut them for high-income households. Those seem like reasonable goals, but they don't break the knot. They simply add two more constraints to the list of goals he would like to achieve and makes the list even more impossible (if there is such a thing) to achieve jointly than the earlier list.

Romney campaign surrogates and right-wing media outlets have focused on the idea that new taxes on saving and investment should be imposed. After decades of these same outlets claiming that taxes on saving and investment are bad for the economy, scholars at AEI, Heritage, some academics and the Wall Street Journal editorial page appear lined up behind higher taxes on some forms of interest income, and removal of tax-deferral on some long-term saving products, as a way to finance part of the Romney tax plan. This is an interesting development and should be pursued.

To be clear, though, pursuing this policy wouldn't be refuting our earlier study, it would be accepting the constraints and conclusions there and finding a way around them.

Likewise, Romney's recent support of placing a cap on taxapayers' itemized deductions has the potential to finance some of the tax cuts, and so is a step in the right direction. It remains to be seen, though, whether Romney can develop enough "pay-fors" to cover his tax cuts and not burden the middle class.

Or as one example of what might happen, Alan Viard, a scholar at the American Enterprise Institute noted in the New York Times, suggested that Romney is "going to need to cut rates significantly less than 20 percent if he wants to honor his other goals." Exactly: something would have to give.

More generally, the basic power of arithmetic is overwhelming in showing that Governor Romney has so far overpromised on the tax side.

You still can't drive cross country in 15 hours without speeding.

Authors

William G. Gale

Publication: Real Clear Markets

Romney Starts to Fill in Blanks on His Tax Plan

William G. Gale — Fri, 05 Oct 2012 11:42:00 -0400

For months, voters have been in the dark about key details of Mitt Romney's tax plans.

He specified $5 trillion in tax cuts, a 20% cut in income tax rates, a 40% cut in the corporate tax rate, repeal of the estate tax and alternative minimum tax and elimination of taxes on interest, dividends and capital gains for households with incomes below $200,000.

He did not want his changes to raise the deficit, but he was utterly mum on how to raise $5 trillion to offset the tax cuts.

During the summer, two colleagues and I showed that if Romney did not want to add new taxes on savings and investments -- and raising savings and investments is the second of four main planks in Romney's overall economic package -- he could not finance his tax cuts without generating a net tax cut for households with income above $200,000.

Even if all the available tax expenditures were closed in the most progressive manner possible, it would not raise enough revenue among high-income households to offset the tax cuts they would receive. This was true even when we adjusted the revenue estimates to allow for the impact of potential economic growth, and even when we gave the campaign a trillion-dollar mulligan by ignoring the cost of the corporate tax cuts.

As a result, we concluded that if Romney did not impose new taxes on savings and investments, the only way to finance his tax cut proposals and reach revenue neutrality was to raise taxes on households with income below $200,000.

This was not a forecast of what Romney would actually do; it was simply a matter of arithmetic.

But it highlighted the need for specifics; $5 trillion is not a trivial amount, even in Washington, and the prospect of middle-class tax increases sets off alarm bells.

Earlier this week, Romney finally started the process of proposing ways to pay for his tax cut proposals. He broached the idea of putting a cap on each taxpayer's total amount of itemized deductions -- including mortgage interest, state and local taxes, charitable contributions.

Although critical design features remain foggy, Romney has said the cap could range from $17,000 to $50,000, and it could vary with income.

Several things are already clear.

First, capping -- or even eliminating -- itemized deductions will not come close to paying for Romney's tax cuts. It would be a step toward financing, but much more will be needed.

Nevertheless, as a piece of the revenue puzzle, a cap is an interesting and important idea and a welcome step forward.

Members of Congress are quick to see the political advantages of a cap. Relative to curtailing specific deductions, a cap allows them to leave existing deductions in place but restrict the overall use of such deductions. In that sense, the cap is like the alternative minimum tax was intended to be -- a limit on the overall use of tax shelters, even if political leaders could not shut down each one.

A cap on itemized deductions goes after one of the three areas of the income tax where the money is. The other two are the exclusion of health insurance premiums from taxation and saving and investment incentives like 401(k) plans, and the lower tax rates on capital gains and dividends and carried interest. A cap on a taxpayer's use of all of these subsidies -- as opposed to just itemized deductions -- could get at all three areas.

Martin Feldstein of Harvard University and the Romney campaign and Maya MacGuineas of the Center for a Responsible Federal Budget have proposed a different style of cap that applies to more than just itemized deductions.

While Romney's cap appears to apply to all itemized deductions, it may have a disproportionately negative effect on charitable contributions. After all, people have to pay their state and local taxes, and many people are already in the middle of a long-term commitment to pay down their mortgage.

For those households, there may be little room left under the cap to take deductions for charitable contributions. And, for all households, the cap would eliminate tax deductions for contributions larger than the cap, so large gifts to charities would automatically lose their tax-preferred status.

So, a cap is not a panacea, but it could well be one part of a constructive solution. Likewise, his acknowledgment that his earlier, disparaging comments about the 47% of households that do not pay federal income taxes were misguided suggests a reconsideration of the role taxes play in those households. If the journey of a thousand miles begins with a single step, Romney has finally taken the first step. But there is still much more work to be done.

Authors

William G. Gale

Publication: CNN

Study Says Romney's Tax Plan Would Most Benefit Wealthy Americans

William G. Gale — Thu, 02 Aug 2012 00:00:00 -0400

Editor's Note: In an interview with Judy Woodruff of the PBS NewsHour, William Gale discusses his new study, co-authored with Samuel Brown and Adam Looney, arguing that the rich—not the middle class—stand to benefit most from Romney's plan.

Watch the full interview at pbs.org or read an excerpt below.

JUDY WOODRUFF: Mr. Obama again highlighted a study by the nonpartisan Tax Policy Center that concluded Romney's proposal would provide large tax cuts to high-income households and increase the tax burdens on middle- and/or lower-income taxpayers.

But Eric Fehrnstrom, a top Romney adviser, called the report -- quote -- "a joke" and raised questions about its impartiality and methodology. The sharpened debate on tax fairness underscores the importance both campaigns have placed on middle-class voters.

A recent NBC News/Wall Street Journal poll gave Mr. Obama a 16-point lead on Romney when it comes to who would better look out for the middle class.

For a closer look at what exactly is in the Romney tax proposal at the heart of this political fight, we turn to Bill Gale of the Tax Policy Center. He is a co-author of the report in question. And Scott Hodge of the also nonpartisan Tax Foundation, he has a different read on the Romney plan.

And, gentlemen, we thank you both for being with us.

BILL GALE, Tax Policy Center: Thank you.

SCOTT HODGE, Tax Foundation: Thank you.

JUDY WOODRUFF: So, Bill Gale, to you first.

Just quickly, how do you respond to the Romney adviser who called this assessment a joke and he questioned its impartiality and methodology?

BILL GALE: Well, first thing, let's be clear. That's a shoot-the-messenger kind of answer.

If they had a substantive response to our analysis, I presume that they would make a substantive response. Last fall, when we put out analysis of the other Republican candidates' tax options, the Romney campaign liked our analysis a lot and said very nice things about us. So it seems like their opinion of us depends on whether we're reporting on what they do or what someone else does.

JUDY WOODRUFF: Well, Bill Gale, let me ask you what in a nutshell did the Tax Policy Center conclude about where the tax burden falls, assuming the Romney plan were enacted -- tax plan?

BILL GALE: Well -- thank you.

We did a very straightforward exercise. We said, Governor Romney wants to cut rates by 20 percent. He doesn't want to raise the rate on capital gains or dividends or other saving investments. But he wants his reform to be revenue-neutral.

That means you have to raise the revenue somewhere else. We took the most optimistic way, the most progressive way to raise that revenue. And we showed that, even under those circumstances, there would be a big tax cut for high-income households and a tax increase for middle-income households.

JUDY WOODRUFF: That's boiling it down to a great degree. But...

BILL GALE: Yes, and what I want to emphasize is it's a matter of arithmetic. It is not some incredibly fancy calculation.

It's simply that, if you cut tax rates for high-income households, you lose so much revenue there, that you can't make it up by shutting down the tax exemptions that high-income tax households have.

Authors

William G. Gale

Publication: PBS NewsHour

Image Source: C. Sherburne/PhotoLink

The Senate Tax Plan Doesn't Go Far Enough in Either the Short Term or Long Term

William G. Gale — Tue, 31 Jul 2012 11:26:00 -0400

Editor's Note: William Gale contributed to U.S. News & World Report's Debate Club on the topic of the Senate tax plan. This plan would extend the Bush-era tax cuts only for those making under $250,000 and rejected one that would extended the cuts for all Americans. Democrats voted 51-48 in support of extending the cuts, which will expire at the end of the year, only to middle- and low-income Americans. Republicans opposed the Democrats' plan on the grounds that it raises taxes.

As the U.S. economy continues to putter slowly along, policy makers need to provide ways to boost aggregate spending and accelerate the economic expansion back to full employment. At the same time, the looming budget shortfalls in the medium- and longer-term will require significant changes to both spending and tax programs.

Read the full op-ed at usnews.com »

Authors

William G. Gale

Publication: U.S. News & World Report

Image Source: Chip East / Reuters

@ Brookings Podcast: Combine Going Over the Fiscal Cliff with a Stimulus

William G. Gale — Fri, 27 Jul 2012 00:00:00 -0400

While falling off the "fiscal cliff" (of automatic spending cuts and tax increases if Congress fails to act) could hurt the economy, expert William Gale says the actual result, if coupled with a temporary economic stimulus, would be greater incentives to make a better long-term budget deal.

Video

William Gale: Combine Going Over the Fiscal Cliff with a Stimulus

Authors

William G. Gale

The Debate over the Fiscal Cliff and Tax Cuts: A Live Web Chat with Ron Haskins

Wed, 25 Jul 2012 12:30:00 -0400

Event Information

July 25, 2012
12:30 PM - 1:00 PM EDT

Online Only
The Brookings Institution
1775 Massachusetts Ave., NW
Washington, DC

The fiscal cliff is fast approaching with the Bush tax cuts set to expire at the end of 2012 and a sequestration of federal spending slated for January 2013. Once again, the U.S. approaches the debt ceiling while Washington is mired in political gridlock and consumed with the campaign.

What can Congress do to avoid the looming fiscal cliff? Are preventive measures possible before the November election? On July 25, Brookings expert Ron Haskins took your questions and comments in a live web chat moderated by Vivyan Tran of POLITICO.

12:30 Vivyan Tran: Welcome everyone, let's get started.

12:26 Comment From Justin: Is there any way to avoid a dramatic budgetary showdown at the end of the year? Can we do something now so we don't have to go through that again and risk defaulting?

12:36 Ron Haskins: I don't see how a showdown can be avoided now. There is always time to reach agreement on the issues involved in any dispute, but the reason Congress has not settled either the Bush tax cuts or the sequester (or the 2013 Appropriation Bills for that matter) is that neither side is willing to compromise enough to get a deal. The theory was that the sequester would be so horrific that it would force Congress into action. Good luck with that. I wouldn't be surprised if even in the lame duck session they can't reach agreement on the Bush tax cuts or the sequester. My guess is that the sequester will go into effect and the Bush tax cuts will be extended for a few months. One big shoe that has not yet fallen is the fallout from the furloughs that will soon be issued (probably before the election) by companies that will be hit by the sequester (probably primarily defense contractors). I have heard that many of these companies will start issuing furloughs in September or October. It would not be surprising if the furloughs produce a major round of stories in the media.

12:36 Comment From Christian, MD: How would you grade Obama's budget policies in his first term? Has he improved the situation?

12:43 Ron Haskins: I am generally not a strong critic of the Obama administration, but I don't see how anyone who follows the deficit issue could rate Obama higher than a C or even a D for his performance in reducing the deficit. He missed a huge opportunity to do something serious when his own deficit commission (the Bowles-Simpson Commission) made a splendid set of recommendations that would have reduced the deficit by around $4 trillion over ten years. Obama should have introduced the bill in Congress and then tried to work with Republicans and Democrats to write a bill. But Obama all but ignored the Commission. He has increased the deficit more than any other president; we're now running deficits that exceed $1 trillion per year. Not only have we failed to make progress, we've moved backwards.

12:43 Comment From Anonymous: What compromises should the two parties be making to avoid the fiscal cliff?

12:47 Ron Haskins: The broadest compromises the two parties need to make have been known for years -- Republicans need to agree to tax increases and Democrats need to agree to reduce the rate of growth in entitlements, especially Medicare. Perhaps the most important reason the parties are having so much trouble coming to an agreement is that the main issue each party must compromise on is the number one issue on their agenda -- taxes increases for Republicans and entitlement cuts for Democrats.

12:48 Comment From Alex, VA: What impact will another debt ceiling controversy have on investor confidence? Are these political games hurting our reputation globally?

12:51 Ron Haskins: I think I have noticed that hardly anyone can predict financial markets. But it seems pretty clear that investors realize that Congress is completely unreliable and that there is no way to know when they will seriously address the deficit. Our interest rates remain low primarily because other nations are in even worse shape than we are. Even when we're down, we're still the most vibrant economy in the world and we still have the most successful innovators. But the day will come when investors will lose confidence, we'll have to pay higher interest rates to get people or nations to give us their money, and the implications for the federal deficit will be monstrous.

12:51 Comment From User: Can you tell us what immediate effects we should expect as a part of the sequestration process? Or elaborate on the process in general...

12:54 Ron Haskins: CBO predicts that if the sequester goes into effect and the Bush tax cuts are not extended, the nation will slide into recession in the first quarter of 2013. I think most economists (and I'm surrounded by them here at Brookings) agree with this prediction. So get ready for the recession to return.

12:54 Comment From Gail, Fairfax: It seems like election season is the last time Republicans will want to compromise on their no tax stance. Should we be worried that we're approaching the fiscal cliff at the worst possible time?

12:59 Ron Haskins: Although I agree with you, we had Senator Patty Murray at Brookings last week and she recommended that Democrats "go off the cliff" -- by which she meant that she would refuse to avoid the sequester and would refuse to extend the Bush tax cuts, thereby throwing the nation into recession. But if that were to happen, with the Bush tax cuts gone, Congress could greatly increase tax revenues and still give everyone a tax cut (relative to the new post-Bush tax cut baseline). In fact, this new negotiating position is one of the reasons some Democrats agree with Murray and would welcome going off the cliff.

12:59 Ron Haskins: Thanks to everyone for a set of excellent questions.

1:00 Vivyan Tran: Thanks everyone, we'll be back in September.