Reforming Taxes as Part of Budget Reform
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Transcript of Reforming Taxes as Part of Budget Reform
Reforming Taxes as Part of Budget ReformTestimony before the National Commission on Fiscal Responsibility and Reform
June 23, 2010
C. Eugene SteuerleInstitute Fellow & Richard B. Fisher Chair
The Urban Institute
Outline
Taxes & the Budget Principles of Public Finance More on Tax Subsidies & “Expenditures” Tax Gap & Tax Havens Thinking Comprehensively & Lessons
from Past Tax Reform
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Taxes & the Budget Reforming taxes involves dealing with:
Entire revenue side of budget, including special taxes for:• Social Security & Medicare & highways
Complex measurement issues (e.g., cost of business) Incentives for work & saving (which affect future revenues) Tax rates About 1/4 to 1/3 of all “spending” or subsidies
• More housing subsidies (e.g., mortgage interest) than HUD• A larger low-income subsidy (EITC) than welfare (TANF)
Thousands of provisions Like expenditures, each provision a different rationale
3
Relationship Between Tax &Budget Reform Four ways to reduce deficits
(1) Reduce direct spending (2) Raise tax rates (3) Spend less on tax subsidies(4) Work more (& save more)
• Example: Raise early retirement age • Biggest budget effect: income tax revenues• Actually increases Social Security benefits
All except (1) related to taxes
4
Taxes & Spending per Household($2010)
2011 2020
Taxes per household $ 20,000 $ 26,000
Total Spending per household $ 30,000 $ 35,000
Tax Expenditures per household $ 9,600 $ 12,400
Interest Spending per Household $ 2,000 $ 7,000
Source: S. Rennane and C. E. Steuerle, the Urban Institute, 2010. CBO Alternative Baseline, with author adjustments for health reform. 5
Relationship Between Tax &Budget Reform
A common problem: permanent built-in growth Many mandatory spending (entitlement) programs Most tax programs
Throughout all U.S. history until today, the long-term budget under current law was in surplus
E.g., huge 1980 surpluses under 1970 law E.g., huge 1954 surpluses under 1944 law
Today, revenues spent before new Congress assembles
6
Steuerle-Roeper Index of Fiscal Democracy:-- % of Revenues Not Yet Committed to
Permanent (Mandatory) Programs--
Source: S. Rennane, T. Roeper and C. E. Steuerle, 2010. Data from OMB and CBO, with author adjustments for health reform. Excludes TARP.
-10%
0%
10%
20%
30%
40%
50%
60%
70%
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Principles of Public Finance--Apply to Taxes & Expenditures--
Equal Justice (equal treatment of equals) Efficiency (competitiveness, growth,
bang per buck, no special favors) Progressivity (e.g., don’t tax those who can’t pay;
subsidize needs, not everyone) Simplicity (includes transparency, ability to
administer) Individual Equity (entitled to rewards from own efforts)
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Opportunities for Reform:Adhering to & Balancing Principles
(1) Special candidates for reform: a principle violated
without furthering other principles• Preferences by industry, consumption, taxpayer
(2) Check for balance How strong is policy rationale for intervention? How much can base broadening deter rate increases? What are the real marginal tax rates—direct & indirect? What are the error rates? Do we need multiple “programs” for education, capital gains rates, etc.? What is the evidence for effectiveness? Who really benefits? Does form (e.g., credit or deduction) matter? Are floors or caps reasonable? 9
Tax ExpendituresExpenditure-like preferences in tax code Exclusions, deductions, credits, special rates, timing shifts Goals: social, economic, redistributive
Usually targeted at specific groups or for specific activities
Other Issues Accounting for them doesn’t make them good or bad per se
• Like expenditures, do affect behavior Often not “neutral” or efficient
• E.g., favor one form of energy production over another• E.g., favor one form of saving over another
Some controversy over which to count • Most conflicts over capital income taxation• For example, should base be income or consumption?
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How Tax Expenditures Differ From Direct Spending
Enactments show up as tax cuts, not spending increases Removals show up as tax increases, not spending cuts Administered by IRS, not spending agencies Other Considerations
“Authorized” by tax-writing committees Most are permanent (“tax entitlements”) and many intended to
be permanent (“tax extenders”) Use annual accounting period (e.g., EITC based on annual
wages, welfare based on monthly income) Most (other than EITC and child credits) not “refundable”
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Income & Corporate Tax Expenditures: Comparison to Income Tax and Total Revenues
(2010, $ billions)
Total Income Tax Expenditures 1,099
Total Income Tax 1,093
Total Revenues 2,126
Income Tax Expenditures as % of Total Income Tax 101%*
Income Tax Expenditures as % of Total Revenues 52%*
*Percentages especially high in 2010 due to recession
Source: Urban-Brookings Tax Policy Center, 2010.12
Tax Expenditures: Largest in 2009(Billions, $2009)
Source: OMB Analytical Perspectives. Income Tax Expenditures only.
Employer contributions to health insurance* 144Exclusion for pensions & retirement plans(income tax only) 85
Deductibility of mortgage interest 79
Accelerated depreciation-machinery & equipment 57
Capital gains 53
Earned income tax credit 49
Deductibility of non-business state and local taxes 45
Child credit 45
Step-up basis of capital gains at death 41*Income tax only. At least $60 billion more in Social Security tax expenditures (own estimates).
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Tax Expenditures: Some Comparisons to Spending by Function, 2009 ($, billions)
Source: Center for a Responsible Federal Budget. Tax Expenditure calculations do not include interaction effects.
OutlaysTax
Expenditures* TotalNational defense 661 12 673
International affairs 38 46 83
General science, space and technology 29 12 41
Energy 5 5 10
Natural resources and environment 36 2 37
Agriculture 22 1 23
Commerce and housing 292 385 677
Transportation 84 4 88
Community and regional development 28 3 31
Educ., training, emp., and social services 80 109 188
Health 334 168 502
Medicare 430 430
Income security 533 130 664
Social Security 678 31 709
Veterans benefits and services 95 4 100
Other 168 175 343
Total 3,513 1,087 4,600
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Distribution of Major Tax Expenditures
Percent Reduction in After-Tax Income: Eliminating Major Individual Income Tax Expenditures, by Income Quintile
BottomQuintile
2nd
QuintileMiddleQuintile
4th
QuintileTop
Quintile
Without interactions 5.6% 8.0% 6.8% 6.5% 10.7%
With interactions 6.5% 8.2% 6.8% 6.8% 11.4%
Source: Burman, L., E. Toder and C. Geissler, 2008. Urban-Brookings Tax Policy Center. 15
Distribution of Tax Expenditures Throughout the Income Scale
Benefits from high- to low-income taxpayers:
Lower rates on capital gains and dividends Itemized deductions Exclusions for pension & health insurance Student loans & higher education subsidies Above-the-line deductions Child-care expenses & tuition credits Child Credit (partially refundable) Earned Income Credit (fully refundable)
Source: Burman, L., E. Toder and C. Geissler, 2008. Urban-Brookings Tax Policy Center. 16
Examples of Issues Throughout Income Distribution
High income: zero taxes or multiple taxes? Much income accrued & never taxed or taxed at capital gains
rates But also multiple taxation:
• individual, corporate, estate
Middle income: are adjustments appropriate & by how much? Housing, pensions Adjustments for family size—too little or too much?
• Example: family of 4 & family of 2, each making $50,000
Low income: who should administer and how? Earned income tax credit
• Alternative to welfare• But leaves out singles, particularly low-earning males
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Sources of Tax Gap, 2001 ($ billions)
Source: Toder, E. 2007. “What is the Tax Gap?” Tax Analysts.
Tax SourcesNon-filing
Under-reporting
Under-payment Total
Individual Income Tax 25 197 23.4 245
Non-business income 56
Business income 109
Adjustments, deductions, exemptions 15
Credits 17
Corporation Income Tax 30 2.3 32
Employment Tax (e.g., Social Security) 54 5 59Estate Tax 2 4 2.1 8
Excise Tax 0.5 0.5All Taxes 27 285 33.3 345Memo: Taxes paid by individuals 27 240 25.5 293Memo2: Taxes on business income of individuals 148 Source: Internal Revenue Service, "Tax Gap for Tax Year 2001", in Mark J. Mazur and Alan H. Plumley (2007)
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Tax Gap & Tax Havens: Opportunities
Moderate saving relative to deficit, BUT… Tax Gap
Simplification & lower rates = less tax gap More IRS enforcement/resources
• Direct effects: about $4 per $1 of spending• Indirect effects: deterrence
More information reporting + withholding Greater equity, but labor switched out of “productive” activities
Tax Havens• Both evasion (cheating) and legal avoidance (income shifting)• Business income shifting perhaps costs $20 billion to $60
billion• Includes large interest deductions where few assets• Disputes over “transfer pricing” & location of intangibles
• Financial capital extremely mobile
Sources: E. Toder & R. Altshuler, Urban-Brookings Tax Policy Center; H.Grubert, Treasury; IRS; C. E. Steuerle 19
Thinking Comprehensively Inevitable controversy over cuts in spending & tax increases
Headlines same for attacking 5 or 500 special interests Controversy already assured over renewal of Bush tax cuts Might as well claim some major achievement
Lesson from 1984-86 tax reform effort Burden of proof under narrow reform:
• Special interest argue they have been “picked on” unfairly” Switch in burden of proof under broad reform:
• Special interests must argue why principles don’t apply to them Precedent very important
Congress facing fiscal huge challenges for many years20
Opportunities: Interactive Tax & Budget Issues Work longer: more revenues at any given tax rate
Combined private pension & Social Security reform Recent British example
Employee benefit reform: affect income taxes & Soc Sec solvency
Financial reform: tax-induced leverage Corporate debt preferred to equity Individual borrowing for larger houses & second homes Interest deductions, yet excluding interest in 401 (k) plans
Unprecedented opportunity to combine direct spending & tax subsidies (not possible even in 1986 tax reform)
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Consider Broad Rules & Criteria for Action
Limit automatic growth in all mandatory programs Remove special preferences for particular types of
industry, consumption or taxpayer Trigger action for excessive growth or fiscal
imbalance Goal is to encourage action
Remove needless duplication (& combine programs) Education, capital gains, housing, urban, etc.
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Real Budget Reform MeansLower Taxes & Better Spending
Over long-run, taxes = spending Current spending = revenues collected today
+ revenues collected tomorrow
Bills don’t go away because paid with credit Interest costs reduce funds for alternatives
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