Archive for the ‘Taxes’ Category

Fiscal Cliff Solution November 2012

November 17, 2012

Paul Krugman, in his “Let’s Not Make A Deal” column of the November 8, 2012 New York Times, implored the President to hang tough and not agree to an extension of the Bush era tax cuts for the “wealthy”, which the President defines as married couples making more than $250,000 a year.  On principle, I agree with Prof. Krugman.  However, there is room to compromise without selling out the voters.

Speaker Boehner said after the election that he does not want to raise tax rates because he does not want to hurt small businesses.  But we know that many unincorporated businesses are not really small, including giant construction companies (such as Bechtel) and hedge funds.   The President has proposed to reduce the corporate tax rate while also eliminating loopholes in the tax code that allow many corporations to pay a much lower effective tax rate that the top nominal corporate tax rate.  Companies like Bechtel should incorporate and pay that reduced corporate tax rate.  Hedge fund managers should no longer be shielded from taxes by the “carried interest” provision.

In our town, there are many people running small businesses, and many of those small businesses are incorporated.  There must be a way to protect small businesses that are not incorporated, while at the same time raising the rates for households making more than $250,000.  For example, the tax code could define a new category of small business that allows a lower tax rate (equal to the corporate tax rate) for businesses that employ fewer than 20 people. Perhaps only retained earnings would be eligible for the lower tax rate.  Or perhaps the proprietor would be allowed to declare that a certain amount of earning per employee (say $5,000 or $10,000 per employee) would be taxed at the lower tax rate.

When combined with a reduction in tax expenditures (“loopholes”), a small increase in tax rates on high-income households, but not small businesses filing under this new category, might generate enough additional revenue to satisfy the president as part of a grand bargain to gradually bring down the federal deficit.


Debt Ceiling-Deficit Reduction Talks

July 10, 2011

President Obama needs to start explaining to the American people what is at stake in the current negotiations between the Administration and the Congress on raising the debt ceiling.  Unless Congress raises the federal debt ceiling, the U.S. federal government will soon run out of money to pay its operating expenses and service its debt.  August 2 is the date, according to Treasury Secretary Timothy Geithner.  Republicans have been demanding drastic reductions in federal spending, with no increase in taxes of any kind, before they will approve an increase in the debt ceiling.

Last week, Congressional Republicans walked out of deficit reduction talks hosted by Vice President Biden.  Now President Obama has increased his participation by inviting Congressional leaders to discuss how to break the impasse.  During a Thursday meeting at the White House, the President proposed three options for reducing the deficit over a ten year period – a $2 trillion option, a $3 trillion option, and a $4 trillion option.  The Wall Street Journal gave a general idea of what was included in the $4 trillion option, but we do not have any specifics.  Initially, both President Obama and Speaker John Boehner were described as being in favor of a $4 trillion deal.  However, on Saturday night, Speaker Boehner issued a statement saying that he no longer favored a $4 trillion deal because that would have included “tax increases”, as Republicans call elimination of tax loopholes that favor the rich.

Recent polls indicate that a majority of Americans oppose raising the debt ceiling, but they also oppose any cuts to Social Security or Medicare.  In response to the intransigence of the Congressional Republicans, President Obama needs to explain to the American people that maintaining the full faith and credit of the U.S. government is paramount.  He needs to explain the impact that Republican demands will have on the lives of ordinary Americans. The President also needs to report to his own supporters what options he laid out for the Congressional leaders, and what the impact of those options would be.

The following four options are illustrative of what is at stake for positions of the Obama Administration, the Bowles-Simpson Deficit Reduction Commission, the Congressional Republicans, and the TEA party.  (Since we do not have the advantage of a large staff of economists like OMB or the Congressional Budget Office to score the options, I cannot give precise numbers for the size of the budget savings.)

Debt Ceiling/Deficit Reduction Options

Option I outlines the main features of a proposal that the President laid out in a speech on  April 13, 2011.  President Obama has emphasized some of the points in this list at various times during the first six months of 2011.

I. Increase Debt Ceiling, Invest in Infrastructure and Jobs

  • Must pay interest on debt.
  • Fund Infrastructure Investments
    • Roads, bridges, ports;
    • Maintain sewers and sewage treatment plants;
    • National electrical power grid.
  • Green energy technology development
  • Manufacturing innovation laboratories
  • Cap defense spending.
  • Implement the Affordable Care Act, including support for Medicaid.
  • Support states in school improvement projects.
  • Eliminate farm subsidies and ethanol production subsidies.
  • Eliminate tax breaks for oil companies.
  • Eliminate tax loopholes while cutting top corporate tax rate.
  • Let Bush-era tax cuts expire as scheduled.
  • Tax hedge fund manager fees as ordinary income.
  • Tax dividends as ordinary income.

II. Increase the Debt Ceiling, Gradually Reduce Spending, Increase Revenues

Option II outlines the main implications of adopting the recommendations of the President’s Deficit Commission, co-chaired by Erskine Bowles and Alan Simpson.[i] See

  • Pay interest on debt.
  • Gradually reduce defense and discretionary spending.
  • Maintain current levels of green energy development.
  • Maintain social security payments at current levels.
  • Maintain Medicare benefits at current levels, but aggressively seek ways to reduce health care cost increases.
  • Eliminate farm subsidies, ethanol subsidies, and tax breaks for oil companies.
  • Eliminate corporate tax loopholes while cutting top corporate tax rate.
  • Tax hedge fund manager fees as ordinary income.
  • Adopt the Bowles-Simpson Zero Plan to reduce the federal deficit to zero:
  1. Eliminate all tax expenditures—for both income and payroll taxes—except for the child credit, the earned income tax credit, foreign tax credits, and a few less common preferences.
  2. Eliminate the alternative minimum tax (AMT).
  3. Retain personal exemptions (no phase-out).
  4. Replace the current six-bracket individual tax rate schedule with a three-bracket schedule of 12, 20, and 27 %.
  5. Tax capital gains and dividends as ordinary income.
  6. Index tax parameters using the chained Consumer Price Index.
  7. Increase the Social Security wage base by 2 percent per year more than the growth in the average wage (making the FICA cap $140,100 in 2015).
  8. Phase in an increase in the federal excise tax on gasoline of 15 cents per gallon (13.5 cents per gallon on average in 2015).
  9. Eliminate corporate tax expenditures and reduce the corporate tax rate to 27 percent.

We do not have enough details from the Thursday White House meeting to know whether all of these Bowles-Simpson proposals were included in the options presented by President Obama.  The Wall Street Journal reported in a separate story[ii] that the President suggested the adoption of the chained Consumer Price Index as the basis for Social Security Cost of Living (COLA) adjustments and federal pension adjustments as well as for indexing tax parameters.  It is not clear why the President suggested this instead of raising the cap on salaries and wages subject to FICA.

Some economists favor the adoption of a chained Consumer Price Index because it takes into account changes in the quantities of goods and services that consumers buy as relative prices change.  For example, if the prices of French wines go up and the prices of smart phones go down, consumers may buy more smart phones but less French wine.  At present, some tax parameters are adjusted by the CPI-U, which does not take into account changes in quantity preferences as relative prices change.  Social Security benefits and federal pensions are adjusted using CPI-W, which is based on the increase in average wages.  However, over the past decade CPI-U and CPI-W have tracked very closely, whereas the chained CPI increased more slowly.

If someone were to retire now at age 62, the future benefits would be less using the chained CPI than using the current formula – 4% less at age 75, 6.5% less at age 85, and 9.2% at age 95.[iii]  The changes would be even worse for younger Americans.  If the chained CPI were really a better formula for showing the cost of living, there might be some justification for adopting it.  However, health care costs are rising faster than general living costs, and seniors are the largest consumers of health care.  None of the proposed CPI formulae take into account the higher costs that seniors incur for health care and long term care.

Increasing the FICA cap is a better way to ensure the solvency of the Social Security System.  There is no reason to stop at $140,000 annual salary.  If FICA applied to wages and salaries up to $200,000 annual income, the Social Security System could remain solvent for the rest of the century.

III. Raise the Debt Ceiling, Reduce Spending, Reduce Taxes on the Wealthy, Eliminate Social Security and Medicare

Option III reflects the mood of Congressional Republicans, including a lot of Republican proposals.   Republicans say repeatedly that the United States does not have a revenue problem, it has a spending problem, and many Republicans in Congress would vote for Option III.

  • Pay interest on debt.
  • Maintain defense budget.
  • Drastically reduce discretionary spending.
  • Eliminate Department of Education and drastically reduce Pell Grants (student aid for college education); states are responsible.
  • Eliminate spending on green energy development; private sector is responsible.
  • Eliminate food stamps and Women, Infants and Children programs.
  • Cut 50% of funding for the Securities and Exchange Commission and the Commodity Futures Trading Commission.
  • Cut 30% from funding for Food and Drug Administration (FDA).
  • Privatize social security for those under 55; individual’s accounts would be invested in the stock market.
  • Repeal the Affordable Care Act.
  • Privatize Medicare, but with a Federal voucher system; current retirees would keep their current benefits.
  • Make Bush-era tax cuts permanent.
  • No tax increases:  maintain farm subsidies, ethanol subsidies, and tax breaks for oil companies; hedge fund managers continue 15% tax on their fees; dividend rates are 0% or 15%.
  • Cut top corporate tax rate to 27%.
  • Eliminate the alternative minimum tax.

IV. No Increase in the Debt Ceiling

The U.S. government reached its statutory debt limit on May 16, 2011.  The Treasury has been using “extraordinary measures” that will allow the government to extend its borrowing authority until August 2.  There is a large amount of debt coming due on August 4, and there will be no way to roll over the debt or pay the interest due unless the debt limit is increased.  Standard & Poors has stated that any U.S. Treasury bond that has a payment due on August 4, 2011 will be downgraded from AAA to D if Congress does not increase the debt limit.  The results of such a debt default would be catastrophic, and many Congressional leaders have stated that it will not happen.

Option IV assumes that Congress fails to come to a long-term deficit reduction deal but enacts a temporary and small increase in the debt ceiling on August 2, 2011.  Clearly, Option IV is not a long-term solution to the problem of balancing the budget, but it would cause so much economic pain that it would quickly get the attention of an apathetic public.

  • Government is allowed to spend only its current revenues.
  • Must pay interest on the debt as well as fund current operations.
  • Drastic reductions in government expenditures until debt ceiling increased
    • Government salaries are cut 50%.
    • Social Security payments are cut 50%.
    • Government retirement pensions are cut 50%.
    • No Medicare payments until debt ceiling is increased
    • All National Parks are closed.
    • FEMA suspends operations.  Reponses to natural disasters, such as hurricanes, earthquakes, floods, fires, and tornadoes, will be the responsibility of the states.
    • Staff positions at foreign embassies are cut 50%.
    • All consular offices are closed.
    • U.S. Passport Office is closed until debt ceiling is increased.
    • Subsidies to the U.S. Postal Service are eliminated.
  • Start to sell stored commodities such as gold in Fort Knox and oil in the Strategic Petroleum Reserve.

It should be clear that Option IV would create quite a stir, and if implemented for very long would result to riots in the streets just like in Athens. People need to see where the TEA party recommendations would lead.  It is unlikely that Republicans in Congress could “hang tough” in the face of the public outcry if Option IV were forced on the President.

We should add what the consequences of Option III would be. If the Republican agenda were adopted quickly, if Option III were implemented within a year, it would lead to a new recession.  IMF studies show that a budget cut of 1% of GDP typically reduces demand by about 1%, and increases the unemployment rate by 0.3%.[iv]

Since the Federal Budget Deficit is about 10% of GDP, an immediate or short-term cut in Federal spending to try to balance the budget with no revenue enhancements (as the Republicans demand) would result in a reduction of 10% in domestic demand and a rise in the unemployment rate of 3% to 12.2% This would be worse than the recent recession that officially ended in 2009. The Federal Budget would not in fact be balanced because ensuing recession would result in lower tax revenues.

President Obama should not cave in to Republican demands.  He should explain in a lengthy televised address to the American people what the three options are that he suggested to the Congressional leadership, and what the consequences would be if the Republicans were to force a solution like Option III above.  Then he should make it clear that unless the Republicans compromise, the outcome will be Option IV, which will be a disaster.

[ii] “How Tweaking Benefits Would Work,” Wall Street Journal, July 8, 2011, p. A4.

[iv] World Economic Outlook, October 2010, Chapter 3, “Will It Hurt? Macroeconomic Effects of Fiscal Consolidation,” p.113.

Are Our Taxes Too High?

April 18, 2011

On Wednesday, April 13, 2011, President Obama gave a speech outlining his proposal to reduce the federal deficit by $4 Trillion over 12 years, with more than $2 Trillion in spending cuts including $480 Billion in Medicare savings, $1 Trillion in revenue increases by not extending the Bush tax cuts for upper income taxpayers, and $1 Trillion in savings on interest payments on the federal debt.  The President also proposed a bipartisan panel to simplify the tax code and to reduce or eliminate special tax breaks for individuals and corporations.[i]  He said he would not raise the eligibility age for Medicare.  Even before the president gave his speech at George Washington University, Republicans were blasting the proposal as an unacceptable plan to raise taxes.

House Speaker John Boehner (R-Ohio) said

“I think the president heard us loud and clear. We’re willing to resolve our differences and do something meaningful but raising taxes will not be part of it.”

“We don’t believe that raising taxes is the answer here,” added House Majority Leader Eric Cantor (R-Va.), who also attended the meeting morning meeting at the White House.[ii]

Rep. Paul Ryan, Chairman of the House Budget Committee, said “We don’t have a problem with our budget because Americans don’t pay enough taxes. We have problems with our budget because we spend too much money.”[iii]

Later in the week, the House approved the Ryan Budget, which proposes to cut the top income tax rate to 25% and reduce, but not eliminate the projected budget deficit, by making drastic cuts in many federal programs and replacing Medicare with a voucher-like system for anyone who is now less than 55 years old.

Do we Americans pay too much in taxes?

In 2009, federal, state and local income taxes consumed 9.2% of all personal income, the lowest level since 1950.[iv]  The OECD Center for Tax Policy and Administration studied the ratio of all taxes to national GDP.   In 2007, the United States was 27th in the ranking of the 30 OECD member countries.[v]  Due to the Great Recession and the Obama tax cuts of 2009, the U.S. fell to 28th, with only Turkey and Mexico having lower ratios of taxes to GDP.  Do we really want to be like Turkey or Mexico?  If our tax ratio were at the same level as Germany, in the middle of the OECD ranking, we would not have such a difficult problem balancing the federal budget.  And note that Germany now has a lower unemployment rate than the U.S.

Here are a few more numbers to consider: The last time the U.S. federal government was in the black was during the second term of the Clinton Administration.   Even excluding the Social Security surplus, the surplus of federal revenues over federal expenditures was $1.9 billion in fiscal 1999 and $86.4 billion in fiscal 2000. Alan Greenspan (Federal Reserve Chairman) as well as the Congressional Budget Office worried that the federal government was on a path to pay off the entire federal debt.  Instead, the Bush-era tax cuts coupled with major off-budget spending for two wars and a Medicare drug benefit, added $3.2 trillion to the debt.  Then Republican-managed deregulation led to the greatest financial crisis in a century, followed by the Great Recession, which resulted in a sharp drop in tax revenues.  The Republicans try to blame the current deficit on President Obama, but the fact is that stimulus spending since Mr. Obama took office — including large tax cuts — accounts for about $600 billion of the current $14.2 trillion in accumulated debt.[vi]

One of the major factors in grim budget projections is the rising cost of health care.  Representative Ryan says the U.S. cannot afford Medicare, so he proposes to replace Medicare with a voucher-like system that relies on the private insurance industry.  There is nothing in the Republican budget proposal to lower health care costs.  Indeed, the Ryan plan might contribute to increased health insurance costs, since administrative costs of private insurance (12% to 20% of premiums) are higher than the administrative costs of Medicare (2% to 6%).[vii]

The Republican response the President’s deficit reduction proposal is a disappointing reiteration of the tax-cuts-above-all ideology that has gotten this country deeply into debt.   Republican politicians may think this is good politics.  I am not a politician.  I care deeply about this country’s future.  The current federal deficit is unsustainable, and national fiscal salvation will require shared sacrifice.  I am ready to pay taxes at the rates in effect from 1995-2000 during the Clinton Administration.

There will be a long debate on how to eliminate the budget deficit.  We will have more comments in coming posts.

Temporary Payroll Tax Reduction Must Not Drain Social Security Trust Fund

December 9, 2010

There is a need to improve the tax compromise that the President reached with Congressional Republicans. Any temporary reduction in payroll taxes must be offset by future tax increases to ensure the continued solvency of Social Security.  We cannot wait for some future Congressional action to save Social Security.  The bill being drafted this week needs to include language to raise in future the revenues lost in the coming year because of the temporary payroll tax reduction.

There are several ways to do this.  One way is to raise the cap on annual earnings to which the payroll tax applies.

Another way would be to have a doughnut hole of earnings that would be exempt from payroll taxes, and then any earnings above the upper limit would be subject to payroll taxes.

A third way would be to make dividends subject to the same tax rate as payroll taxes, and specify that those taxes would go to the Social Security Trust Fund.  This would recover taxes from owners of closely held companies, like Linda McMahon, who pay themselves in dividends instead of salary.

Erskine Bowles and Alan Simpson, co-chairs of the National commission on Fiscal Responsibility and Reform (Deficit Reduction Commission), have acknowledged the need to restore the Social Security Trust Fund after a temporary payroll tax reduction.  Your Senator or Congressman can use that as the basis for including an amendment to the current tax bill that ensures that the Social Security Trust Fund is not depleted by this bill.