• Three tax reform frames

    There are three key frames that are needed to best think about tax reform: math, fairness and economic growth.

    First math. Tax receipts must go up if we are ever going to have another balanced budget. There is some consensus that a tax reform that “broadens the base and lowers the rate” is the way to achieve this, and I agree. However, it is important to understand that we must have a net tax increase across all federal tax sources, or we won’t have a balanced budget ever again given any plausible spending scenario. The first frame for tax reform is math.

    Second, the components of federal tax receipts could be changed, which raises the key issues of fairness and economic growth. In making trade-offs between these two values, it is useful here to recall the historical share of different sources of federal tax revenue (personal income and payroll taxes, corporate taxes, and all other taxes including excise and estate taxes). From the CBO’s latest report (p. 81):

    Corporate taxes have been a relatively small proportion of total federal tax receipts for 30 years (~10-13% of total receipts) while income and payroll taxes have been much larger sources of federal receipts with income taxes being the more volatile of the two. Excise and estate taxes have been small and declining (note: these shares would be very different in 1950, with corporate and excise taxes much larger).

    The projected increase in income taxes as a percent of GDP shown in the figure after 2012 is simply the tax code reverting to pre-2001 levels on January 1, 2013, and the dip in payroll taxes and subsequent increase in 2012 is the enactment of the payroll tax cut in 2011 and the sun-setting of same (above it is shown as ending on February 29, 2012 as is current law).

    A great deal of discussion of the tax code and tax reform has focused on fairness, which is a key concept, but fairness needs to be anchored to a bottom line percent of GDP to be collected in taxes (the Fiscal Commission suggests 21% of GDP). Once a target percent of GDP to be collected in taxes is set, fairness must be discussed along side the impact of the tax code on economic growth (higher growth is better for the deficit and for jobs). If we are going to develop a plan that can produce a sustainable budget, all three of the following frames must be an explicit part of the tax reform discussion.

    • math
    • fairness
    • economic growth

    The bottom line for tax reform if you want a sustainable budget is how will federal tax receipts be increased, not if.



    • I don’t understand this business of “fairness needs to be anchored to a bottom line percent of GDP”.
      Fairness is about how the tax burden is distributed which has nothing to do with the total tax burden.

    • @Mark Spohr
      I think fairness is a secondary goal (as is economic growth) of tax policy. The primary goal of tax policy is to raise the revenue needed to finance govt. If you only talk of fairness, or only economic growth, in discussing the tax code without linking it to a level of spending, then the discussion is unlinked from the main point of tax policy. I prefer a progressive income tax code; however, I would prefer a less progressive one that raised 21% of GDP to a more progressive one that yielded 18% of GDP.

      • I’m with Mark. I don’t see why one must decouple and order as you (Don) did: fairness, economic growth, and the level of taxing and spending. What’s the objective (evidence or theoretical) basis for that? Aren’t the choices and framing here just manifestations of personal preference or values?

      • Another thing I don’t understand is the fixation on an arbitrary number for the tax as a % of GDP. If you look at the top 20 developed economies, they have a wide variation in the % GDP collected as tax and this doesn’t seem to have any relation to their performance. I think it’s really more important in how the money is spent.
        One could easily argue that the US at 18% of GDP is too high because we waste a lot on a bloated military and a grossly inefficient health system.
        On the other hand, you could look at Germany with 40% of GDP in tax and say it is about right since they spend their money providing a strong social safety net including education, job training, economic support to businesses throughout the business cycle and, of course, comprehensive quality health care. The result is that they have weathered the current global recession much better than the US (and are a top exporting country) and also have health that is measured at the top of the 20 compared to the US which is at the bottom. One reason could be that they have a highly regulated health system which costs about half of what we spend.
        There is no magic number for tax as % of GDP. It all depends on how you collect and spend the money (math, fairness and economic growth, as you point out).

        • Next week I will post about the distinction between allocative and productive efficiency. I think it applies here too. Because various sectors of the economy — health a prime example — are not productively efficient (have a lot of waste), it is impossible to assess whether the level of resources allocated to them are optimal.

          In the current context, it is not clear to me how one assesses the “rightness” of any particular level of government activity without first achieving productive efficiency. Because we know health care is not productively efficient and it is a large portion of government spending, I don’t see how X% GDP for any X can be argued as the right level. Maybe we should spend more or less. One cannot tell.

    • Growth is important as long as we are talking about 60% or more of the population becoming wealthier, not just the rich becoming richer.

      • @George
        economic growth and fairness discussion go hand in hand for me. All else equal, you would rather have higher growth, but there are tradeoffs that have to be made on fairness, or distribution of the gains from growth, as you say.

    • However, it is important to understand that we must have a net tax increase across all federal tax sources, or we won’t have a balanced budget ever again given any plausible spending scenario.

      Since much of our tax money is spent on excessive military spending, transfers to people who would not be poor without the transfer and medicare does not use its market power or eliminate very low/no benefit care to keep spending down, it is technically easy to balance the budget without new revenue and without hurting the needy. I outline this in more detail here: http://un-thought.blogspot.com/2011/09/why-eliminating-deficit-is-easy-but.html

      Also the incidence of the corporate tax is pretty perverse (it can fall on poor savers over high income big spenders) and so it should be lowered to 3 %. The 3% would serve as an insurance premium to pay for the limited liability protections that corporation owners get.

      It seems to me like a like a progressive consumption tax would be the best way to tax overall. I outline a way to get a progressive consumption tax here: http://un-thought.blogspot.com/2011/10/how-is-this-for-progressive-consumption.html