The Center's work on '2001/2003 Tax Cuts' Issues

Bernstein: Why Debt Matters

March 25, 2014 at 2:57 pm

In testimony today before the House Financial Services Committee about the federal debt, CBPP Senior Fellow Jared Bernstein concluded with two important points about long-term debt:

First, it is clear that our long-term debt picture has very significantly improved. . . . [C]onsiderable deficit savings have been legislated since 2010.  Also, one of the main factors driving the long-term debt is the intersection of our aging demographics and the growth of health care costs.  However, in recent years, those costs have slowed significantly, thanks in part to the types of measures introduced in the Affordable Care Act, and that too has lowered our debt projections (see chart). . . .

The second point of the figure, however, is that while our debt forecasts are improved, they still reveal significant pressures, with debt projected to exceed 100 percent of [gross domestic product] before 2040.  This projection strongly supports the need to continue to implement the efficiency enhancing measures in the ACA, to continue to monitor and build on the recent progress we’ve seen on health care costs, and the pursuit of balanced fiscal measures like those in the President’s new budget.

Click here for the full testimony.

Obama Proposal a Clear Step Forward, But Would Be Better with More Revenue

July 30, 2013 at 3:48 pm

The President’s new proposal for corporate tax reform and infrastructure investments provides a creative way to address both the urgent need for job creation and the risk that corporate tax reform will contain timing gimmicks that expand long-term deficits.  But the proposal would be better if its corporate tax reform contributed to long-term deficit reduction.

Let’s consider each point in turn.

First, the need for jobs: today’s main economic challenge is that millions of Americans who want desperately to work and support their families can’t find jobs.  The share of the adult population with a job is still stuck at levels when the Great Recession hit bottom.  With many construction workers out of work while our infrastructure continues to decay, this is the obvious time to rebuild and repair roads, bridges, and airports.  The President deserves credit for pushing this idea.

Second, the risks of timing gimmicks in corporate tax reform: as our recent report explains, corporate tax reform — whether designed to be revenue neutral or to raise revenue over the first decade — could easily end up expanding deficits in later decades.

That’s because many of the corporate tax subsidies that policymakers might scale back to pay for lowering the corporate tax rate are structured in such a way that cutting them would generate much larger savings in the first ten years than over the long run.

For example, a 2011 Joint Tax Committee analysis of a potential corporate tax-reform package that was revenue neutral over the first decade found that it would produce annual revenue losses before the end of the decade, which would then grow over time (see graph).

The President would address this timing problem and ensure that corporate tax reform doesn’t add to the deficit in the long run by devoting its temporary revenue gains to timely infrastructure investments, and using only permanent revenue gains for permanent rate cuts.

Third, the need to do more on long-term deficits: the President’s proposal meets a “do no harm” fiscal test, but corporate tax reform needs to contribute to deficit reduction over the long run.  The risk is that revenue-neutral corporate tax reform now will “use up” the politically achievable savings from cutting corporate deductions, credits, and other preferences known collectively as “tax expenditures,” taking corporate taxes off the table for deficit reduction.

At a time when policymakers are cutting critical investments in areas like scientific research and Head Start, corporate revenues should contribute to deficit reduction, not be exempt from it.

CBO Immigration Cost Estimate Doesn’t Support Use of “Dynamic Scoring” for Tax Reform

July 24, 2013 at 2:06 pm

Some members of Congress are claiming that the Congressional Budget Office (CBO) and Joint Committee on Taxation (JCT) used “dynamic scoring” to estimate the budgetary effects of the Senate immigration bill and should do the same for tax bills, starting with tax reform.  But they’re off base on the immigration bill, and their call for dynamic scoring for tax reform is an invitation for fiscal irresponsibility.

Advocates of “dynamic scoring” want to see “macroeconomic feedback” effects incorporated into estimates of the budgetary effects of legislation.  That means trying to estimate (1) how the legislation might change households’ work and saving decisions and businesses’ investment decisions, (2) how those decisions would affect broad macroeconomic variables like gross domestic product (GDP) and employment, and (3) how those changes in the economy would induce changes in revenues and spending.

CBO and JCT do not do this in their cost estimates, and with good reason.  Economists do not agree on the size — sometimes even the direction — of macroeconomic feedback from cutting marginal tax rates or making other changes to taxes or spending.

Such dynamic scoring would also impair the credibility of the budget process.  Because the estimates of macroeconomic feedbacks are very uncertain, including them in budget estimates would be highly controversial and inevitably viewed as biased and politically motivated.

In its official cost estimate of the immigration bill, CBO made an exception to its longstanding policy of assuming that the legislation under consideration does not affect the overall size of the economy.  It did not, however, embrace dynamic scoring.

CBO and JCT confront a unique challenge with immigration bills, which — unlike virtually all other legislation — would substantially expand the U.S. population and labor force and therefore affect the budget independently of any impacts resulting from changes in households’ and businesses’ behavior.  As our analysis of the Senate bill explains, CBO’s cost estimate accounted for the direct effects of these population and labor force increases on the size of the economy, revenues, and federal benefit spending.  CBO employed a similar procedure in its cost estimate for the 2006 immigration bill.

Other than that, CBO sought (in its words) “to remain as consistent as possible with the rules CBO and JCT follow for almost all other legislation” and did not “incorporate the budgetary impact of every economic consequence of the bill.”  CBO did not, for instance, include more speculative and uncertain effects on GDP, such as changes to business investment and productivity.  In short, CBO’s cost estimate of the immigration bill does not include the type of “dynamic scoring” that some members of Congress are calling for with respect to tax legislation.

As it sometimes does with major legislation, CBO provided a separate analysis of additional economic effects not in its official cost estimate of the immigration bill, as well as their potential impact on the budget. Reflecting the high degree of uncertainty surrounding these effects, CBO provided a range of estimates rather than the precise estimates required in an official cost estimate.

This is the appropriate approach for any legislation with such potential economic effects, including tax-reform legislation.  But by claiming that CBO employed dynamic scoring in its cost estimate for the immigration bill, advocates of using dynamic scoring for tax bills are seriously misrepresenting CBO’s approach to the unique situation that it faces with immigration bills.  Policymakers should not fall for this mistaken claim when they consider tax reform.

The fact remains, as we explained a year ago, that budget plans — whether on the tax side or on the spending (“investment”) side of the ledger — should not rely on dynamic scoring.

“Blank Slate” Approach to Tax Reform Leaves Biggest Question Unanswered

June 28, 2013 at 11:54 am

Yesterday’s call from Senate Finance Committee Chairman Max Baucus and ranking Republican Orrin Hatch to initiate tax reform with a “blank slate” that doesn’t include any of the deductions, credits, exclusions, and other tax breaks collectively known as “tax expenditures” leaves a critical question unresolved:  what will policymakers do with the proceeds from narrowing or eliminating tax expenditures?

Will they use a substantial share of the savings to help put together an alternative to sequestration or otherwise devote such savings (presumably in conjunction with spending reductions) to the long-term deficit reduction that the nation needs?  Or will the savings go entirely to cutting tax rates?

Using some of the savings as part of a responsible, balanced alternative to sequestration —thereby averting harsh cuts in areas ranging from national security to education, medical research, and Head Start — and to help put the nation on a firmer long-term fiscal footing ought to be a higher priority than the pursuit of ever-lower tax rates.

Tax reform that curbs unproductive tax expenditures surely has merit.  Yet revenue-neutral tax reform would be highly problematic, as it would likely take revenues off the table for deficit reduction for years to come by using up virtually all politically achievable reductions in tax expenditures.  That, in turn, would likely take mandatory programs off the table for deficit reduction as well, because many policymakers would justifiably reject large mandatory cuts in the absence of new revenues.

In addition, policymakers face an immediate need to replace the harmful sequestration budget cuts, which are affecting defense and non-defense programs alike, with a mix of savings from tax expenditures and mandatory programs.  But revenue-neutral tax reform could foreclose that option by using up all of the politically achievable tax expenditure savings to pay for tax-rate reductions.

An essential ingredient of tax reform — and the one target for policymakers to specify in advance — is therefore a revenue target: one that contributes to a balanced deficit-reduction package that includes replacing sequestration.  Revenues raised through tax reform — including through a “blank slate” approach — should go to lower rates only after this target has been met, as most budget agreements under discussion over the past few years would have done.

This means that while policymakers may have useful exploratory discussions on tax reform now, they should defer actual legislative action until there is a larger fiscal policy agreement that includes a revenue target under which tax reform will contribute meaningfully to deficit reduction.

Special Tax Breaks for Capital Gains and Dividends Strike Out

May 31, 2013 at 2:14 pm

The new Congressional Budget Office (CBO) report on tax expenditures (credits, deductions, and other tax preferences) and a recent column by Bruce Bartlett, former adviser to presidents Reagan and George H.W. Bush, add up to three strikes against the tax code’s favorable treatment of capital gains and dividends, which face much lower tax rates than wages and salaries.

Strike 1:  High Cost

CBO estimates that the preferential rates for capital gains and dividends will cost $161 billion this year, making it the second-largest individual tax expenditure.

Moreover, this figure doesn’t include another costly tax break on capital gains:  capital gains tax is forgiven at death.  So, if a taxpayer holds on to an asset until she dies, neither her estate nor her heirs will ever pay tax on any increase in the asset’s value before her death. Nor does it include the plethora of other loopholes (such as “like-kind” exchanges and “inside buildup”) that wealthy people use to defer or avoid paying even these highly discounted capital gains rates.

Strike 2:  Extreme Tilt to the Wealthy

Since capital gains and dividends are heavily concentrated at the top of the income scale, so are the benefits of taxing them at preferential rates.  CBO estimates that fully 68 percent of the benefits go to the top 1 percent of households, while just 7 percent go to the bottom 80 percent of households (see graph).

Their extreme tilt to the top means that these tax breaks make the tax code much less progressive.

Strike 3: Little Economic Benefit

Proponents of preferential rates for capital gains and dividends — and further cuts in those rates, such as those enacted in 2003 — argue that they benefit the country as a whole by stimulating business activity.  But, as Bartlett explains, research by the Federal Reserve and others on the 2003 dividend rate cut shows that it did not produce the promised gains.

Similarly, research on the capital gains preference that we discuss here finds, as leading tax expert Joel Slemrod put it, that “there is no evidence that links aggregate economic performance to capital gains tax rates.”