The Center's work on 'Taxes and the Economy' Issues


“Dynamic” Estimates Are Highly Uncertain, Subject to Manipulation

November 17, 2014 at 5:10 pm

An American Action Forum event today to promote “dynamic scoring” for tax and spending legislation unintentionally illustrates what Chye-Ching Huang and I explain in a newly updated paper:  estimates of the macroeconomic effects of policy changes — which is what dynamic scoring would include — are highly uncertain and subject to manipulation, so they shouldn’t be part of official cost estimates.

In reasonably balanced remarks, Senator Orrin Hatch (R-UT) said that “we should not expect dynamic scoring to produce outsized miracles from either the supply side or the demand side.”

But Tax Foundation President Scott Hodge, in giving his organization’s estimates of the effects of several tax proposals, promised just such miracles.  According to Hodge, cutting the corporate income tax rate or allowing full expensing of investments (that is, allowing firms to deduct the investments’ full cost from their taxable income up front, rather than depreciating it over the investments’ lifetime) would more than pay for itself by boosting economic growth and, in turn, tax revenues.

That’s highly implausible.  But it shows how advocates can manipulate assumptions or cherry-pick dynamic-scoring estimates to buttress their agenda.  Ways and Means Committee Chairman Dave Camp (R-MI) did the same thing when he cited only the most optimistic of many “dynamic” estimates in touting the benefits of his tax reform proposal, as our paper and the graph below show.

Latest CRS Findings Refute Scare Talk About Medical Device Tax

November 6, 2014 at 12:51 pm

With congressional Republicans reportedly planning a renewed push to repeal the medical device tax, a Congressional Research Service report updated this week is especially notable.  It confirms what we’ve been saying for some time:  The 2.3-percent excise tax, which will raise $26 billion over the next decade to help pay for health reform, has only a very limited economic impact, contrary to the dire predictions of industry lobbyists.

  • “The effect on the price of health care,” CRS says, “will most likely be negligible because of the small size of the tax and small share of health care spending attributable to medical devices.” (page ii)
  • “The drop in U.S. output and jobs for medical device producers due to the tax is relatively small, probably no more than 0.2%.” (page 7)
  • “It is unlikely that there will be significant consequences for innovation and for small and mid-sized firms.” (page 8)
  • “The tax should have no effect on production location decisions, since both domestically manufactured and imported medical devices are subject to the excise tax.” (pages 18-19)

In short, the scare talk about the medical device tax doesn’t square with reality.  Moreover, proponents of repeal need to explain how they would replace the billions in lost revenue.

Considering Tax Reform? Here’s a Must-Read

October 2, 2014 at 1:49 pm

With leading members of both parties placing tax reform high on the agenda for next year, a  new paper by William B. Gale, Co-Director of the Urban-Brookings Tax Policy Center (TPC), and Andrew Samwick, a Dartmouth College professor and former Chief Economist for President George W. Bush’s Council of Economic Advisers, is a must read.  They review the evidence about how income taxes affect economic growth and explain:

The argument that income tax cuts raise growth is repeated so often that it is sometimes taken as gospel.  However, theory, evidence, and simulation studies tell a different and more complicated story.

Gale and Samwick highlight some often-overlooked factors about how tax changes affect growth, including:

Tax changes affect the budget.  As Gale and Samwick note, research shows that large, unfinanced tax cuts can hurt growth because the increase in deficits creates a drag on national savings and investment that outweighs any positive incentive effects.  Conversely, in the face of increasing long-run deficits, revenue increases could boost growth.

Scaling back inefficient tax subsidies can promote growth.  Howard Gleckman, a TPC fellow and moderator of a discussion at the TPC event releasing Gale and Samwick’s paper in which I participated, noted that our panel:

[G]enerally agreed that the real benefit [of tax reform] likely comes from scaling back or even eliminating inefficient tax preferences, rather than reducing rates. Those changes make it more likely that people will allocate resources to maximize their economic benefit, rather than to maximize their tax savings.  If that shift is big enough, it could increase the overall size of the economy.

We could use the revenues generated by such base broadening to reduce long-run deficits, which would boost growth over the long run. (As we repeatedly emphasize, however, getting the economy back to full employment should be a greater priority than deficit reduction.)

Tax Incentives for Retirement Savings Need Reform

September 29, 2014 at 2:18 pm

“We need to hear facts and serious policy proposals, not political slogans” like “upside-down tax incentives,” the Senate Finance Committee’s top Republican, Orrin Hatch, said at a recent committee hearing on retirement savings.  But tax incentives for retirement plans like 401(k)s and individual retirement accounts (IRAs)are indeed “upside down,” providing the largest subsidies to high-income taxpayers while benefiting low-income households the least (see chart).  As we’ve written, tax incentives for retirement savings are expensive, inefficient, and inequitable, making them ripe for reform.

New studies, including one highlighted at the September 16 Senate hearing, show how some very high-income taxpayers are accumulating enormousbalances using tax-preferred accounts — well beyond the accounts’ intended purposes.  Roughly 9,000 taxpayers have IRAs with balances that top $5 million, a Government Accountability Office (GAO) study found.  Despite contribution limits to tax-advantaged retirement accounts, such balances are possible because some executives buy shares of stock for their IRAs at extremely low valuations — sometimes less than a penny each.  Those balances then swell when the stocks are valued at market price — and the gain is tax-free.  Senate Finance Committee Chairman Ron Wyden (D-OR) termed this abuse of IRAs an unintentional “tax shelter for millionaires.”

The GAO study complements research published in the Journal of Retirement, which estimated that about 85,000 households each held over $3 million in certain tax-preferred plans, including IRAs.

Retirement savings tax incentives are among the largest federal category of “tax expenditures,” in terms of federal revenue losses.  While lavishing large tax benefits on very wealthy filers, they do little to encourage new saving among a broad segment of lower- and middle-income Americans.

The need for reform is clear.

President Takes Important First Step Against Corporate “Inversions”

September 23, 2014 at 5:16 pm

In an important first step to stem “inversions,” in which a larger U.S. multinational merges with a smaller foreign firm to avoid U.S. taxes, the Treasury announced new rules that not only effectively remove one way that taxpayers subsidize such deals, but also tighten existing limits on them.  The President should (and likely will) look for further steps the Administration can take, and Congress should do its part to protect the corporate tax base from this brazen tax avoidance.

Here’s some background.  Corporations do not pay taxes on foreign earnings until they bring them back to the United States.  Many firms are looking for ways to access their foreign-held profits while avoiding U.S. taxes — the same taxes that domestic firms pay on their profits.  A corporate inversion is one way to achieve this goal, which is why firms such as Medtronic, AbbVie, Pfizer, and Mylan have all sought or announced plans to invert.

The Treasury’s new rules aim to discourage firms from pursuing such tax avoidance inversions.  One new rule prevents inverted firms from using so-called “hopscotch” loans to access a foreign subsidiary’s prior earnings and avoid U.S. tax.  These loans, which a subsidiary in a foreign tax haven makes to the new foreign parent (thereby “hopscotching” over the former, U.S.-based parent in order to avoid U.S. tax), will now count as U.S. property and thus be taxable.

The Treasury is also closing some loopholes in existing anti-inversion regulations, such as tightening the rule that a U.S. firm combining with a foreign firm continue to be taxed as a U.S. firm if it owns 80 percent or more of the combined company.  The Treasury rule aims to ensure that this 80 percent threshold is a real one.

The President and several key members of Congress have called for legislation to lower this threshold even further.  They want to set the threshold at 50 percent, meaning that a U.S. firm could not invert without losing control of the new firm.  That would act as a strong deterrent against inversions.

The President and Congress should also pursue how to crack down on “earnings stripping,” which allows companies to use debt to siphon profits out of the United States.  A further option would be to require companies that invert to pay the taxes they owe before they “leave” the country.  The President and Congress should take these next steps to combat the inversion epidemic.