The Reality of Raising Taxes at the Top, Part 3: Would Tax Increases Affect Savings and Investment?

April 27, 2012 at 3:02 pm

The second installment in this series on how tax increases at the top might affect economic growth noted that changes in tax rates don’t substantially affect high-income people’s decisions about how much to work.

Today, we’ll consider their potential impact on savings and investment.  Opponents say that raising the capital gains and dividend rates — which would primarily affect high-income taxpayers, since they receive most of the capital gains and dividend income — would discourage saving and investing, thereby slowing the economy.

But the research doesn’t support that claim, as our new paper explains.

Capital gains tax increases do reduce after-tax returns to saving, and this may cause some taxpayers to save and invest less. But, other people may save and invest more in order to reach a certain savings goal, balancing out those who scale back. On the whole, the Congressional Research Service (CRS) concludes that capital gains tax rate increases appear to have “little or no effect” on private saving.

This squares with billionaire investor Warren Buffett’s observation:

I have worked with investors for 60 years and I have yet to see anyone — not even when capital gains rates were 39.9 percent in 1976-77 [they are now 15 percent] — shy away from a sensible investment because of the tax rate on the potential gain.  People invest to make money, and potential taxes have never scared them off.

Moreover, what matters for economic growth is the impact of tax increases on national saving, or the sum of public and private saving.  If the federal government devotes the revenue generated by tax increases to reducing deficits (which represent public “dissaving”), the resulting increase in public saving is likely to more than offset any reduction in private saving.

That’s why the CRS concludes, “capital gains tax increases likely have a positive overall impact on national saving and investment.”

Looking for a link between capital gains tax rates and economic growth more directly, tax expert Professor Joel Slemrod concluded that “there is no evidence that links aggregate economic performance to capital gains tax rates.” Similarly, capital gains tax expert Len Burman has explained on his blog, and reiterated during a conference call for journalists earlier this week that “there’s no obvious relationship between capital gains, tax rates, and the rate of economic growth.”  (You can listen to the call here.)

As our paper discusses, there is also no sound evidence that increasing top income tax rates depresses saving or investment.

Our next installment will look at how tax increases at the top might affect small businesses and entrepreneurship.

Who Really Punted on Pell?

April 27, 2012 at 11:22 am

Pell Grants to help students from low-income families pay for college face a $58 billion shortfall over the next decade — even though the Congressional Budget Office says the program’s costs will remain flat during that period — because the way Congress has funded them in recent years has made the costs appear artificially low.

Obama Reduces, Ryan Increases Funding Shortfall in the Pell Grant ProgramThe New America Foundation had harsh words recently for President Obama’s proposal to begin addressing Pell’s funding gap, while praising the approach in the House-passed budget from Budget Committee Chairman Paul Ryan:

The president punted on a long-term plan to shore up Pell Grants because he could be criticized for making tough choices. Then, when House Republicans put out a feasible, gimmick-free Pell Grant proposal that makes tough choices (i.e., cuts to other aid programs and eligibility changes) needed to fund the program for the long-term, the president didn’t attempt to work with them, but lambasted them instead.

As our new report shows, it’s fair to say that the President has not yet made the tough choices necessary to put Pell Grant funding on a sound long-term footing.  But New America is wrong to say the Ryan budget has secured the program’s future.

Just the opposite: the Ryan budget almost triples the Pell shortfall — to $161 billion — at the same time it imposes cuts that would make fewer lower-income students eligible for the grants and scale back the grants for students who still receive them.  That’s because the budget would cut Pell funding by more than $150 billion over the next ten years.

In contrast, the Obama budget covers Pell funding needs for the short term and avoids benefit or eligibility cuts that could make college less affordable for many low-income students, while reducing the shortfall modestly to $51 billion.

If shrinking the gap to $51 billion is a “punt” because the shortfall does not reach zero, isn’t increasing the shortfall an even bigger punt?  If policymakers had their own Ray Guy award (given annually to college football’s top punter), it would go to Chairman Ryan, not President Obama.

Why Limiting Health Flexible Spending Accounts Makes Sense

April 27, 2012 at 10:18 am

Health reform (the Affordable Care Act, or ACA) includes a number of spending reductions and tax increases designed to ensure that expanding health coverage does not drive up the deficit.  Opponents, however, are trying to undercut the law by proposing to repeal many of these financing provisions.

We’ve recently written about the ACA’s excise tax on medical devices and will weigh in soon about its fee on health insurance providers.  In congressional testimony this week, I explained why the ACA’s limits on using health flexible spending accounts (FSAs) to pay for over-the-counter medications make sense both as tax policy and as health policy.

From 2003 through 2010, people could use FSAs and other tax-advantaged accounts to buy over-the-counter drugs and other products, such as pain relievers, cough syrup, herbal remedies, and sunscreen.   Thus, accountholders received a tax subsidy for these purchases.

Under the ACA, starting in 2011, people can use FSAs and other accounts to buy over-the-counter items only with a doctor’s prescription.

There are several reasons to limit the purchase of over-the-counter health products with tax-favored accounts.

  • Only a minority of workers benefit from the tax break.  Just one worker in seven has an FSA, and an even smaller fraction of workers is enrolled in other tax-favored accounts that can be used for health-related spending.
  • People with high incomes benefit disproportionately from the tax break. That’s because they are in higher tax brackets, tend to consume more health care, and can afford to deposit larger amounts in their accounts.  Middle- and lower-income people benefit much less, if at all.
  • Administrative and compliance costs are relatively high. Employers typically pay vendors to manage the accounts, and accountholders must spend hours complying with onerous recordkeeping requirements.
  • Tax-advantaged accounts encourage the overconsumption of health care.  Before the ACA restriction, people could use these accounts to buy nearly any health care item or service, regardless of whether it was medically necessary, cost effective, or of meaningful health value.
  • Over-the-counter medicines and other items constitute routine personal expenses, which are generally not considered deserving of a tax subsidy.

At the hearing, Rep. Tom Reed (R-NY) asked me if I thought that the money allocated to my FSA is “my money” that I should be free to use as I choose.  I replied that what’s at issue is not my money but a tax subsidy.  “I do not have a God-given right,” I said, “to a tax subsidy for buying cold medication.”

The Reality of Raising Taxes at the Top, Part 2: Would Tax Increases Affect Work Effort?

April 26, 2012 at 1:15 pm

The first installment in this series on how tax increases at the top might affect economic growth explained that while high-income people reduce their taxable income in response to tax hikes, that’s more because they adopt tax avoidance strategies than because they work, save, or invest less.  Nevertheless, opponents of raising taxes at the top claim that doing so would discourage high-income taxpayers from working, and so harm the economy.

The evidence shows, however, that changes in tax rates don’t substantially affect high-income people’s decisions about how much to work.  As tax expert Len Burman recently told Congress, “Overall, evidence suggests [high-income Americans’] labor supply is insensitive to tax rates.”

Here’s why.  A marginal tax rate increase may encourage some taxpayers to work less because they will get to keep less of each dollar they earn.  But some people will choose to work more, in order to make as much money (after taxes) as they did before the tax increase.  The evidence suggests that these two opposing responses largely cancel each other out.

Some groups, such as married women and older workers, do respond to tax rate changes with big changes in their work hours, but that’s not true generally for those at the top.

Our next installment will look at how tax increases on high-income people might affect saving and investment.

The Reality of Raising Taxes at the Top, Part 1: Would Tax Hikes Shrink Taxable Income?

April 25, 2012 at 4:25 pm

This blog series, based on a major new CBPP report, will look at the different ways in which raising taxes on high-income people might affect economic growth, starting with its impact on their taxable income.

Opponents often argue that raising taxes on high-income households would hurt economic growth.  But as our new report shows, recent research doesn’t support that claim.  In fact, tax increases of the sort policymakers are considering would likely benefit the economy over the long run if we use the savings to reduce deficits.

With that in mind, and after decades of sharp increases in income inequality and dramatic tax cuts for upper-income people, there’s an overwhelming case for raising taxes on high-income people as part of a balanced deficit-reduction package that shares the load with middle- and low-income Americans.

We discussed these findings with two noted tax experts — the Tax Policy Center’s co-director, William Gale, and Syracuse University’s Daniel Patrick Moynihan professor of public affairs, Leonard Burman — on a conference call for journalists this morning.  You can listen to their presentations here.

First, let’s look at the impact of higher taxes on taxable income.  Opponents often note that high-income taxpayers report less income to the IRS after their taxes go up.  That’s true – they do. But, as an important study by tax economists Joel Slemrod and Alan Auerbach found, the main reason isn’t that these people are working, saving, or investing less in response to the tax hikes. Instead, it’s mostly because they are adopting various tax avoidance strategies to minimize their taxable income, like arranging to receive their income in the form of capital gains or carried interest rather than ordinary income (which is taxed at higher rates).

To be sure, increased tax avoidance has some economic costs, since resources spent on avoiding taxes could otherwise be spent on more productive activities.  But those costs are likely nowhere near as large as if it were true that when tax rates go up, high-income people work, save, and invest much less.

Moreover, policymakers can limit tax avoidance — and make the tax code more economically efficient — by scaling back the code’s many deductions, credits, and other targeted tax breaks.

Our next installment will look at how raising taxes at the top might affect how much high-income people work.