Of Zeno’s Dichotomy Paradox, “Takers,” and Deficit Reduction

February 16, 2012 at 1:05 pm

Do you know Zeno of Elea’s famous Dichotomy Paradox?  More than 2,000 years ago, he noted that if Homer wanted to walk all the way to the market, he would first have to walk halfway there, then half of the remaining difference, then half of the remaining difference again so that, ultimately, he would take ever smaller steps without ever getting there.  Zeno was wrong, of course, as mathematicians and philosophers have long demonstrated.  Homer could get from here to there — as long as he stopped focusing only on the remaining distance.

You might not think Greek philosophy bears much relevance to fiscal policy. But Zeno’s Dichotomy Paradox comes to mind when I think about how some policymakers frame discussions of deficit reduction.

Here’s why:

When I served as a House Budget Committee staffer, a colleague described one particular senator as a “taker.” After one side in a tough budget negotiation offered to split the difference, the senator “took” that offer, called it the new starting point, and insisted on splitting the remaining difference 50-50. He should get three-quarters of what he wanted, he argued, because the other side had already conceded the first half.

Now, let’s think about how “takers” relate to current discussions of fiscal policy.

In late 2010, the release of the Bowles-Simpson and Rivlin-Domenici deficit reduction plans laid the groundwork to start this nation on a fiscal journey.  Those plans each called for trillions of dollars in deficit reduction through a combination of substantial spending cuts and substantial tax increases.  Efforts last year to make major progress on that journey — through negotiations that Vice President Biden chaired in the spring with key lawmakers of both parties, the negotiations between President Obama and House Speaker John Boehner in the summer, and the negotiations by the congressional “Supercommittee” in the fall — all failed.  But policymakers started the journey nonetheless by enacting large budget cuts, primarily through the Budget Control Act, which they enacted in August to resolve the debt limit crisis.

As President Obama’s new budget, which he sent to Congress earlier this week, shows (Summary Table 3 on page 207), the President and Congress cut $1.7 trillion last year from “discretionary” (non-entitlement) spending over the period 2013-2022.  When you count the resulting interest savings, that figure surpasses $2 trillion.  This amount came entirely from budget cuts.  No deficit reduction came from higher taxes.

Now, policymakers are starting to debate the remaining part (or parts) of the journey.  As we have noted, $4.3 trillion in deficit savings would occur over the next ten years through a combination of the savings enacted last year and the new measures in the President’s budget (if Congress enacts them).  About three-fifths of the total (not counting interest savings) would come from spending cuts, with about two-fifths from revenues.

The “takers,” however, are having none of it.  Acting as though the first $2 trillion of the journey no longer count, lawmakers such as Senator Jeff Sessions (R-AL), the Senate Budget Committee’s top Republican, are criticizing Obama’s budget because it secures most of its savings by raising taxes.  The fact that the first $2 trillion of deficit reduction consisted solely of spending cuts, secured through threats by numerous lawmakers last spring to shut down the government and threats last summer to let the nation default, is conveniently swept aside.  For “takers,” the journey is just starting now.

But we must view the journey in its entirety.  Deficit reduction as a whole — irrespective of how many steps it comes in — must be balanced, even though the initial steps of last year were not.

Why Tax Services?

February 15, 2012 at 3:33 pm

Broadening state sales taxes to cover more services makes sense for several reasons, as my new report on estimating the revenue impact of such a step points out:

  • It can generate substantial revenue. States could generate $50-$100 billion annually by taxing all services that households buy except health care, education, housing, and a few others.  States that tax very few services, like California, Illinois, Massachusetts, and Virginia, probably could increase their sales tax revenue by more than one-third if they taxed most of the services that households consume.
  • It is essential to prevent the long-term erosion of sales tax revenue. For decades, household spending has been shifting from goods, which are largely taxable, to services, which are mostly tax exempt (see graph).  If this trend continues, states will need to include services in the tax base to maintain sales tax revenues over the long term.
  • Service Sector Growth Eroding Sales Tax Bases

  • It can reduce the year-to-year volatility of sales tax collections. Sales tax bases are dominated by purchases of “big-ticket” durable goods (such as cars, appliances, and furniture), which often decline sharply during economic downturns.  Purchases of some services do not rise and fall as sharply in response to changes in the economy.  Including more services in the sales tax base thus could slightly moderate the volatility of sales tax revenues over the course of the business cycle.
  • It will make the sales tax fairer. The sales tax is intended to be a general tax on consumption.  There is little reason to distinguish between consumption of goods and consumption of services, which in fact can substitute for one another.  For example, it is unfair to tax the person who rents a DVD of a movie but not the person who watches the same movie on pay-per-view.

For details on the issues involved in expanding the sales tax base, see this 2009 CBPP report.

A Broken Promise Is Better Than a Broken Economy

February 15, 2012 at 2:29 pm

President Obama pledged to cut the deficit in half in his first term. It’s a good thing he didn’t keep that promise or we’d be looking at a much weaker economy.

Faced with a tanking economy and a surging budget deficit upon taking office in 2009, President Obama and Congress quickly enacted policies that greatly expanded deficits in the short term in order to help stabilize the economy.

That’s a sound approach — and it worked.
United Kingdom Has Lower Deficits But Lower Growth
The 2009 Recovery Act and other aggressive monetary and fiscal policies enacted in late 2008 and 2009 will have only a tiny impact on long-term deficits, and they may well have prevented another Great Depression.

As we’ve documented in our chart book, the legacy of the Great Recession has been a stubbornly slow recovery.  It is unfortunate that policymakers did not enact a well-thought-out second round of stimulus at the beginning of 2010, and the last minute tax cut/unemployment-insurance compromise they worked out at the end of the year was far from ideal. But contrast the U.S. experience with what has happened in the United Kingdom and the Eurozone, where policymakers bought into the misguided notion (which many Republicans here share) that the path to prosperity begins with fiscal austerity.

Austerity hasn’t been working out well.  As the charts show, deficits have been smaller and fallen faster in the United Kingdom than the United States since 2009, but the U.S. economy has grown more, while the U.K. economy is faltering.

It’s true that the new Obama budget’s projected 2013 deficit of $901 billion (5.5 percent of GDP) is more than half of the projected 2009 deficit of $1.2 trillion (8.3 percent of GDP) that he inherited.  But the budget includes proposals that would make significant progress in reducing deficits over the next ten years — although we’ll need to do more, especially for future decades.

In particular, under its economic assumptions, the Obama budget would achieve what most budget analysts, and all recent bipartisan panels, have identified as the crucial fiscal goal for the decade ahead: stabilizing the debt so that it no longer rises faster than the economy.  It would cut the deficit to 3.9 percent of GDP in 2014, less than half the size of the 2009 deficit, and to below 3 percent of GDP by 2018.  (The Congressional Budget Office assumes somewhat slower economic growth and thus will likely have somewhat higher numbers than these in its March analysis of the President’s budget.)

The United States has not pursued the ideal approach of enacting policies that increase the deficit in the short run in order to support the weak economy while simultaneously enacting deficit-reduction policies that kick in several years later, when the economy is stronger.  But the contrast with the European experience strongly suggests that providing support for a weak economy without specifying how to pay for it later is far better than not providing support at all.

Industry Cries Wolf on Health Reform’s Medical Device Tax

February 15, 2012 at 9:56 am

In a new paper, we show that industry arguments for repealing the health reform law’s 2.3-percent excise tax on medical devices — surgical gloves, wheelchairs, cardiac pacemakers, and so on — are either wrong or greatly exaggerated.

Claims that the law (the Affordable Care Act, or ACA) singles out the medical device industry are false.  The excise tax is just one of a number of spending reductions and revenue increases included in the ACA that enable it to expand health coverage to 34 million uninsured Americans without adding to the deficit.

Contrary to lobbyists’ talking points, the tax will not cause manufacturers to shift production overseas.  It applies equally to imported and domestically produced devices, and devices produced in the United States for export are tax-exempt.  Thus, the tax will not reduce the competitiveness of U.S-made devices either here or abroad.

The excise tax is also unlikely to discourage innovation in the medical device industry, despite claims to the contrary.  The rate of innovation in medical technology has slowed in recent years for reasons entirely unrelated to the excise tax.  In fact, according to the consulting firm PricewaterhouseCoopers, health reform may well spur medical-device innovation by promoting more cost-effective ways of delivering care.

As The Economist states, the effect of the excise tax on the medical device industry will be “trivial compared with other shifts,” such as “scandals, recalls, stingy customers, [and] anxious regulators,” all of which have left the industry in a “rut.”

And repealing the tax would undercut health reform.  Congress would have to offset the cost of repeal by increasing other taxes or reducing spending; one likely target would be the ACA’s health coverage expansions.  Also, repealing the tax would encourage efforts to repeal other revenue-raising provisions of the ACA.

What Happens if Congress Doesn’t Continue Emergency Unemployment Benefits?

February 14, 2012 at 3:15 pm

The emergency federal unemployment insurance (UI) program is set to expire at the end of the month.  If Congress fails to extend it:

  • The number of weeks of available benefits for unemployed workers will shrink dramatically, to fewer than 26 weeks in some states (see the maps below).
  • Nearly 4.5 million jobless workers will lose UI benefits before the end of the year (see the table below).
  • The economic recovery will slow.

Besides the obvious benefit of supporting unemployed workers and their families at a time when there is still only one job opening for every four unemployed workers, UI is one of the most cost-effective ways to support the economic recovery.  CBO ranked it first in its bang-for-the-buck effectiveness among the measures it examined.  Mark Zandi, Chief Economist of Moody’s Economy.com, estimates that failure to continue emergency UI benefits could reduce GDP by 0.3 percentage points this year and cost hundreds of thousands of jobs.