Achieving a “2020” Vision

I wouldn’t be surprised if people on the internet have already used this play on words, but seriously – why isn’t this a major campaign slogan yet? Even if the vision is inarticulate and 2020 has nothing to do with the objectives, it’s still a catchy phrase.

But I take it one step further by integrating it into a neat little tax plan. Specifically: 20% flat rate. $20,000 standard deduction. By 2020.  It’s that easy.

Here’s how my dream plan would work:

  • Repeal the current income tax code.  Replace with a 20% flat rate applied to all taxable income (including capital income).  This provision contains a lot of benefits, with some amendable drawbacks.  A flat 20% rate would be fair and efficient.  Everyone could calculate it (exactly 1/5 of their taxable income), and its simplicity would destroy the artificial need for tax-preparation services.  This saves the economy billions in both dollars & hours.  It is reasonably fair – proportionally, everyone pays the same, but the rich still pay more in absolute amounts.  It would not change the tax owed by those with capital income too much (already, the top rate on capital gains is around 20%).  Additionally, its simplicity is pro-poor, who often lack the resources for tax consultation services.  Granted, it would represent, in some ways, a “tax hike” for many lower and middle-income people (who previously had lower rates applied to their incomes).  But this can be at least partially (if not fully) offset by a much higher personal exemption and preservation/improvement of a few antipoverty tax-credits (see below).
  • Introduce a $20,000 personal exemption for all households, indexed to inflation.  Starting in 2020, this generous exemption amount would be fully phased in.  It essentially means that not a penny of every dollar up to $20,000 per year will have the income tax applied to it.  In this way, people at or near poverty would not see their tax burdens increased (for many, potentially decreased compared to the current system).  Indeed, it’s at least five times larger than the current personal exemption ($4,000) and provides complete relief to people whose income is nearly twice the poverty line ($11,770/year in 2015).  The exemption amount would be adjusted for non-real increases in income (e.g. inflation) on an annual basis, chained to the index of the candidate’s choice.  Such a high exemption amount should help pave the way for elimination (or near-elimination) of any deductions (especially itemized deductions, such as the mortgage interest deduction, which primarily benefits wealthy taxpayers).  Among the biggest benefits in the vision’s exemption provision is that it allows for some continued progressivity in the tax code.  For example, a person with $20,000 in annual income would pay 0% in income taxes ($20,000 total income – $20,000 exemption = $0 in taxable income * 20% = $0 in taxes = 0% of total income); in contrast, someone with an income of $100,000 would pay about 16% in income taxes ($100,000 total income – $20,000 exemption = $80,000 in taxable income * 20% = $16,000 in taxes = 16% of total income).  So, the effective tax rate is progressive (increases by income), but it is proportionally the same for everyone above $20,000.

And there you have it.  Those two elements – the 20% rate with the $20,000 personal exemption – form the 2020 in the plan.  Benefits, already described somewhat above, include:

  • Simple calculation
  • Elements of fairness (combo of progressivity and equal proportionality)
  • Would likely boost growth & efficiency of tax collections
  • Could very well boost economic growth
    • simple calculation = less time & resources devoted to calculation = higher productivity, savings
    • lower rates boost economic demand and/or supply

Drawbacks include an uncertain impact on the federal budget and the tax burden of the poor/middle class.  For the former, there is reason to think that this plan could well boost tax revenues (thereby helping to close the annual deficit).  The simple calculation of the tax could boost compliance, and the higher growth it could produce would mean higher incomes = more revenues.  Additionally, the elimination of many deductions and credits would save a ton of money; currently, federal tax expenditures total around $1 trillion per year.  As for the burden on the poor/middle class, this plan could entail the loss of several tax credits or deductions that currently benefit them.  To mitigate the impact, some of these credits/deductions could be maintained, but at the threat of making the plan less fiscally sustainable.  Additionally, the impact on those whose incomes are not high but fairly above the poverty line (e.g. those above $20,000, but not too far above) is concerning; it’s unclear whether the proposed tax plan would represent a sizable increase in their tax burden relative to the current system (despite the $20,000 exemption).  People will also scream that this is a tax cut for the rich (who face marginal tax rates of up to almost 40% in the highest income quintiles).  However, it’s important to remember that even the effective income tax rate of the richest in America usually comes in around 20%.  With the 20% rate applied to all of the income of the super-rich (except the first $20,000), their effective rate will basically be 20%.  And with the elimination of some of their favorite deductions and loopholes, it could even represent a tax hike for them.

For too long, our political system has been paralyzed by short-term thinking and an unhealthy attachment to everyday opinion polls.  Now more than ever is the time for policymakers to start projecting clear, attainable visions for the future, with workable frameworks.  When it comes to the tax code, this plan isn’t anywhere near perfect; not by a long shot.  But it’s a place for them to start.

 

 

 

Building a New Era of Governance – Part 2

6) Continue with efforts to reform the healthcare system.  Love it or hate it, the Patient Protection and Affordable Care Act (PPACA, e.g. Obamacare) is here to stay (sorry Project 2017); at the very least, the law will not in its entirety be repealed.  The myriad subsidies, tax credits, and benefit requirements are far too popular; to repeal them would be political suicide.  What Congress needs to do now is to focus on modulating and improving upon what already exists.  Obamacare goes a ways towards addressing the pre-existing deficiencies in the system (although in an arguably inefficient and potentially self-defeating, if not destructive, manner).  These deficiencies are not hard to identify.  American healthcare is outrageously expensive (see below), and too few people have access to the system (anomalies which are very much related, via the effects of adverse selection).  Those who do have access (especially those on employer-sponsored plans) then face rigidities such as a lack of portability and increased dependency upon a single employment setting.  Obamacare generally does a pretty good job at addressing the lack of access to care; already, it has significantly boosted insurance rates via expansions of Medicaid and the provision of individual and business tax credits/subsidies.  The renewed ability of individuals to purchase insurance has also addressed the portability issue.  However, its record on holding down long-run costs appears to be more mixed.  It has provisions that simultaneously place downward and upward pressure on costs.  For the former, the individual mandate should help by increasing the pool of healthy individuals contributing to the system (countering adverse selection), offsetting the costs of newly-enrolled less-healthy individuals.  Additionally, the law contains numerous “experiments” designed to hold down costs, such as the creation of “bundled payment plans” as opposed to the traditional fee-for-service payment model (which rewards doctors on quantity, not quality, of services rendered).  At the same time, the law contains many expensive provisions, such as the prohibition of lifetime caps on benefits and new restrictions on varying premiums based on certain risk factors.  Thus far, costs have leveled off in recent years; then again, we did go through a massive recession that put a dent in demand for health services, and spending growth has been rising as of late, albeit very modestly.  Regardless of Obamacare’s impact on cost growth in particular, an ageing populace and the continued existence of marketplace distortions calls for continued efforts to make health spending more efficient and cost-effective.  I think that Republicans in Congress can pursue policy options that are both effective and politically sustainable.  They include the following:

In both relative and absolute terms, the United States spends far more resources than other countries on healthcare (source: vox.com)

 

The growth in healthcare expenditures has slowed in recent years, though its permanence has yet to be determined

The growth in healthcare expenditures has slowed in recent years, though its permanence has yet to be determined

PPACA has had a dramatic impact on the nation's uninsurance rate

PPACA has had a dramatic impact on the nation’s uninsurance rate

a) Repeal the Cadillac Tax, replace with a gradual phase-out of the tax exclusion on employer-sponsored insurance premiums.  While FDR’s World War 2 wage and price controls arguably created the present-day Employer Sponsored Health Insurance (ESHI) system, this policy has no doubt been greatly aided by the Federal government’s decision to exclude employer sponsored insurance from taxation (and kudos to Ike for making it open-ended in 1954!).  By excluding fringe benefits from taxation, the federal government has virtually subsidized the provision of employer-sponsored insurance.  From both an employer and employee perspective, $1 in healthcare is much more cost-effective than an additional dollar in wages.  This has led to costlier plans, and an increasing proportion of overall compensation being dedicated to benefits (as opposed to wages).  Adding insult to injury, the same tax benefits do not apply to individual plans, which are typically purchased using after-tax income (although Obamacare has implicitly equalized this a bit via the provision of subsidies and tax credits for individual plans).  To try and further “equalize” treatment, the authors of PPACA included the phase-in of a 40% tax on “Cadillac” insurance plans, specifically the cost of plans that exceed pre-determined thresholds (about $10,200 for individual coverage and $27,500 for family).  I see this tax as very arbitrary – 40% on randomly selected amounts, that has no guarantee of “equalizing” tax treatment between ESHI plans and individual plans.  The thing is, we already have taxes in place (federal income & payroll taxes) that could apply to these premiums; it’s just that the government has exempted them completely.  In addition to its failure to equalize treatment and how unnecessary it is, it also does not raise anywhere near as much revenue as a hypothetical full repeal of the ESHI tax exemption would.  The Cadillac tax is estimated to raise about $80 billion between 2018 and 2023 – a six-year period.  Meanwhile, the ESHI exemption in totality costs the federal government a whopping $250 billion every single year.

The tax exclusion of employer-sponsored health insurance is by far the most costly federal tax expenditure

The tax exclusion of employer contributions to ESHI is by far the most costly federal tax expenditure

I see this as a prime opportunity for Republicans to claim credit for killing a tax (the Cadillac tax) while simultaneously making the tax treatment of healthcare more sane and raising the government badly needed revenue.  What they could do is enact legislation that repeals the Cadillac tax in its entirety, but simultaneously places caps on the tax exclusion equal to the thresholds imposed by the Cadillac tax.  In this way, benefit amounts exceeding $10,200 for individual coverage and $27,500 for family coverage will be subject to normal taxable income.  Unlike other proposals, though, I would move for these threshold amounts not to be indexed to price changes whatsoever – be it a measure of inflation, a flat rate, etc.  In this way, more and more plans will gradually be subject to the tax (much like bracket creep of the 1970s) so that the discretionary impact of the exclusion can be tempered over time.  Better yet, have the thresholds lowered on an annual basis so that eventually all “fringe” benefits will be taxed, and there will be no implicit subsidization of ESHI.  Of course, an elimination of the biggest single tax break in the federal tax code would produce enormous backlash in and of itself; indeed, it would be rather hefty tax hike.  That’s why I think the Republicans should also consider using some of the revenue generated to lower marginal tax rates (one of their favorite pastimes); any potential revenue left over could be used to lower the deficit and perhaps expand insurance subsidies for the poor and middle-class elsewhere (which would be especially appealing to Democrats).  Combined with a repeal of the (more visible and unpopular?) Cadillac tax, I think this could be a politically palpable solution.  It will help eliminate artificial demand for healthcare and give the many types of insurance options equal – as opposed to preferential – treatment.

b)  Force (or nudge) states to dismantle barriers for the purchase of insurance across state-lines.  This is an area where federalism & devolution has failed – and the federal government ought to step in.  Other than for the appeasement of insurance companies, there is no reason states should restrict consumers from purchasing policies from out-of-state companies.  This has had the effect of creating localized insurance monopolies that have artificially driven up costs.  Sure, it will take time for interstate insurance provider networks to materialize; but it’s better to start now than to continue with the status quo.  Republicans really shouldn’t encounter as much resistance from Democrats with this measure; after all, Obamacare intentionally created state-level exchanges where consumers can “shop” for different policies, with the intent that (perhaps one day) a single national exchange or market could be created.  However, Republicans may run into arguments that this will cause a decline in benefit standards as consumers seek the most cost-effective policies; however, shouldn’t Obamacare’s minimum benefit provisions (that differentiate plans into bronze, gold, silver, etc.) create a floor on a substantial portion of policies?  And if not, Congress could always mandate a bare minimum of standards to create a floor under state floors (though this would probably lead to a conservative backlash; the party establishment must proceed with caution).

c) Medical malpractice reform.  Yup, it’s a relatively small part of the overall cost picture, but even Democrats have to admit that $45 billion a year in defensive medicine is a bit much (even if a portion of it is “worthwhile”.  Although it might work better at a state-level, federal policies such as enacting caps on total payouts, raising the thresholds to file suit and concepts such as “loser pays” could all do their bit to reigning in excessive medical malpractice costs.

d) Promote cost transparency.  Obamacare has already done a wonderful thing by mandating that employers report insurance costs on employee’s W-2 forms.  This has helped in the process of getting employee’s “skin in the game”, so that they are congnizent of costs that otherwise feel disconnected  from them (what a revolutionary concept).  Congress ought to expand the variety of benefits that require W-2 reporting, and could try to find additional means for cost information to reach consumers directly.  Of course, it must be mindful of the unintended consequences of such mandates, as reporting consumes time & resources in and of itself.  Again, since transparency provisions already passed Obamacare in its original form by an overwhelmingly Democratic Congress in 2010, I don’t see why further transparency provisions can’t be a bipartisan effort.

e) Temporarily increase Disproportionate Share Hospital (DSH) payments to hospitals.  Right now, hospitals across the nation are straining to provide uncompensated emergency care for millions of uninsured Americans, care that the federal government partially pays for via DSH payments.  Unfortunately, these payments are usually not enough, forcing costs onto general insurance premiums.  As Obamacare expands and insures more people, this problem should theoretically ease somewhat, and the strains on DSH should ease.  Nonetheless, this insurance expansion in incomplete (especially since not all states are on board with expanding Medicaid), and may not be enough to substantially reduce the strains on the already overburdened DSH payment system.  So why would conservative Republicans have an incentive to increase federal spending?  Quite simply, higher DSH payments could indirectly ease insurance premiums for millions of people (allowing for less private-level “redistribution” from the insured to the uninsured”, and costs could be lowered for the federal government too in a way that offsets the increased spending on DSH.  Expanded DSH would also be appealing to Democrats, as it would serve to benefit one of their core constituencies (the uninsured poor).  It is one of those times when less requires more.

f) Loosen federal restrictions on Health Savings Accounts (HSAs).  I see HSAs as a part of the solution to get people to have skin in the game when it comes to healthcare spending.  When combined with high-deductible health plans, HSAs establish a connection between medical spending and personal savings that can help to curb the consumption of excess medical care.  The Federal government should lift existing statutory contribution limits and abolish all taxes that apply to HSA withdrawals, including for so-called “non-qualified” withdrawals.  The latter option, in addition to being more fair, would help to eliminate distortionary tax-minimizing behavior that could actually inflate health spending.  HSAs go along with the conservative notion of individual responsibility (which might explain their strong support by Republicans), and certainly Democrats shouldn’t be opposed to an increase in savings accounts (especially considering Obama’s proposed myRA retirement accounts).

g) Eliminate the Employer Mandate.  One of Obamacare’s most controversial provisions is that employers with 50 or more “Full Time Employees” (FTEs) provide them with health insurance or pay a penalty.  An FTE is defined as someone who works 30 hours or more.  This has lead to huge disagreements over the provision’s impact on the labor market, with critics claiming that this provision is weakening the 40-hour workweek by incentivizing employers to cut back on workers’ hours to avoid the mandate and associated penalties.  Proponents have countered that most workers already work more than 40 hours a week, and thus are at little risk having their hours drastically cut to below 30/week.  In response to a recent bill to move the threshold from 30 hours to 40 hours, these proponents have also said that this bill makes cuts in workers’ hours much more likely, as so many work 40 hours (or a little more) per week.  Both sides have points; but really, it almost doesn’t matter.  The employer mandate, like much of Obamacare, creates arbitrary thresholds that threaten to severely distort the economy and strangle business decisions.  The 50 FTE threshold has already led to an increase in “49er” businesses, who artificially limit their employee count to less than 50 to avoid the mandate and payment of penalties.  Additionally, I feel the employer mandate exacerbates an existing major problem with American healthcare: the very fact that so much of it is provided by employers!  This 4th-party payment system is incredibly non-transparent and non-portable, disregarding the economies of scale it provides via pooling, and explains a major part of the cost dilemma.  As such, I think the mandate deserves repeal.  Since Republicans will obviously fail at repealing the law, they might as well go after a single provision of it to incrementally enact positive change.  Although repeal of the mandate is also likely to fail, it is still worth a shot, especially considering how the new 114th Congress has already decided that targeting the mandate will be one of its first legislative acts.  Perhaps this will also give some Democrats who are weary of the net impact of Obamacare to finally demonstrate their political independence from a surprisingly unpopular law.

Building a New Era of Governance – Part 1

*Note: the views expressed in this posting are my own, and do not in any way represent the views of any other group or institution, public or private


Last Tuesday, November 4th, it is fair to say that the second Republican “wave” since 2010 swamped Congress and state governments across the nation. In Congress, the GOP managed to pick up at least 7 seats in the Senate (giving them a majority of 52, over the key threshold of 51), as well as at least 12 seats in the House (increasing their majority to at least 244). Gubernatorial elections also proved to be a route for the Democrats, as the Republicans snatched up another 3 governor-ships from the Democrats.

Despite these impressive gains, however, they will prove to be utterly meaningless unless Republicans in Congress can seize this opportunity to act in a bold, pragmatic, and bipartisan manner to go about conducting the nation’s business. More than anything, people are simply disgusted and fed up with what is shaping up to be (by many measures) one of the least productive governmental terms in American history (see chart).  While some may view inaction as a good thing (less activity means a smaller government = good, right?) I do not see this stagnation as benefiting anyone.  Even if few bills are passed, old ones already enacted are left to atrophy and will not be updated regularly to adapt to changing circumstances, creating new problems.  Additionally, it takes legislation to repeal legislation; inaction does not mean the government is in fact getting any smaller (and assuming a smaller government is even desirable in the first place).

Overall, as many pundits have noted, it is best to view the results of this election as an expression of disillusionment with a lack of leadership on either side of the aisle and a desperate plea for governance, as opposed to an endorsement of some ideological mandate. Especially when it comes to Congress, people are incredibly irritated that its members are well-paid, work part time (with much of their time spent campaigning), and yet very little of the country’s increasingly urgent problems are attended to. It is true, what many business-minded people would say: if the government were a private entity, they would’ve pushed out of the market a long, long time ago.

4.10.14.2

In terms of bills passed per legislative session, the 113th Congress is shaping up to be among the least productive in recent history

It is true that the outlook for an increase in Congressional productivity remains bleak, at least for the next two years. It’s a well-established pattern by now that American government doesn’t do too much unless a single political parties occupies both the Whitehouse and controls both chambers of Congress. However, this need not be an excuse for inaction; in fact, it cannot. The following is an agenda that I think Republicans can pursue that will not only help to solve the problems the public wants solved (and in a way that is congruent with the wishes of the electorate), but to help to build a new era of lasting American governance.

1) Lengthen the terms of the President, House, and Senate.  Of the many issues facing the country, this one (along with the next two agenda items) may seem like one of the least deserving of our attention.  However, relatively short Senate, Presidential, and (especially) House terms I believe has had a dramatic impact on the productivity of individual members.  Since elections come so frequently, many in the federal government must be in a near constant campaign mode that not only distracts them from legislative work but serves to polarize their “views”, making bipartisan consensus much more difficult.  At least attempting a Constitutional amendment, though quite unlikely to pass, could get the ball rolling on a future reform down the road.  Enactment of this reform, along with the following agenda item, could help to address the entrenched legislative paralysis.

2) Find a way to tie Congressional & Presidential pay to performance.  This one would be tough to implement (requiring another Constitutional amendment) and to find sufficient political support for, but I think it is an absolute must if we are to make meaningful legislative activity a core incentive for our politicians.  In my view, an independent committee (much like a state-level Civil Service Commission) would simply be given power to set Congressional & Presidential salaries and benefits upon a non-biased, impartial “performance review”.  This commission would be made up of individuals equally divided between the main political parties and would themselves be subject to background checks to ensure institutional independence

Many other potential reforms, such as a partial or complete scrapping of First-Past-The-Post (FPTP) representation in favor of more proportional representation and the outsourcing of congressional redistricting to independent commissions could help to both decrease the partisanship of the federal legislature and increase the “representative-ness” of individual members of Congress.  Ironically, the prospects of these reforms passing is weak at best; nonetheless, they would be crucial for the government to enact productive agendas in the future, and thus should be given priority in the agenda of the 114th Congress, even if chances of passage are slim.

As for other politically-feasible policy objectives that should be on the Congressional calendar:

3) Immigration reform.  No, seriously.  As discussed in more detail in my post “Why Republicans Should Embrace Comprehensive Immigration Reform”, the United States is in desperate need of both low and high-skilled labor, especially as the population ages in the coming decades.  Allowing in more immigrants (especially high-skilled) is not only politically reachable but is in line with a Republican emphasis on supply-side economic reforms.  Emphasis on increased border security (which is a prerequisite for any action for the party base, even if redundant and impractical) could be combined with reforms and/or increased funding to streamline the legal naturalization process.  At the very least, both Democrats and Republicans agree on the need for more high-skilled immigrants and an increase on the cap for H-1B work visas.  Increasing visa caps could help stem the tide of illegal immigrants (which Republicans are more concerned about anyway) via the substitution effect.  For best chances of passage, I would leave out measures that deal with illegal immigrants currently residing in the U.S. – a piecemeal, incremental approach would work best here.  Overall, immigration reform is an almost cost-free method to spur the economy in both the short and long-term, and considering how long it has been on the national agenda, it is incomprehensible that some sort of agreement cannot occur.

Due in part to an aging population, the U.S. Labor Force Participation Rate has reached levels not seen since 1978, increasing the need for new sources of labor

4) Corporate tax reform 

Again, opportunities for bipartisan agreement are rife here.  Everyone knows the corporate tax code is an unmitigated disaster, with high rates, too many loopholes, lost revenue, and distorted economic activity.  Make the system more territorial, modify depreciation schedules, scale down MNC deferral opportunities, eliminate tax expenditures, and reduce marginal rates.  Specific expenditures that are especially worthy of the chopping block are special preferences for oil & gas operations, insurance companies, corporate jets.  This operation need not be revenue-neutral, either; although this would technically constitute a tax “increase”, the removal of distortions and tax compliance hurdles will act as a counter-acting tax cut.  The government can gain revenue by increasing effective rates while simultaneously increasing growth and leaving businesses feeling better off than they do under the current tax regime.

5) Replace the sequester with targeted cuts & incremental, implement long-term reforms

The era of yawning short-term fiscal deficits is over – temporarily, at least.  Indeed, America has witnessed its fastest pace of fiscal consolidation since World War 2, with deficits as a percentage of GDP falling from 9.8% of GDP in FY 2009 to 2.8% of GDP in FY 2014 – a swing of 7% in just 6 fiscal years.  This has come about due to a variety of factors, including economic growth, slightly higher taxes and broad-based cuts to discretionary outlays.  It is this last option that is cause for concern, however, as the cuts initially enacted in the Budget Control Act of 2011 (the founding legislation of the so-called “sequester”) are quite blunt.  They also come at a time when discretionary spending is approaching record lows as a percentage of GDP, and arguably when increased federal spending on items such as infrastructure are desperately needed and interest rates remain at historic lows.  Additionally, they have subtracted from economic growth in the short-term, lengthening the time needed to close the output gap between real and potential GDP.  As has been projected for decades now, the biggest threat to American fiscal sustainability is the coming explosion in mandatory spending.  Therefore, the new GOP-led Congress must enact gradual but effective entitlement reform now – the longer it waits (as past Congresses have), the more abrupt the future adjustment.

Fiscal policy has not been this contractionary since the end of World War 2

Fiscal policy has not been this contractionary since the end of World War 2

Economic growth since 2009 has increased revenues and decreased "automatic stabilization" spending.  Meanwhile, higher taxes have also increased revenues, and new spending cuts have been enacted.

Economic growth since 2009 has increased revenues and decreased “automatic stabilization” spending. Meanwhile, higher taxes have also increased revenues, and new spending cuts have been enacted.

Non-defense discretionary spending has fallen to record lows as a percentage of the American economy

Non-defense discretionary spending has fallen to record lows as a percentage of the American economy…

...even as interest rates remain at record lows

…even as interest rates remain at record lows

Debt Held

The true threat to America’s finances comes from the coming explosion in mandatory “entitlement” spending. Congress much enact tough reforms now to stem this tide of red ink.

 

To be continued…

The Imperative of Tax Reform in a Distracted World

Taxes. Nobody likes them, nobody wants them, and they’re only considered good when they’re going one direction: down. But they are fundamentally necessary for any society to function. In fact, if levied at moderate rates and the revenues they generate are properly spent, taxes are key for societal prosperity.

In America’s case, taxes are generally somewhat lower, especially at the federal level, compared to other developed countries . This is not to say that Americans don’t pay a significant amount of tax. Being a country with a sizeable tax burden and one that is relatively low tax are not mutually exclusive concepts. Still, at the federal level, marginal income tax rates and top rates are generally lower than those prevailing in Europe, and a Federal sales tax simply does not exist (also unlike Europe). When factoring in state and local taxes, levels are equalized a bit more, but burdens still are generally lower in America.

Figure-2

Americans’ average tax burdens generally lower than peer countries

However, looking at rates and the revenue bite is only a part of the burden story. As is often said, America’s federal tax code is, quite simply, horrendous. In addition to the normal complexities of a progressive system (e.g. different rates for different brackets at various stages of income generation), the tax code is stuffed with various deductions, exemptions, credits, and loopholes that impose a not-so-insignificant burden on all Americans.  In the aggregate, this complexity is in itself a massive tax (or set of taxes). Precious time and real dollars must be spent to navigate and understand the code, resources that could be used for far more productive uses. The real tragedy of all this complexity is that it ultimately benefits no one in the end. The government does not generate revenue from complexity (indeed, it loses revenue from the loopholes and from reduced economic activity). Society as a whole wastes resources that could otherwise generate positive returns to try and minimize their burdens. The result is the potential for slower growth and lower living standards than would have been the case.

In this way, the net economic burden of America’s federal tax code could actually be on par with (or even exceed) the burden experienced in European countries (especially when including state and local codes). It is naturally rather difficult to put a value on this non-revenue burden, though most estimates place it at at least a few hundred billion dollars annually for the country as a whole.

Since personal income taxes represent a sizeable portion of the federal tax code (and its various complexities), many proposed “solutions” to the federal tax code burden (assuming it is labeled as a problem) focus on restructuring the federal income tax. One of the most popular proposals is replacing the current structure with a flat personal income tax.

policybasics-taxrevenues-f1

The Income Tax is the single largest source of Federal Tax Revenue

There are many laudable benefits to a flat tax. For one, it would be much easier for each taxpayer to calculate his or her “effective tax rate”. With a progressive income tax, rates change as income progresses. For (hypothetical) example, each dollar of taxable income within the $1 to $9,999 range would have a rate applied to each dollar, say, 10%. However, dollars within the $10, 000 through $19,999 bracket would have a different rate, say 15%, applied to each dollar. Naturally then, this makes calculating the effective tax rate (the total amount of tax as a percentage of total income) rather difficult. With a flat tax, however, there are no brackets – for all taxable income, the same rate is applied to each dollar. This makes the flat tax rate and effective tax rate essentially equal (assuming no credits, deductions, exemptions, or loopholes). In this way, unlike the current income tax structure, an individual can know with much greater certainty how much of their income will be withheld.  The need to outsource tax liability calculations to a firm is reduced, if not eliminated, freeing up resources and largely destroying a major source of federal lobbying efforts.

Second, in my view, a flat tax conceivably has something for everyone to like. It is simple, transparent, and does not penalize people who generate more income, which is especially important to conservatives . They see it as being neutral and as a means to boost individual productivity, efficiency, savings, and investment. However, a flat tax still makes people with higher income pay more in absolute amounts. The difference is that the proportion of income that goes to taxes is the same for everyone. For a simplistic example, let’s say there are two individuals A and B. Say A has a taxable income of $100 and B has a taxable income of $1000. If a flat rate of 10% is applied, A will pay $10 in tax while B will pay $100. B, being higher income, still pays more than A in taxes. But the proportion payed is the same for both A and B. This seems fair and attractive to both ends of the American political spectrum.

Third, the elimination of brackets and all of the other complexities riddling the current code would likely boost public confidence in the government and would reduce the feeling that a person is being unfairly taxed at arbitrary rates within arbitrary brackets.  This increased confidence might boost tax collection and faith in political institutions, which has been severely lacking in recent years.

Of course, the flat tax has many drawbacks. One of the most important concerns raised by critics of the flat tax is that it lacks the counter-cyclical elements of progressive income taxes.  For example: during a recession, incomes generally fall.  Falling incomes will place individuals in lower top tax brackets (meaning they have to “progress” through less brackets).  This means a lower effective tax rate – in essence, the structure of a progressive tax code means that it provides an effective tax cut during recessions or periods of slow economic activity.  In other words, it acts as an automatic stabilizer.  This is not so for flat taxes – the rate is always the same, regardless of changes in income.  The only route for effective tax cuts in a flat-tax world is via discretionary fiscal policy – actual legislative action – to reduce the applied rate.  This runs into the problems of policy lags – recognition lags, implementation lags, and impact lags.  It takes time for policymakers to identify economic conditions and the need for change, more time to actually make and implement a policy change, and even more time for an implemented change to have an affect – by which point, the policy change may be inappropriate for the macroeconomic environment.  If policymakers ever move towards a flat tax one day, they may have to consider a revamp of federal automatic stabilization systems for smoothing out the business cycle – and if not, the onus of economic stabilization will continue shifting towards monetary policy.

A second and virtually identical concern is the lack of progressiveness of flat taxes.  The US income tax code is currently considered among the most progressive in the developed world.  However, overall progressiveness in America’s redistribution systems is rather low, as many other federal, state, and local taxes are regressive, and “social assistance” programs, regardless of their impact of work incentives, are fairly skimpy by rich country standards.  Make the income tax code flat, and you remove a major source of progressiveness in America’s redistribution systems and would almost certainly increase after-tax income inequality.  Depending on your views regarding redistribution and income inequality, this could be either a good thing or a bad thing.

Regardless of whether a flat tax is pursued or not, it is (quietly) agreed by both the American Left and the American Right that the tax code needs radical simplification.  Right now, though, the imperative of tax reform has been pushed to the side to make way for a focus on ISIS, poverty reduction, immigration, and healthcare issues (to name a few), and ironically, the complexities that tax reform would attempt to solve helps to further ensure that such reform never takes place.  It is overcoming this entrenched policy stagnation that is the great task of our times.

The Unfinished Business of Healthcare Reform

I plan on finally resuming regular postings on here by next week.  Before I begin, however, the following is a post I made in January 2013 on MSU Roosevelt Institute’s blog.  It argues that healthcare reform in the United States is far from finished, and proposes that new federal measures be enacted to help address chronic deficiencies within the system.  While it is certainly not comprehensive, and does not necessarily reflect my current views on what needs to be done in regards to healthcare, it still provides a good framework for an in-depth discussion on the subject.

 Of the many issues facing the United States today, few are as controversial as the issue of healthcare.  For years, debates have raged across the country as to how to properly address perceived deficiencies within America’s healthcare system, with opinions severely polarized as to how healthcare should be delivered, payed for, and what role (if any) the federal government should play. The recent passage of the Patient Protection and Affordable Care Act (PPACA) on March 23, 2010 seems to have only intensified the debate further.  This should not be viewed as a negative consequence, however; quite the contrary.  For healthcare reform is – and should be – an ongoing, gradual process; no single action can solve all the problems immediately.  Indeed, given the importance of an adequate healthcare system to the well-being of societies everywhere, it would be desirable for the debates to become a regular part the national status quo.  Truly, the importance of a good healthcare system cannot be understated: not only does it help to increase the overall health and wellbeing of a nation’s citizenry, but it also helps to ensure that they remain active and productive members of the economy as well.  It is this higher productivity that is vital for sustained economic growth and higher living standards for everyone.  Unfortunately, as any American will readily admit, the US system does have some serious flaws that threaten this vision unless bold modifications are undertaken.  Specifically, these flaws include exceptionally high healthcare costs (and high cost growth rates), a glut of uninsured individuals, a lack of insurance portability, and perceived threats to quality.  Despite the passage of PPACA (whose vices & virtues this post will not be discussing), many of the roots of these overarching weaknesses remain unaddressed.  What are they, then?  Although the causes are many, three of them especially stand out.  First, because the federal government has exempted employer-sponsored healthcare benefits from an employee’s taxable income, many employees are encouraged to select more health insurance/costlier coverage as opposed to higher wages, and effectively feel insulated from the cost (thinking they are spending someone else’s money).  Because this tax exemption does not apply when people attempt to buy individual insurance, the federal government is also effectively incentivizing people to stick with employer-sponsored insurance as opposed to the (more portable & transparent) individual insurance plans.  A second major cause of the US’ healthcare problems is the inability to buy insurance across state lines.  This effectively creates localized monopolies that drive up the price of insurance.  Lastly, the negative consequences of American eating & exercise habits are a major burden on the system.  Given the entrenched nature of these causes, it is naturally quite difficult to find solutions that are deemed acceptable to everyone across the political spectrum.  However, because they address elements of concern for both sides of the aisle, the following proposed solutions, when considered, do have the potential to gain widespread support:

  • Remove the federal tax exemption for employer-sponsored insurance; cut income taxes to offset cost.  Repealing the distortionary tax exemption will decrease artificial demand for healthcare (thus lowering cost pressure, something both sides would like) and will encourage the individual purchase of portable plans. It has the added benefit of hitting high earners the hardest, which should make it more appealing to liberals.  A cut in income taxes to offset the cost would appeal to conservatives, and such tax cuts have the added benefit of being adaptable to maximize progressivity.
  • Encourage states to loosen barriers that prevent the out-of-state purchase of health insurance by offering them increased Medicaid funding in return.  Loosening barriers to allow cross-state purchases of health insurance would encourage competition between insurance companies, lowering costs.  These lower costs have the added benefit of offsetting the need for increased Medicaid funding.
  • Mandate and appropriate funding for the annual creation and delivery of specialized pamphlets that notify citizens of the importance of healthy lifestyles, allow them to easily estimate the impact their habits and choices have on both their own wellbeing and society’s, and offers guidance on the do’s and don’ts to becoming healthier.  The cost of funding should be offset by tax increases or spending cuts elsewhere in the budget.

When combined, such reforms not only have the potential to gain substantial bipartisan support, but will make great progress in permanently strengthening America’s healthcare system for many, many years to come.

– Tyler Leighton

Sources:

State of the Union Reactions, Part 2

I was talking last time (Part 1) about my immediate reactions to the State of the Union Address, particularly from a political lense.  Now I’d like to focus on the major problems the President wishes to tackle and the strength of his domestic policy recommendations, in order as they come up in the address (though, because of the length of the address, I won’t be hitting every point).

Obama is right to place heavy emphasis on equality of opportunity.  Unlike the concept of income inequality, an opportunity agenda is something that has broad support across the political spectrum and is a shared value nation-wide.  One of his best recommendations is an overhaul of the tax code, whose loopholes cause precious time and resources to be diverted away from productive activities as individuals and companies seek to minimize their burdens.  Running at an estimated cost of at least $250 billion/year in lost economic output and at least $1 trillion/year in lost revenues, the tax code is an abomination.  This lost output translates into lost job opportunities and slower job creation.  If the President fails to reform it (e.g. by cutting loopholes and lowering marginal rates), it will assume the title of Obamination.  His proposal to use some of the savings to help rebuild the nation’s infrastructure is also not a bad proposition, as the American Society of Civil Engineer’s 2013 Infrastructure Report Card estimates that America would need to allocate an extra $1.6 Trillion just to upgrade our infrastructure to a state of “good repair”.  If we continue to fail to maintain the nation’s physical capital, our competitiveness will deteriorate and the sluggishness in productivity growth that has been the norm since the 70’s will drag on.  Additionally, his idea of further connecting businesses and universities via regional hubs is also laudable.  Universities are a critical source of research and discovery; connecting them with businesses can help transform those ideas and discoveries into useful, productivity-enhancing goods and services.  All of these ideas will bolster American opportunity.

From there, his message starts to deteriorate a bit.  He mentions that his administration has made more loans to small businesses than any other, and wants to do still more.  Is this really a good thing?  State-directed lending (à la China) has had mixed results both in the past and present.  Although sometimes successful, loans tend to be politically driven and may not exhibit much, if any, return on investment.  As such, they tend to distort the market and allocate resources inefficiently, propping up businesses, ideas, and methods that aren’t economically viable in the long-run.

The address then turns back to embracing the market with his sound advocation of patent-reform and the ongoing natural gas/fracking boom.  Indeed, both are important issues; litigation has gotten out of control in many parts of the country, adding needless transactions burdens on thousands of businesses; a sounder process that reduces frivolous litigation would be welcome.  Streamlining the permitting process and reducing red tape for natural gas is also a long-needed reform; it’s good that the administration is finally realizing that fossil fuels still hold massive potential in both creating jobs and lowering American energy costs (which have dramatically increased our competitiveness relative to other developed nations, such as those in Europe).  At the same time, his mentioning of reducing fossil fuel subsidies is good as it produces problems similar to the problems small business loans produce.  Republicans would be smart to firmly stand with the President on this issue and work to get rid of the subsidies once and for all.  Corporate welfare almost never works – we have far better uses for our money.

After talking about the usual climate change mantra, he then shifts to immigration.  Personally, my views contain a mix of both Republican and Democratic thinking.  I agree with the Republicans that “blanket amnesty” would have some serious harmful effects on the country.  Specifically, I think granting illegal immigrants citizenship status who broke the law without penalty would undermine the rule of law, something that has already been undermined during this administration (think federal drug enforcement).  Not only that, it isn’t really fair to those who took the time and effort to come here illegally.  At the same time, Democrats are right in that deporting millions of illegal immigrants isn’t practical (or smart policy) either.  Not only is it extremely costly in fiscal terms, but it is damaging economically.  Like it or not, immigrants add to our GDP, lower costs for businesses and allow other citizens to specialize in higher value-added jobs.  Deporting them would raise costs, disrupt economic activity and ultimately slow growth.  Additionally, many illegal immigrants now have children – the so-called “Dreamers” – who came to this country through no fault of their own.  Deporting them or, worse, splitting up families via deportation is emotionally traumatizing and morally questionable.  As such, I think the best solution is to grant them citizenship status only after a) thorough background checks have been conducted b) high penalties (for breaking the law) have been applied, including perhaps putting them at the end of the line behind other immigrants that are attempting to get naturalized status.  Also good would be to streamline the naturalization system in a way that maintains our national security.  The President didn’t lay out the terms of his desired reform package in his address, though I’m sure that whatever he supports will contain lots of needed naturalization and far too little penalization.

The President then moves on to the importance of education, especially pre-K education.  It is true that early childhood education can improve cognitive development and boost achievement in a child’s academic career (and even later on in life), and is something the country needs to consider to bolster its human capital and even total factor productivity (the level of efficiency in turning capital and labor into economic output).  However, his advocation of “invest(ing) in new partnerships with states and communities across the country” to boost pre-K education should be approached with caution.  I believe that states and localities know best how to create competitive, high-quality educational programs.  Getting the federal government involved, even if it is “just” via funding, might not be a good idea.  Federal involvement can hinder local innovation and can make localities far too reliant on federal aid (something that can make states puppets of whatever the federal government wants – think Medicaid).  Increasing federal involvement since the 1970s, especially since the creation of the Department of Education by the Carter Administration hasn’t noticeably boosted educational access or progress; indeed, since the 1970s, progress on indicators ranging from reading and math proficiency to graduation rates have stagnated.  Let the states and localities do it on their own; no federal involvement is necessary.

Obama’s policy proposals then turn outright populist with his insistence that Congress raise the minimum wage, and lended support to Senator Tom Harkin and Representative George Miller’s proposal to raise the federal minimum from $7.25/hour to $10.10/hour.  On net, I think this is a very bad idea.  Let’s start with the usual neoclassical argument: assuming that the current minimum wage right now is at the “equilibrium” wage (which likely is not true), a raise in the price floor would lower business demand for labor while simultaneously increasing the supply of people willing to work.  This creates a labor surplus that would translate into unemployment.  Indeed, a Congressional Budget Office estimate of the proposal’s effect on employment projected that enacting the Harkin/Miller bill would reduce employment on net, with its central estimate at about a 500,000 decrease in employed workers.  Then we hear the counterargument by left-leaning economists, such as those at the Economic Policy Institute.  They argue that an increase in the minimum wage could actually increase economic growth and job creation, counteracting any job losses.  This would be due to the “multiplier” effect of raising the wage of millions of low-income citizens, whose marginal propensity to consume (according to Keynesian theory and many studies) is high.  In other words, the newfound income these people would have would be spent almost immediately, increasing aggregate demand and generating economic activity.  That is a possibility I suppose. However, we must remember that the equilibrium wage is vastly different across the nation – different states have different price levels and levels of competitiveness; for some, raising the minimum wage could theoretically increase job creation; in others, however, raising the minimum would place it far above the current equilibrium, increasing unemployment.  As The Economist has noted, places like Puerto Rico are already suffering from high labor costs due to the current minimum wage, and economists in general have long recognized the high minimum wages of many European countries as contributing to their high long-term unemployment rates.  In places like these, the costs of further increases would far outweigh the economic “benefits”.  Additionally (as The Economist also mentioned), let’s face it: many of the jobs minimum wage workers currently perform could easily and efficiently be done by technology and automation.  I believe that the only reason many of these jobs still exist is due to cultural norms, which have a tendency to get in the way of rational economic thinking.  Raising the minimum wage could accelerate the shift towards these technologies substituting for low & medium-skilled workers, hurting them in the short term.  No matter what, the minimum wage is a command-and-control solution to tackling the problem of poverty and low-wage work that will cause more harm than good.  Other ideas (such as an increase in the earned income tax credit that the President mentioned) that reward workers without distorting the market and disincentivizing them from working (or employers from hiring) are needed.  Additionally, wages are partially a result of overall cultural norms – change the norms, and perhaps we can change the wage. 

The last big thing I wanted to address from Obama’s speech is a commendable proposal, the MyRA.  Partially due to record-low interest rates, savings rates for Americans are at an all-time low.  This is very worrying.  Savings are crucial for a good retirement (which Social Security was originally meant to compliment, not substitute) and for consumption smoothing (look up the Modgliani life cycle hypothesis).   A lack of them can put further liabilities and pressures on entitlements.  Additionally, savings help the economy to grow by boosting available financial capital for investment.  Without them, long-term economic growth is put into jeopardy.  Helping workers to put away reliable savings, especially at a time when defined-benefit pensions are dissapearing in favor of less stable 401Ks is potentially a good idea for governmental involvement.  My only caveat: should it be federal?

Overall, the speech was good, with a mixture of good and bad proposals.  The nation now needs to prioritize and, when that is done, begin to have thorough debates on these critical issues.  Forget midterms; this is among the administration’s last good chances to finally leave a positive mark on American history.