January 6, 2013
How Good is the Fiscal Agreement?
How Good is the Fiscal Agreement? Becker
Not good at all in my opinion. The biggest defect is the failure to do much about federal spending, which has grown rapidly since 2000, especially during the past 4 years, and will continue to grow unless major reforms are made. Some of the increases in taxes are desirable but many are not, and the whole set of tax changes will do little to close present and future fiscal deficits. Most of the reforms in taxation and spending that I advocate in this piece will not be considered politically feasible because of the power of special interests. In fighting special interests, however, one needs to be clear on the desired goals, and that is the spirit motivating my discussion.
The fiscal agreement has very little reform of the basic tax code. Nothing was done about the many undesirable special exemptions called "corporate welfare". These include, among many, employer deductibility of contributions to health care coverage of its employees; subsides to the oil industry, and subsidies also to alternative sources of energy, such as solar.
Middle income and rich families mainly take advantage of the deduction for interest paid on home mortgages that cost about $90 billion in federal tax revenue in 2012. Although many attempts have been made to provide economic and social justifications for encouraging home ownership, the arguments and evidence have been weak.
Charitable contributions are the other major itemized deduction. That deduction has greater justification because it helps decentralize charitable giving away from the government. Nevertheless, with such large fiscal deficits, that deduction should also be restricted. The fiscal agreement did limit total deductions by couples earning more than $300,000, but it did not distinguish among deductions, and the limit should apply to all personal income tax filers.
The optimal income tax structure-if income rather than consumption remains the basis of taxation- would have a rather flat percentage tax on a very broad definition of income that eliminates the great majority of deductions, and incorporates dividends and capital gains into reported income. The extra tax revenue from increasing marginal tax rates as incomes increase is not worth the social cost in the form of tax avoidance measures and tax evasion. An element of progressivity should be introduced through providing an exemption from income taxes for persons with incomes below a reasonable poverty line.
The tax changes in the fiscal agreement combine higher taxes on the "rich", including limits on their itemized deductions, with higher taxes on capital gains, dividends, and estates. As Posner indicates, all the changes combined are estimated to bring in only about $600 billion in additional tax revenue over ten years. This increase is a drop in the bucket when federal spending is almost $4 trillion per year. Even the $600 billion figure is a large overestimate of what will be generated in added revenue because it assumes no changes in behavior on the part of businesses and individuals affected by higher tax rates. Corporations are likely to adjust to the higher rates by reducing dividends, taking more of their incomes abroad, and making other changes that reduce their tax burdens. Individuals facing higher marginal tax rates will increase their itemized deductions when this helps reduce their tax obligations, shift their effort and energy from work to untaxed or lower taxed activities, and take increasing advantage over time of loopholes discovered by tax lawyers and accountants.
Virtually nothing was done in the compromise on the spending side-that supposedly is to be taken up in a couple of months. As Posner indicates, they did continue to extend unemployment benefits to a maximum of 99 weeks. This does not involve a lot of spending, but the extension makes no sense when employment is growing each month, and when almost 4 million jobs are going unfilled. Paying compensation for almost two years of unemployment has contributed to the large number of workers who have been unemployed for over a year.
Federal spending has increased from about 18% of GDP in 2000 to over 24% at present. A good part of the increase went to spending on social security, Medicare, and Medicaid, but many other categories of spending increased as fast or even faster than these entitlements. Adjusted for inflation, between 2000 and 2011 Medicare grew by over 100% and Medicaid by 83%, while income security programs grew by over 130%, and defense grew by 86%. Spending on highways and mass transit, energy, and various other programs also grew by a lot. So-called discretionary spending as a whole that includes various domestic programs and defense grew by over 70%. So even if we exclude entitlements, there are many places to cut federal spending to help move the country toward the spending situation at the end of the Clinton presidency. There was no widespread belief then that the federal government was on a starvation diet.
Of course, it is also crucial to try to rein in the growth of Medicare and Medicaid since they are so important. Medicaid and related government health programs are supposed to be for children and parents in poor families, but the definition of "poor" has expanded beyond a reasonable level, and should be scaled back.
A mandate for health care coverage can be justified perhaps as an effort to control free riding, but such a mandate should require only coverage against health catastrophes, and it should only subsidize the premiums of poor families. The Affordable Care Act's mandate, by contrast, requires extensive coverage, and subsidizes premiums for individuals earning up to 4 times the poverty level.
Medicare can also be reformed in several ways (see the more extensive discussion of Medicare reform in my blog post on 4/10/11). One important change would be to increase the fraction of out of pocket spending by the non-poor elderly receiving medical treatment under Medicare. This fraction is much below that in Switzerland, a country that generally provides excellent medical care. Obamacare does little to increase out of pocket expenses, and instead adds a series of quotas on care and price controls on payments for care.
The over age 65 population is much healthier than when Medicare started over half a century ago. This suggests that extending Medicare eligibility to age 67 or 68 from age 65 would not impose major hardships on persons of these ages, and it would encourage them to make greater use of private insurance. Of course, to allow older persons to prepare for this change in eligibility age, it should not go into effect for say 5 years, and could be phased in after that.
I am not optimistic that the reforms discussed in this piece or other reforms will be enacted in the near future. The President and both sides in Congress have inflexible positions. Nor has the media been of much help in arousing the public since it has concentrated on how to raise taxes on the so-called rich rather than on tax and spending reforms. Still, in trying to change the discussion, it is important to show how to reform the tax code, and the many reasonable ways to cut federal spending.
More on the Fiscal Cliff—Posner
I shall discuss several closely related questions: (1) was the deal that averted the "fiscal cliff" a good one? (2) what would be the best deal to avoid a repetition of a fiscal-cliff type of crisis in the near future? (3) should there be a debt ceiling? (4) what is Republican economic policy and is it coherent and economically sound? and (5) where is Mitt Romney in all this?
(1) Had no deal to avert falling off the fiscal cliff been struck, large federal income tax increases would have gone into effect at the beginning of the new year and a rapid process of huge cuts in federal spending would have been triggered. The result would have been a sharp negative jolt to the economy, though how sharp no one knows. But given the present fragility of the economy, failing to avert a fall off the cliff would have been irresponsible, and quite possibly a public relations disaster for the Republican Party, which is having trouble getting its act together after the intense disappointment of the election result.
The terms of the deal that averted the fall off the fiscal cliff were reasonable, given the deal's temporary character. The term that has received the most attention was a modest increase in income tax rates for people in the top seven-tenths of one percent of earners. The significance of this "tax increase" was that it broke the taboo against raising taxes, though actually it wasn't a tax increase; on January 1 all federal income tax rates were going to increase unless there was a deal, and the deal allowed the increase to go into effect for just that top seven-tenths of 1 percent. Actually the deal did raise taxes (though this has received little attention), by increasing the tax rate on dividends, and on capital gains, of the very high earners and by limiting deductions for taxpayers in the top 2 percent. Estate taxes were also raised slightly, and Medicare surcharges allowed to go into effect.
As part of the deal there were some spending increases as well, notably a continuation of extending unemployment benefits to 99 weeks, which is criticized as discouraging the unemployed from searching for jobs until they reach or come close to the 99-week cut off. But a countervailing consideration is the loss of consumption that would result from reducing the benefits; and it is consumption that drives production, which in turns drives employment. Moreover, it is uncertain how much more vigorous a search for employment in a depressed economy would actually increase employment. The problem may be on the demand rather than the supply side of the labor market.
Overall the deal is estimated to increase net federal revenues by $600 billion over ten years; I don't know how reliable such an estimate is.
(2) A net increase in federal revenues of $60 billion a year is not enough to reduce the federal government's debt, now almost $16 trillion, significantly. The deficit in 2012 was $1.1 trillion. That was, however, considerably lower than the 2011 deficit and the lowest since 2008, the year of the financial crash. As the economy recovers, federal tax collections will rise and the deficit shrink, unless the increased tax revenues are offset by continued increases in entitlement spending, mainly for Medicare. But this is unlikely, because the Affordable Care Act will reduce Medicare reimbursement to doctors and hospitals, which in turn will reduce the number of medical procedures and other forms of medical treatment.
There is doubtless room for significant further tax increases, notably the President's recommended increase in marginal rates paid by the second percentile from the top of the income distribution. Significant cuts in spending are likely to be blocked by interest groups. And the dream of tax reform is probably just that—a dream—because all the deductions and loopholes are fiercely defended by their beneficiaries. But modest increases in tax rates, combined with a growing economy, may suffice to reduce the government's debt to a safe level without substantial reforms. By the end of the 1990s, a decade that began with significant federal tax increases, the deficit (that is, the annual increase in federal government debt) had fallen to zero, though what that did was pave the way for the Bush spending and tax-cutting splurges.
(3) The debt ceiling refers to Congress's specifying a dollar limit beyond which the Treasury is forbidden to borrow. The debt ceiling is an absurdity. The amount of debt that the government takes on is a function of the balance between tax revenues and government expenditures, both being quantities that Congress determines by its tax and spending laws. If Congress is profligate, the government still has to pay the resulting debt. The "ceiling" is just a device to force Congress to raise taxes or cut spending or both to avoid the government's defaulting.
It's an illegitimate device. Government policy is formed by the two Houses of Congress and the President, who by virtue of his veto power and broad executive powers is effectively a third House of Congress. When neither the Democratic nor the Republican Party controls all three Houses, the result is to give the minority party a degree of leverage. A law cannot be passed without being approved by both the Senate and the House of Representatives. At present the Republicans control the House of Representatives and this gives them legitimate leverage. They want additional leverage by using their control of the House to threaten to withhold approval of raising the debt ceiling. In other words, they want to use the threat of the government's defaulting on its debt to magnify Republicans' legislative power. That strikes me as illegitimate. Nothing in the Constitution contemplates the use of default threats to magnify the power of the House of Representatives, or any other branch of the federal government. It is possible therefore that if Congress does not raise the debt ceiling, the President may decide nevertheless to order the Treasury Department to keep on borrowing.
(4) I don't understand what current Republican economic policy is. Maybe there is none, but if there is one it seems to be to combine no increases in tax rates, for anyone, with drastic spending cuts in government spending (except for defense), the aim being to drive the deficit to zero and reduce the overall government debt (the $16 trillion) drastically—perhaps they want to reduce that to zero too. The Republican Party advocates tax reform that would increase tax revenues without increasing tax rates, and such reform is both desirable and possible in principle, but not feasible politically. That means the party is advocating a policy that will not increase tax revenues at all because it will not be adopted. Similarly, as regards spending cuts, the party has not identified any significant cuts that are feasible politically. Increase the Medicare eligibility age to 67? That would be a severe blow to the gut of a great many lower-middle and middle-middle class people, many of them Republican supporters—and remember the placards in the Republican primaries that read "Save Our Medicare." Cut Social Security? President Bush tried that in a more congenial political environment and failed. Cut Medicaid? Medicaid is underfinanced as it is, and an important form of poor relief. Cut food stamps? The farm interests would block that. The only concrete recommendation for a spending cut that I recall Mitt Romney having made during the campaign was to eliminate the funding of the Corporation for Public Broadcasting, which would save the government some $450 million a year out of an estimated $3.7 trillion in federal spending for the current fiscal year. The result would be a reduction in federal spending of only a little more than one-tenth of 1 percent.
(5) Speaking of Romney: his silence during the debates over the fiscal cliff has been complete, so far as I am aware, and is a remarkable political phenomenon. Remember that the case he and his supporters made for his candidacy was that as an experienced and very successful businessman he would know how to solve the nation's fiscal problems. Of course he lost, decisively in the Electoral College, but his showing in the popular vote was a respectable 47 percent. He and his campaign staff made a number of serious mistakes in the campaign, but he certainly campaigned vigorously and had many passionate supporters.
One might expect that a defeated presidential candidate whose business acumen could not be doubted would not become a nonperson to his party in a period of economic crisis just because he had failed to defeat an incumbent President. Remember Romney's five-point plan to save the economy? The details were never spelled out, for political reasons that are no longer operative. One would therefore have expected Romney's party to be fronting Romney as a spokesman for fiscal reform.