Transcript August 1999, EITC Roundtable

Tax Policy

In 1997-98 I was Deputy Assistant
Secretary for Tax Analysis at the U.S.
Treasury Department.
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Directed an office of 43 Ph.D. economists.
We were responsible for economic analyses
of all tax proposals from the Administration
and Congress.
The 1997 budget deal was the
Administration’s top legislative priority.
The Political Environment

1992: The deficit was $290 billion and
forecast to grow to $319 billion by 1997.

President Clinton was elected, in part, on the
pledge of “putting people first.”
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Sharp battle early in the administration about addressing
the deficit or investing in education, training and skills.
1993 tax bill passed with no Republican
votes. Raised taxes on very high income
taxpayers, but was broadly perceived as a
general tax increase.

1994: Democrats lost Congress for the first time
since the Truman administration.
The Environment, continued…

1995: Congress passed a budget that cut
taxes by $150 billion over 5 years and $340
billion over 10.
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President vetoed the bill, Government shut down
and Congress ended up passing a budget with no
tax cuts.
1997: Economy was doing well, deficit
performance was good.
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Democrats wanted to demonstrate they are able
and willing to cut taxes in a fiscally responsible
manner.
Tax Policy Analysis at Treasury
Scholars’ Views on Desirable
Tax Policy

The best tax system will have

A broad base, so as not to favor one type of
activity over another
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Markets provide appropriate price signals.
Low tax rates

The efficiency loss of taxes increase with the square of
the tax rate.
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Adding tax preferences (“loopholes”) adds complexity to
the system, violates “horizontal equity.”
It undermines confidence in the system by contributing to
the feeling that someone smarter, better advised or better
connected is not paying their fair share.
Cutting Taxes:
What Politicians Believe

Tax expenditures meet the magic of polling.

Tax expenditures are deviations from a baseline
(comprehensive) tax system. Like a direct
expenditure, but in the tax code.

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Home mortgage interest deduction.
Research and experimentation tax credit.
Tax expenditures allow politicians to enact
new programs while also cutting taxes.

D’s like things focused on education and training.
R’s like things focused on capital formation.
Differences Between the D’s
and R’s

Neither side supports, when push comes to
shove, the reforms advocated by “good
government,” tax policy people
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D’s like tax expenditures directed at education,
health care, training. They care about distribution
and fiscal responsibility.
R’s like tax expenditures directed at capital
formation and business. They talk a lot about the
burden of taxes and generally wish to shrink the
size of government.

Some R’s use the rhetoric of “ripping the tax system out
by its roots” but that seems less popular these days.
The 1997 Budget Deal
The 1997 Budget Deal

President was deeply interested in the HOPE
and lifelong learning credits and preserving
the EITC.

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Congressional D’s, refundable child credits.
Secretary Rubin, “fiscal discipline.”
Congressional majority likes capital gains tax
cuts, saving incentives and estate tax cuts.
Must fit all this into a package with $130b in
gross cuts and $80b in net cuts over 5 years.
My Role
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Create sample packages with “menus” and
explanations.
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Endless variations of child credits, estate and gift tax
cuts, capital gains taxes, AMT reform, IRAs, and
education provisions.
Distributional analysis and “typical family” calculations.
Determine “poison pills,” effects outside the budget
window.
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Congress isn’t just sitting quietly. Respond to them.
Enormous number of interagency, White House and
Congressional meetings.
Budget passed in August, 1997.
Thoughts I Have Looking
Forward
Shift Gears: Tax Policy in 2006
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Even before the tax cuts in 2001 Treasury
and CBO statistics told a consistent story
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Federal Tax burdens for a family of 4 with median
income (around $54,000) were at their 20-year
low.
Family of 4 with half the median income had the
lowest federal tax burden since 1966.
Family of 4 with twice the median income had
nearly the lowest burdens of the last 20 years.
The 10-year surplus in 2001 was expected to
be $5.6 trillion, leading to a spirited debate
about cutting taxes.
2002
1997
1992
1987
1982
1977
1972
1967
1962
1957
1952
1947
1942
1937
1932
1927
1922
1917
Share (in %), excluding capital gains
Top Decile Income Share, Saez and Pikitty
50%
45%
40%
35%
30%
25%
2003
1998
1993
1988
1983
1978
P99-100
1973
1968
1963
P95-99
1958
1953
1948
P90-95
1943
1938
1933
1928
1923
1918
20%
19%
18%
17%
16%
15%
14%
13%
12%
11%
10%
9%
8%
7%
6%
5%
1913
Share (in %), excluding capital gains
Income Shares of P90-P95, P95-P99, and P99-P100,
Saez and Pikitty
The Debate Surrounding the
2001 Tax Bill
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Con
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Cut taxes very sharply for the same families that did
extremely well during the 1990s.
Ugly policy: for example, it eliminates the estate tax,
but only in 2010! It comes back in 2011.
Revenue better used for other things: shore up social
security and Medicare for baby boomers.
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Raise long-term interest rates, inhibit economic growth
Pro
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With surpluses forecast, some argued that it made
sense to “give back” money to the people who paid it.
Lower tax rates may make the economy more
productive as people work harder, save more.
The Future of Tax Policy:
Confusion or Clarity?
Tax Policy Today

The FY2006 Budget is the most recent
expression of the President’s tax policy
priorities. It proposes to
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Make permanent most of the tax cuts adopted in
the 2001 and 2003 tax bills.
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Lower rates from (28,31,36,39.6) to (25,28,33,35).
Repeal estate tax (in 2009 it only affects married couples
with estates exceeding $7 million)
Cut tax rates on dividends and capital gains
Substantially increase contribution limits on wide range
of tax-preferred saving incentives.
Make the $1,000 (per child) child credit permanent (and
available to all taxpayers, regardless of income).
Two Things I Am Sure About

Tax policy is unlikely to be a central issue in
upcoming elections.
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National security (terrorism) and jobs will
dominate discussions. Tax policy will get a little
attention in broader discussions of “the economy.”
The deficit is a major issue and the political
process is not well-equipped to deal with it.

There has been a $8.5 trillion reduction in
forecasted budget surpluses (to a $2.9t deficit).

The deterioration is dramatically understated, since it
does not account for needed changes to social security
and Medicare, adjust for the AMT, and makes unrealistic
assumptions about security-related and other spending.
My Concerns with the
President’s Proposals

Deficits are a serious issue.

About 60% of the $8.5t decline is due to legislation. The
remainder is due to changes in economic and technical
assumptions.
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Of legislated changes, 45% is from tax cuts, 30% defense and
homeland security, and 25% is domestic outlays (i.e. Medicare
prescription drugs).
I fear a gulf is developing in this country between
the “haves” and the “have nots,” and tax policy
contributes to inequality.
2004 federal revenue was the smallest share of GDP
since 1950. Spending is at its 40-year average.
The budget does not give a complete accounting of
costs (see next slide…).
Costs of the President’s
Proposals

Complete accounting…
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The AMT will take away 40% of the tax cuts by
2014 (more than 50% for $75k-$100k households
and 75% for $100k-$200k households).
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It is nearly certain that both parties will support an AMT
“fix,” which must be financed.
Assume real discretionary spending per capita will
fall by 8 percent – unlikely given homeland
security needs and other issues that will arise.
Surpluses in the social security trust fund and
Medicare should not be used to mask the size of
the deficit in the non-retirement-trust-fund portion
of the budget.
Getting to Where I Want to Go
The Future
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Deficits – they challenge the political system.
The AMT – a classic test in political economy.
Social security and Medicare – fiscal stability.
Tax complexity – how can the system be
made simpler for typical families?
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Raise the standard deduction (lessen Sched. A).
Adopt a modest capital income exclusion.
Fix the looming AMT problem
Rationalize the hodgepodge of saving incentives.

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IRAs, Roth IRAs, SEP-IRAs, SIMPLE-IRAs, Keoghs,
Education IRA, QSTPs
Reform provisions for families with children.
The Future




Deficits – they challenge the political system.
The AMT – a classic test in political economy.
Social security and Medicare – fiscal stability.
Tax complexity – how can the system be
made simpler for typical families?




Raise the standard deduction (lessen Sched. A).
Adopt a modest capital income exclusion.
Fix the looming AMT problem
Rationalize the hodgepodge of saving incentives.


IRAs, Roth IRAs, SEP-IRAs, SIMPLE-IRAs, Keoghs,
Education IRA, QSTPs
Reform provisions for families with children.
The Future, continued…

Too many children are being raised in
households with incomes below the
poverty line.
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We know some effective programs

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High quality preschool that involves parents.
Supports – transportation, health care, child
care, wage supplements – that help “make
work pay.”

These allow poor parents to support their families,
provide good role models to children, etc.