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Tax Policy

Tax Policy. In 1997-98 I was Deputy Assistant Secretary for Tax Analysis at the U.S. Treasury Department. Directed an office of 43 Ph.D. economists. We were responsible for economic analyses of all tax proposals from the Administration and Congress.

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Tax Policy

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  1. Tax Policy • In 1997-98 I was Deputy Assistant Secretary for Tax Analysis at the U.S. Treasury Department. • 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.

  2. 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.” • 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.

  3. The Environment, continued… • 1995: Congress passed a budget that cut taxes by $150 billion over 5 years and $340 billion over 10. • 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. • Democrats wanted to demonstrate they are able and willing to cut taxes in a fiscally responsible manner.

  4. Tax Policy Analysis at Treasury

  5. 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 • Markets provide appropriate price signals. • Low tax rates • The efficiency loss of taxes increase with the square of the tax rate. • 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.

  6. 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. • 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.

  7. 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 • 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.

  8. The 1997 Budget Deal

  9. The 1997 Budget Deal • President was deeply interested in the HOPE and lifelong learning credits and preserving the EITC. • 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.

  10. My Role • Create sample packages with “menus” and explanations. • 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. • Congress isn’t just sitting quietly. Respond to them. • Enormous number of interagency, White House and Congressional meetings. • Budget passed in August, 1997.

  11. Thoughts I Have Looking Forward

  12. Shift Gears: Tax Policy in 2006 • Even before the tax cuts in 2001 Treasury and CBO statistics told a consistent story • 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.

  13. Top Decile Income Share, Saez and Pikitty

  14. Income Shares of P90-P95, P95-P99, and P99-P100, Saez and Pikitty

  15. The Debate Surrounding the 2001 Tax Bill • Con • 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. • Raise long-term interest rates, inhibit economic growth • Pro • 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.

  16. The Future of Tax Policy: Confusion or Clarity?

  17. Tax Policy Today • The FY2006 Budget is the most recent expression of the President’s tax policy priorities. It proposes to • Make permanent most of the tax cuts adopted in the 2001 and 2003 tax bills. • 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).

  18. Two Things I Am Sure About • Tax policy is unlikely to be a central issue in upcoming elections. • 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.

  19. 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. • 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…).

  20. Costs of the President’s Proposals • Complete accounting… • 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). • 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.

  21. Getting to Where I Want to Go

  22. 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.

  23. 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.

  24. The Future, continued… • Too many children are being raised in households with incomes below the poverty line. • We know some effective programs • 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.

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