The most important tax reform decision

(This is cross posted at Don Taylor’s freeforall blog).

The most important tax reform decision is deciding to collect enough revenue to pay for the spending that the nation plans to undertake.

This basic decision is often lost in the discussion of other (important) issues: marginal rates, tax expenditures, the Buffet rule/fairness, changes in the mix of taxes used to collect revenue, impact on the economy, etc. There are many key decisions to be made if we are to transition toward a sustainable federal budget, but most fundamentally, we must decide what proportion of GDP will be redistributed via government expenditure, and then develop a tax code that can collect the amount of revenue necessary to pay for such spending.

If we are to ever having anything near a balanced budget again, it will require a substantial increase in taxes received as a percent of GDP over the 18 percent of GDP collected on average the past 4 decades or so. Spending has averaged around 20.5 percent of GDP over the same period of time, but that is simply a restatement of the fact that the U.S. has only had 4 balanced budgets since I have been alive.

It is of course mathematically possible to shrink spending to meet the historical level of tax collection. However, it is important to realize that we spent more than 21 percent of GDP (the target for revenue/spending balance in around 2035 suggested by Simpson-Bowles) in 1970, 1975, 1980 and 1985—and the baby boomers were mostly working and paying taxes then, and not moving into eligibility for Medicare and Social Security. And no one has identified a health reform plan that could plausibly be enacted that could slow long range health care spending growth by the degree needed to achieve a balanced budget in the 18-19 percent of GDP range preferred by many Republicans, given other spending realities.

There are technical aspects of tax reform, no doubt. However, the biggest decision is to determine how much revenue is needed to finance the spending programs the country decides to undertake, and to then move to the related issues of reforming our tax collection system. Sometimes the simplest decisions are the hardest to make.

Author: Don Taylor

Don Taylor is an Associate Professor of Public Policy at Duke University, where his teaching and research focuses on health policy, with a focus on Medicare generally, and on hospice and palliative care, specifically. He increasingly works at the intersection of health policy and the federal budget. Past research topics have included health workforce and the economics of smoking. He began blogging in June 2009 and wrote columns on health reform for the Raleigh, (N.C.) News and Observer. He blogged at The Incidental Economist from March 2011 to March 2012. He is the author of a book, Balancing the Budget is a Progressive Priority that will be published by Springer in May 2012.

28 thoughts on “The most important tax reform decision”

  1. Welcome aboard Dan.

    But isn’t the decision when to collect the revenue that pays for spending, not whether? You’re going to collect the revenue one way or the other. If a government goes bust, it collects it from asset sales and outstanding bondholders. If it doesn’t, the taxpayers will eventually have to cough up.

  2. The most basic decisions about the Federal budget do tend to blend into the most basic decisions about what kind of society and political economy the U.S. is to be, or become. It really isn’t possible, or practical, to separate them.

    And, the most fundamental decisions are:
    1.) whether to tax “economic rents” heavily,
    2.) whether the government is to provide cheap, social insurance (a guaranteed pension like Social Security, health care, etc.),
    3.) the extent to which government will provide public goods investment (education, roads, infrastructure), and
    4.) whether government will regulate business and finance effectively to prevent predatory business conduct (usury laws, anti-fraud, utility regulation, pure food and drug enforcement).

    Apparently, the U.S. is trending toward low taxes on the rentiers, and minimizing social insurance, privatizing public goods investment (selling toll roads, burgeoning student loans), and giving a pass to predatory business conduct.

    On some points, of course, there’s a political struggle going on, which results in ambiguous policy chimera, like the ACA so often defended on this blog. But, mostly, we are unambiguously doing the wrong things — building an economy, which features a high frequency of predatory conduct at the margin. Shockingly, this results in falling real wages, and increasingly extreme income inequality, with the benefits of economic progress flowing almost entirely to a tiny elite.

    On this track, I think it would be reasonable to assume that the government, no longer trusted to protect ordinary people, will lose all legitimacy in the eyes of ordinary people. The fiscal capacity of such a government — its ability to collect taxes — is crippled. Its crippled, because plutocrats control the levers of power, and refuse to allow their economic rents to be competed away or taxed, resulting in a sclerotic economy, its fiscal capacity is crippled, by the unwillingness of ordinary workers and small businesses to pay taxes to support a government, which is oppressing them. The eventual result is a high rate of inflation, combined with a high rate of poverty, which further undermines the efficiency of the economy. We have the high rate of poverty, with half the population of the U.S. now at or near poverty, and the unemployment rate declining apace with the labor force participation rate. The only thing preventing the inflation is the dependence of the plutocracy on inflated financial asset prices.

  3. Of course, if you have sworn allegiance to Saint Grover the Imposter, increasing revenue is not an option. More than anything else this illustrates that Norquist really does want nothing more than to stop all government spending.

  4. …most fundamentally, we must decide what proportion of GDP will be redistributed via government expenditure, and then develop a tax code that can collect the amount of revenue necessary to pay for such spending.

    However, the biggest decision is to determine how much revenue is needed to finance the spending programs the country decides to undertake,…

    These two statements seem to conflict. Do we decide on a % of GDP limit first, or programs first? Or maybe – my preference – we decide them jointly.

  5. The above “most important decision” ignores the idea that we ought to overspend (i.e., borrow) in bad times and pay back in good times. We had a recent President and Congress who did that, and the result, as I recall, was “let the good times roll.” Giving lie, I think, to the theory that only lower taxes can enable economic growth.

    1. @Ken Rhodes
      We must be able to deficit finance in emergency situations. This is one reason we need a sustainable budget which I would define as not using predictable large borrowing to pay for predictable expenses (like health care, soc security, defense) so there is ‘room’ in debt-to-GDP terms to deficit finance in emergencies. I didn’t note that in the post, but it is an important point. Also, we could run s small deficit in perpetuity it is just that our projected deficits will not be small over the near/medium term and that is due to predictable spending side realities given the tax code we have.

      This is a fair point…which should come first and my primary thought is that a theoretical discussion is not so useful. We need to see what spending can be funded by a given level of taxation; want more spending, it will take more taxes and vice versa. It is also likely to be iterative and there is plenty of evidence that the public has more trouble with health care tradeoffs than other spending v. tax areas

      1. A very large part of the recent, large increases in the national debt are due to the dubious decision to convert fraudulent financial securities and loans into full-faith-and-credit obligations of the United States, and another very large part of the recent increases in the debt are due to a policy decision to use fiscal stimulus to increase employment and inflation, in order to reduce the overhang of private debt in the economy. In other words, the political struggle over the government budget is inextricably linked to the political struggle over the distribution of income — a struggle the 99% are losing badly. We must be able to finance policy that benefits the mass of people — increases wages, increases employment opportunties, provides economic security — but we can’t because the people in control of the government, the Media and our politics are, by and large, vicious plutocrats. It is not a technical problem; it is a moral problem, but it goes way beyond an false ethics of government budgeting, focused on abstractions.

    2. That’s an interesting idea, but the innovation required is the “paying back” part; We currently overspend ALL the time.

      1. Right. That was my reference (above) to Bill Clinton. That, sadly, is what’s been lacking in the policies of Reagan and Bush 43.

  6. It seems to me that given the vastly better economic growth of 1950-1970 over that of 1970-1990 that something more like 1950 spending levels (roughly, 8% of GDP for each for federal non-defense and state/local) would be significantly preferable to any of the post-1965 comparisons.

    1. Sam,
      Why are you omitting defense spending, which IIRC was higher in %GDP terms? There was also a lot of WWII debt service, I believe.

      1. I believe the numbers I have include debt service. (The data I’m using is from here). Debt service is 1.5% of GDP (out of the 7% total federal non-defense).

        I’m excluding defense spending, because it seems to be more determined by the environment than by policy choices.

  7. @SamChevre & @Ebenezer Scrooge
    The federal budget would be lots smaller if it didn’t include Medicare and Medicaid! And around half of the elderly were uninsured in early 1960s.So, I am not sure what you mean Sam, that 1950 spending levels would be better uses as a comparison…. We will not get rid of Medicare and Medicaid.

    Defense spending was around 8-9% of GDP during Korea era and similar in Vietnam. It is historically quite low in percent GDP terms now (under 5%), though the USA spends about half of all the world’s military dollars and several of the big spenders are NATO allies. The story from circa. 1950 onward is that debt to GDP was 125% of GDP due to WWII, and that it feel steadily, not typically due to balanced budgets (9 since WWII), but because economic growth was substantially higher than the rate of borrowing for several decades.

    1. Is it useful to measure defense spending against GDP but not the other elements of spending? My recollection (with no research at all) was that US military spending ate up as much of US total spending as Medicare/Medicaid – something over 25% of spending. That’s a huge amount, and measuring it against GDP should not distract from its impact on the issue of balancing the budget.

      It is surely debatable that military spending should be said to be ‘determined by the environment rather than by policy choices’. Iraq (how many billions of dollars per month just poured into the sand?) was a policy choice. Keeping the Afghan war going has been a policy choice (it has to do with conditions there but nothing to do with defense of the US).

  8. I want to bang the drum for paying a lot of heed to “changes in the mix of taxes used to collect revenue” – taxing gasoline more heavily, tolling road use, cutting off tax subsidies for housing at the cost of a median dwelling – these things will change behavior, and towards desirable ends.

  9. “If we are to ever having anything near a balanced budget again….” Please explain why we should care about ‘balanced budgets’ in a fiat currency system. There seems to be a very big assumption here that is not fully fleshed out.

    The politics of this are simple: We need to argue first and foremost about what kind of society we desire, given our level of (indeed large) wealth. The money follows. Viewed in this light, I find this fretting about ‘balanced budgets’ to be somewhat pernicious. You also seem to elide the trade imbalance, an imbalance that is the result of a conscious government policy and one that pushes the other sectors of the economy (private, government) into deficit by definition.

    As for what drives levels of public debt, I often go back to read this by JW Mason at The Slack Wire.

    1. @bobbyp
      fair questions. I have a book coming out in May called Balancing the Budget is a Progressive Priority that tries to make the case. I will blog some about that over the next few weeks.

  10. Don — welcome to RBC!

    Question about your work which I have long wanted to ask. When you estimate how much the government spends as share of GDP, do you count foregone revenue due to things like that health insurance and mortgage interests deductions?

    1. @Keith Humphreys
      Tax expenditures for things like exclusion of employer paid insurance premiums or mortgage interest deduction operate as spending programs just as things like Defense and food stamps do in determining the size of federal expenditures. The tax exclusion for employer paid insurance could be thought of as the third largest federal health insurance program (~$250 Billion/year) after Medicare and Medicaid.

      1. So, all income belongs to the government and any money the government allows the taxpayer to keep is a government expense?

          1. “Tax expenditures for things like exclusion of employer paid insurance premiums or mortgage interest deduction operate as spending programs just as things like Defense and food stamps do in determining the size of federal expenditures.”

        1. @CharlesWT
          If you have $3.5 T annual budget and say lets reduce budget by $100 Billion, you can get there by reducing tax expenditures or cutting direct spending programs (or of course a mix of the two). The two choices may have distributional impacts, but you can get to the same bottom line. That is all I meant.

  11. Don, I think it is perceptive on your part (as opposed to the other bloggers here) that we should actually pay attention to the comparison between what the government spends and what it takes in. I have lots of problems with PPACA, but as a practical matter, the telling argument is that we simply can’t afford it (on top of the other entitlements that already exist.)

    Let’s stipulate that the logical inference to draw from your post is that there need to be both spending reductions and revenue increases. This is similar to the conclusion reached by Bowles – Simpson. Then I postulate that much of this revenue must come from the middle class (for the same reason that Willy Sutton robbed banks – that’s where the money is). Progressives, and worse, the Obama Administration (which does so knowingly) falsely purport that this is not the case. In fact, studies have shown that even were the Buffet rule put in place, it would not raise much money from its announced quarry (those over $1 million in income), at least not enough to make a dent in the budget deficit. There are reasons the Obama budget failed to obtain a single vote in the House from EITHER party.

    Having just completed my own taxes, I can tell you that if you all want to raise my marginal tax rate a few points, go ahead, make my day. If you want to let the Bush tax cuts expire, go ahead, the middle income people will do the extra paying. For my part, the first $13,000 of additional tax will simply move from form 6251 to form 1040, netting exactly zero revenue for the Federal Government. That’s reality. If people only did their own taxes, they might appreciate some of this.

  12. your analysis seems to depend on the idea that entitlements are fixed (not in quantity, clearly, they will continue to rise), and cannot be adjusted. the Ponzi scheme (pay beneficiaries with current revenue) that currently exists in Social Security was not the original intent of the system, and the alterations made over time (with demographic changes) have made the program unsustainable. changes to realign the system to act as an annuity system, with grandfathering to protect those currently in the system, are needed to prevent the collapse of the entire system, no matter how much additional revenue we generate. sooner or later, we run out of other people’s money. the same applies to Medicare and Medicaid, for difference reasons. they were intended to provide a true safety net and replacement for employer-subsidized healthcare plans, but contain no growth or cost limiting incentives – basically, they encourage spending. PPACA does nothing to address this issue, except providing authority for a board to (without calling it that) ration care. the title Patient Protection and Affordable Care Act is truly ironic, since the law provides neither. we need to reestablish a true safety net system for those that need it, provide better marketplaces to let people get health insurance without government or employer subsidies for the majority, and remove regulatory and tort excess to lower overall system costs (I get 3 different forms, consisting of no less than 3 pages apiece, for every claim to my insurance company – and I know damn well it is not the company or me requiring it – that leaves only government to cause this waste). after the corrections to our ridiculous entitlement state are done, we can talk about aligning tax revenue to needs. taxes exist to provide operating capital for government operations. why would we put the cart before the horse??

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