The Truth About Taxes: What are Our Choices

The Truth About TaxesWhat are Our Choices?

Presentation to the San Juan CountyLeague of Women Voters

September 12, 2011

Terms of Use: These slides are made available under Creative Commons License Attribution—Share Alike 3.0 . You are free to use these slides as a resource for your economics

classes together with whatever textbook you are using. If you like the slides, you may also want to take a look at my textbook, Introduction to Economics, from BVT Publishers.

Another slideshow from Ed Dolan’s Econ Blog

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The Truth about Taxes

Here are the questions most often asked about taxes:

Are taxes too high? Are taxes too low?

YES!

YES!

Posted Sept. 12, 2011 to Ed Dolan’s Econ Blog http://dolanecon.blogspot.com


The Choice We Do Not Have: Do Nothing

We do not have the choice of doing nothing about the federal budget. If we do nothing, government debt will grow out of control and we will end

up like Greece, or worse

Posted Sept. 5, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com


How Do We Know if the Debt and Deficit are Sustainable?

Whether or not the national debt is sustainable in the long run is a matter of simple arithmetic

Start with the ordinary balance (surplus or deficit) as a percent of GDP Adjust the balance for effects of the business cycle:

The budget should be allowed to move into deficit during a recession It should move into surplus during an expansionThe average balance over the cycle is called the cyclically adjusted balance

Subtract interest payments to get the cyclically adjusted primary balance For the national debt to be sustainable in the long run, the cyclically

adjusted primary balance must be near zero, or in slight surplus



The US Budget Deficit: An International Comparison

The cyclically adjusted primary deficit for the United States is about 6.8% of GDP

That is the worst number among all industrialized countries

To avoid budget disaster, the US needs to reduce the deficitby about 7% of GDPby about $1 trillion per yearby more than ¼ of the current

size of the federal budget



Now for The Choices We Do Have

The first choice is to decide what level of government services we really want

The amount of government spending determines the amount of taxes we need

When we know that, we can choose a tax system that collects enough revenue to pay for the services we want

http://commons.wikimedia.org/wiki/File:Circle-question-blue.svg



How Large are Expenditures? Historical Comparisons

Total federal expenditures since 2008 have been high in relation to GDP, mostly because of the deep recession

Cyclically adjusted expenditures are now about the same as in the 1980s

For comparison, the balanced budget amendment proposed by House Republicans would cap total spending at 18% of GDP, about where they were in Eisenhower’s last year in office



How Large are Expenditures? International Comparisons

Combined US government expenditures are among the lowest of developed countries, although some countries do seem to get along well with even less

For accurate international comparison, the totals shown here include all levels of government—federal, state and local

Federal expenditures are about 60% of the total for the United States



Composition of Expenditures

When many people think of government, they think of schools, parks, and fire fighters

However, the federal government more accurately described as an insurance company with an army attached

All other government functions (nondefense discretionary) are less than a fifth of federal spending


Cutting Spending Involves Hard Choices

To make the budget sustainable without new taxes would require spending cuts of about 7 percent of GDPCutting defense spending in half would save 2.4% of GDPCutting nondefense discretionary spending in half would save another 2.4% of GDPEven after those reductions, 2.2% of GDP would have to be cut from entitlements


Why Cutting Entitlements is Hard

The US old age dependency ratio will rise sharply in coming decades

Even holding total entitlement spending constant, let alone cutting it, would require far lower benefits per person than in recent decades

The bottom line: Yes, it would be possible to cut federal spending to 18% of GDP but doing so would leave us with a lower level of government services and benefits than at any time in the post-World War II period


What Choices do We Have for Tax Revenue?

After deciding how much government we want, we need to find enough tax revenue to pay for itIncome taxes are now the biggest source of federal revenuePayroll taxes (social security and Medicare) have grown over timeCorporate income taxes are much less important than they were at one time

Chart source: http://www.taxpolicycenter.org/briefing-book/background/numbers/revenue.cfm


The Case for Tax Reform

Earlier we said that taxes were both too high AND too low

Are taxes too high? Yes, in the sense that high tax rates distort economic decisions of businesses and familiesAre taxes too low? Yes, in the sense that our current tax system does not produce enough revenue to pay for the services people want and vote for

What we need are not higher taxes or lower taxes, but tax reformBroaden the base by closing loopholesLower marginal tax ratesSwitch to taxes that have fewer perverse incentive effects


The Dirty Dozen Tax Loopholes

The 12 biggest tax expenditures amounted to more than $600 billion in 2008, nearly one fourth of federal revenue that year

If all or most of these loopholes were eliminated, everyone’s tax rates could be cut while still increasing taxes by enough to help balance the budget

Value of tax expenditures in 2008 ($ billions)

1.Employer-paid health care (131)2.Pension contributions and earnings (117)3.Mortgage interest deduction (89)4.Accelerated depreciation (56)5.State and local tax deduction, other than property taxes (49)6.Charitable contributions (47)7.Deferral of income from foreign corporations (31)8.Exclusion of capital gains on sale of homes (30)9.Property tax deduction on homes (29)10.Child credit (28)11.Capital gains rate (24)12.Capital gains basis step-up at death (22)Data source: http://www.taxpolicycenter.org/briefing-book/background/expenditures/largest.cfm


Who Benefits? Example: Mortgage Interest Deductions

The benefits of many tax loopholes are concentrated on a small minority of the population

Example: The mortgage interest deduction has the greatest value for high-income families that are more likely to itemize deductions, own larger homes, and are in higher tax brackets

The average value of the deduction to lower-income groups is very small


What Taxes Are Too High?

Payroll taxes (social security and Medicare) Increase cost of hiring Highly regressive—heavy burden on low- and middle-income workers

Personal income taxes Discourage work effort Discourage saving

Corporate income taxes US has close to the world’s highest rates but collects very little revenue High rates + loopholes distort business decisions

Encourage businesses to move money and jobs offshoreEncourage excessive corporate debt


New tax ideas: Energy taxes

Another path to tax reform is to replace existing taxes with new kinds of broad-based taxes

Advantages of energy taxes Discourage excessive energy use

that contributes to climate change and local pollution

Reduce national security risks associated with excessive US dependence on oil from unfriendly governments

Can take many forms: Gasoline tax, carbon tax, cap-and-trade, or other


New tax ideas: Value Added Taxes

Value added taxes (similar to sales taxes) are the biggest source of revenue in most other countries

Advantages of VATTaxes consumption, encourages

savingBroad tax base with fewer

special-interest loopholes5% VAT in US could raise about

2.5% of GDP, enough to completely eliminate the corporate tax and reduce other rates, too


Why Everyone Should Support Tax Reform

Tax reform for Liberals . . .Raise enough tax revenue to balance the budget and support total government spending around 23% of GDPClose special interest loopholes for corporations and wealthy individualsIntroduce VAT and energy taxesSharply cut payroll taxes to encourage hiringModerately reduce income tax rates for everyone

Tax reform for Conservatives . . .

Bring in enough tax revenue to balance the budget and support total government spending around 18% of GDPClose special interest loopholes while cutting income tax rates for everyoneEliminate corporate income tax altogether, replacing it with VAT


The Bottom Line

The truth about taxes is that we need tax reform that broadens the tax base and reduces marginal tax rates for everyone

Choices we have: What level of services do we

want? What kind of tax system will best

raise the revenue needed to pay for them?

The choice we do not have: continue our current level of services without the taxes we need to pay for them


The Truth About Taxes: What are Our Choices

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