A Curmudgeon's Notebook: On the Agenda for Congress: Tax Reform Plus

This post is work in progress. Please use the comments at the end of the post to provide your thoughts and suggestions.

2012 January 24
Click History for a list of changes and updates.

These are the views of one citizen who is concerned about the lack of progress in Congress on deficit and debt challenges. They are intended to contribute to the needed dialogue. Because our country needs fiscal reform — not because 2012 is an election year — Congress has the opportunity and obligation to address issues that cannot wait. Principal among them is a major reform in the personal income tax code. A suggested objective for a member of Congress might be:

"Recognizing the ongoing budget deficits, the increasing national debt and their effects on jobs and the economy, I am committed to a moderate ongoing annual reduction in the budget deficit, and then to a moderate annual surplus to pay down the national debt."

This post is concerned primarily with major reform in the personal income tax code, but recognizes three related needs:

Changes to the corporate tax code that interrelate with the personal tax reform. Tax policy to help create a competitive business environment may contribute to income inequality (basic unfairness).
Approve a budget resolution for the longer term that provides for moderate annual reductions in the deficit consistent with the "super committee" commitment to cut at least $1.2 trillion (about 8% of GDP) from the deficit over 10 years with significant cuts in the early years. While insufficient to address the forecasted mounting debt (See Figure 1-2 below.), the commitment is needed to provide an important aspect of stability to aid citizens, business and other planners.
Approve a longer-term infrastructure (roads and bridges) appropriation consistent with the above. This would provide the states with the commitments needed for their planning.

Other opportunities for Congress in 2012 are discussed in Appendix A.

To maintain or increase tax revenue, key concepts in the reform include: broaden the tax base by eliminating loopholes, tax incentives, and tax preferences; lower marginal tax rates with the broader tax base; no standard deduction; elimination of special tax rate for capital gains; and no forgiveness of taxes. Both Democrats and Republicans agree on the need and some of the general content. The Simpson-Bowles proposal contains many of the areas of agreement, as does the proposal by the Senate's "Gang of Six". Some of the general provisions are described in the section, General Content of the Tax Reform, in the continuation of this post.

Since some of the changes may have large effects, they should be phased in gradually (say over 5 years), thus giving citizens and the economy time to make adjustments. Gradual changes provide definition of future taxes to provide a foundation for planning.

While the reason for the major reform of the personal tax code is to enhance the public interests, good reform can also create a political advantage for the Republicans. The tax reform could take away the rhetoric of "fair", "fair share", "wealthy pay their fair share", "Warren Buffett pays a lower tax rate than his secretary.", etc. With a tax reform bill passed by the House based on common interests for the country, the pressure would be on the Democratic-controlled Senate to also pass the tax reform. Many tax issues including the termination of the Bush tax cuts will occur at the end of the year if no action is taken. If the Senate fails to act on the House-developed reform, it should be obvious that the Senate is the intransigent body.

The House Republicans have the opportunity to take the leadership position. But the House can have the high road only if the bill is devoted to an objective similar to the suggested above objective and not promote pet-Republican policies that may lack strong economic support, and would provide opponents a source of viable criticism. House Republicans already support the "fairness" message. Passing legislation that has no chance of being approved by the Senate is not progress.

This analysis indicates that almost all tax reductions and spending increases create only small increases in GDP. If so, other factors such as improving confidence may be the most important.

The continuation of this post provides further description and support for the ideas.

Don Nordeen
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Continue reading On the Agenda for Congress: Tax Reform Plus.

Key Words:_ national debt, budget deficit, tax reform, fair, fairness, capital gains, marginal tax rates

Click Continue for Post Continuation plus Comments. Or Click Show All for Above plus Post Continuation and Comments.

On the Agenda for Congress: Tax Reform Plus (continued)

Other posts on tax reform include:

and are part of the basis for this post.

Introduction
Under the Constitution, tax legislation must originate in the House of Representatives. Currently controlled by the Republicans, the House has the opportunity and the obligation to pass tax reform for the common interest of Americans. A suggested objective for a member of Congress might be:

On a general basis, the House Republican plan states the objective:

"America’s tax code has grown too complicated and cumbersome. We need a tax code that is flatter, fairer, and simpler to ensure that everyone pays their fair share, lessen the burden on families, generate economic expansion, and create jobs by making America more competitive."

This general objective should have bipartisan support; however, the dividing issue is likely the definition and meaning of "fairness". Leadership requires that the Republicans define what they mean by "fairer" and "everyone pays their fair share".
The need for fundamental tax reform is high. The country cannot wait until after the 2012 presidential and Congressional elections. Both Democrats and Republicans agree on the need and some of the general content. The Simpson-Bowles proposal contains many of the areas of agreement, as does the proposal by the Senate's "Gang of Six".
And definition of taxes for the longer term is needed for planning and confidence. Low interest rates and much corporate cash are available, and could be invested if and when people and businesses are confident of a good return on their investments. Increasing confidence is essential.
Moderate annual changes, beginning immediately, are needed to avoid a recession from large changes in spending and tax increase as occurred in 1937-1938 [1]. Made by others as well, this same observation is made in the conclusion on page 18 of a Congressional Research Service report:

"Two major policy questions include when, and how, to reduce the deficit. Reducing the deficit while the economy is still fragile and well below full employment would likely involve further contraction that might not be desirable. At the same time, the sooner long run debt problems are addressed, the more room there is for the adjustments to be implemented gradually. The mix of policies (tax increases, spending cuts, and the types of either) depend on many factors including preferences for public programs and distributional objectives, as well as growth."

Taxes are just one part of the fiscal reform required. Maintaining the status quo is not sustainable as the chart below from the Congressional Budget Office shows. The Alternative Fiscal Scenario most likely reflects the status quo, as stated in the note in the chart.

From Congressional Budget Office, June 2010 (revised August 2010),
The Long-Term Budget Outlook at page 14

As of the ending of 2011, the federal debt has reached 100% of GDP — much worse than estimated by the CBO in August 2010. (See Debt Clock for both numbers.) Question: Are the definitions of debt and GDP the same for the CBO and the Debt Clock?

Republican Orthodoxy should be validated.
The tax reform bill should be focused on what is good for the country, not what the Republicans in the House might prefer the tax plan to be [2]. Some of the Republican-held premises and beliefs concerning taxes may not be valid, may be incorrect and/or not consistent with the stated above objective. These include:

Pledges concerning tax increases [3]. Those that are counterproductive to the above objective, which likely includes most of the pledges, should be rescinded.
Belief that lowering tax rates increases tax revenue. This premise is only true under very restricted circumstances, which do not apply to the current tax code [4]. In general, this belief is likely not true. See [5] and 2007 Dec 06 Time Magazine, [Bush] Tax Cuts Don't Boost Revenues. Also see Appendix D for CBO's use of multipliers to estimate the effects on GDP of changes in taxes and spending.
Belief that lower rates for capital gains must be maintained to ensure investment. Rather, the lower rates create more problems than they solve [6]. The data presented by Jared Bernstein indicates that changes in the rate of investment track the business cycle, not the capital gains tax rate. With other reforms that would reduce marginal tax rates, there are fewer reasons for special rates on capital gains. See Capital Gains, Economy and Income Inequality for a few thoughts on capital gains preferential taxes and their effects on Income Equality.
Unwillingness to even discuss the effects of lower tax rates on capital gains, carried interest and other special income on benefits for the wealthy and the resulting increase in income inequality [7], [8]. Explanations that tax rates can't be increased, or that tax expenditures can't be eliminated, in poor economic time are not persuasive.
Belief that an objective for spending is not needed. Just cut the spending! A realistic goal for creating a budget balance seems to be about 18% of GDP, which is the average revenues from 1971 to 2010 according to the CBO. Over that same period, the CBO reports average outlays a of about 21% of GDP. See Appendix C. Additional tax revenue may be required. If a goal is selected that is less than 18%, the spending cuts required to achieve a balanced budget should be stated.
Belief that a balanced budget amendment is the answer to the deficit and debt challenges. This is false for the short term because of the long time for defining and approving an amendment to the Constitution, and the lack of bipartisan consensus on the language. It may be one of the vehicles for addressing the long-term deficit and debt problems.

Perhaps the Congressional Budget Office should be asked to determine the range of effects for items 2 and 3 on jobs, economy and tax revenue. It would also be helpful if the CBO provided an assessment of the effects of deficits and debt — both short- and long-term — on jobs, economy and tax revenue.

General Content of the Tax Reform
A summary of the provisions for consideration include:

Broader tax base with lower marginal tax rates, and extended to include lower-income people so they understand they are part of the system. Use the income ranges that existed in the 1990s as a guide. The proposal by the Debt Commission Co-Chairs, Co-Chairs' Proposal, and the Senate's "Gang of Six" enjoy bipartisan support and can simplify the tax code.
Eliminate the many areas of double taxation by making each income/expense transaction income where received and and expense where paid.
Retain the mortgage interest deduction since elimination would likely result in a shift from other investments on which income is taxed to smaller or no mortgages.
Provide a consistent tax treatment for health-care insurance premiums and other benefits provided by employers as compared to those paid privately.
Eliminate all tax preferences for capital gains, carried interest and other special incomes. Tax all income at the same rates. This should also eliminate the need for an alternative minimum tax.
Eliminate standard deductions and all loopholes, tax preferences, tax credits, and tax expenditures . Justify each exception with implementation only by tax credit which provides the mechanism to quantify the costs of each exception as a tax expense. Do the same for corporation taxes.
Examine the inheritance and estate taxes and the use of trusts to understand what really exists and how the current law creates methods for avoiding taxes. Eliminate all tax avoidance provisions. Require all taxes to be paid based on current value of assets with the basis adjusted for inflation from the time of acquisition. Eliminate all tax forgiveness provisions for unpaid (deferred) taxes. (See The Zuckerberg Tax for an alternate proposal.) Beneficiaries thus would inherent the assets at the current value with no unpaid taxes.
A gradual transition is required for many of the provisions.

Some of the above items are supported by Senator Carl Levin, D-MI, another indicator of some level of bipartisan support. In addition, other tax expenditures he has proposed eliminating include:

These are examples of what should be justified if retained in the tax code.
More detail on the content for tax reform is described in Appendix B.

Politics
While the reason for the major reform of the personal tax code should be to create one that better serves the public interests, it can also create a political advantage for the Republicans with the right provisions.

Democrats have demonstrated that they will not define specific changes in the tax code and spending to address the deficit and debt issues. Examples include:
- The President proposed a budget that was unanimously rejected by the Senate [9], [10].
- The Democrats did not pass any budget and/or appropriation bills when they controlled both the House and the Senate.
- In the current Congress, the Senate has not passed needed appropriation bills, and has refused to consider the appropriation bills approved by the House.

Each of the current criticisms (some may call them demagoguery) should be addressed in the tax reform bill with explanations developed. Some examples are shown below.

Rhetoric	Possible Response and Explanation
"fair share"	The bill creates "fair" taxes as in the Simpson-Bowles recommendation and in the proposal from the Senate's "Gang of Six". Both have bipartisan support.
"wealthy should pay their fair share"	Same as above.
"Warren Buffett pays a lower tax rate than his secretary."	With the elimination of lower rates for capital gains, carried interest and other special incomes and elimination of loopholes and tax preferences, Buffett will pay a higher rate because his income is greater.
"Republicans want benefits for the millionaires and billionaires."	Republicans support fair taxes for all citizens based on bipartisan support of the overall tax reform proposals by Simpson-Bowles and the Senate's "Gang of Six".
"Republicans are not interested in the middle class"	Same as above.
"Republicans refuse to ask "millionaires and billionaires" to pay their fair share."	With the elimination of lower rates for capital gains, carried interest and other special incomes and elimination of loopholes and tax preferences, "millionaires and billionaires" will pay a higher marginal rate.
"Democrats favor a "balanced approach" (meaning more taxes) as the means to address the deficit and debt issues."	The bill creates more revenue by closing loopholes and broadening the tax base as in the Simpson-Bowles recommendation and in the proposal from the Senate's "Gang of Six". Both have bipartisan support.
"rhetoric"	response

The "Possible Responses and Explanations" are dependent upon the content in the tax reform that must be passed by the House. Each tax reform proposal should be tested against the likely and possible "Rhetoric".

Even if the Senate does not pass the tax reforms, House Republicans would have a strong tax platform for re-election if their plan is viewed as fair. Having a bill approved by the House also avoids divisive rhetoric on expiration of the Bush tax cuts.
Other ideas?

Other Posts

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Endnotes

[1] See Lessons of the 1930s: There could be trouble ahead. If a password is required, try a Google search with the search string, ["Lessons of the 1930s: There could be trouble ahead"]. The link from Google may not require a password. Also, search the internet with this subject for additional papers on the subject. Also see Can Contractionary Fiscal Policy Be Expansionary?, Congressional Research Service, June 6, 2011 and Deficit Down; Unemployment Up by Jared Bernstein, Feb 02, 2012. Paul Krugman suggests that austerity measures should not be taken until the economy has recovered. See PAUL KRUGMAN, What Greece Means, New York Times, March 11, 2012 http://www.nytimes.com/2012/03/12/opinion/krugman-what-greece-means.html?_r=1&ref=opinion (accessed 2012 Mar 12).

[2] The House may have the votes from Republicans to pass legislation that contains the jobs, tax, budget, and debt provisions preferred by them, as they did in 2011. However, what was gained? How did the bills passed by the Republican House help the country? Rather, the House Republicans have the opportunity to pass jobs, tax, budget, and debt bills that are easy to explain to constituents, will have appeal to many independents and Democrats, and ensure that the "millionaires and billionaires" pay a higher marginal tax rate than those with lower incomes.

[3] One of the important parts of tax reform is for members of Congress to rescind their Taxpayer Protection Pledge (See Taxpayer Protection Pledge for House of Representatives pledge.) promoted by Grover Norquist because it counterproductive. While one might agree with some of its objectives, the pledge is specific and prescriptive, not general and prescriptive, which needs a different definition. Moreover, the pledge is managed by a private organization and is delivered to that organization, not to his/her constituents. At the bottom of the pledge, it states, "Pledges must be signed, dated, witnessed and returned to: AMERICANS FOR TAX REFORM, 722 12th Street, WASHINGTON, DC 20005". This makes it appear that a pledge to that organization is more important than a commitment to constituents.

[4] The analysis by Dr. Arthur Laffer showed by empirical evidence that reducing very high marginal tax rates (i.e. greater than 60%) did result in increased tax revenue. The three time periods that exhibited this empirical result are during the early 1920s, during the Kennedy administration, and during the Reagan administration. His analysis does not include any such effects for reducing marginal tax rates for rates less than 50%. Any disproportional effect on wealth accumulation for the middle class and those paying the lower marginal tax rates has apparently not be studied. See Extend federal tax cuts for several years for more information and references. Also see Appendix D for a discussion of the use of multipliers developed by the CBO to estimate effects on GDP.

[5] Curtis Dubay, Setting the Tax Record Straight: Clinton Hikes Slowed Growth, Bush Cuts Promoted Recovery, The Heritage Foundation, September 6, 2011. "To be clear: The Bush tax cuts did not pay for themselves. Revenues, on balance, are lower as a result of the Bush tax relief. However, the Bush tax cuts did accelerate the recovery markedly, and they did, and still do, create the possibility of a permanently stronger economy which, in turn, means the net revenue cost of the Bush tax cuts is far less than the traditional static score implies." The recognizes the direct and indirect effects of tax and spending changes on GDP.

[6] Many of the disparities in taxes paid by the wealthy and the those with middle incomes are related to the capital gains. The primary beneficiaries of the preferential capital-gains tax rate are the wealthy. Such disparities create distrust and perceived or actual unfairness in the tax code. Moreover, reduced tax rates for capital gains create the many "tax shelters" that attempt to convert ordinary income to capital gains income. Such tax avoidance activities are not value added for the country. Further, lower capital gains taxes influence executive compensation which can result in very large compensation for executives. With lower marginal tax rates and elimination of double tax on dividends, the effect of elimination of the lower tax rates for capital gains is reduced.

[7] Thomas L. Hungerford, Changes in the Distribution of Income Among Tax Filers Between 1996 and 2006: The Role of Labor Income, Capital Income, and Tax Policy, Congressional Research Service, December 29, 2011 (accessed 2012 Feb 05) at p14. — "Changes in income from capital gains and dividends were the single largest contributor to rising income inequality between 1996 and 2006. Changes in tax policy also made a significant contribution to the increase in income inequality, but even in the absence of tax policy changes income inequality would likely have increased. Although earning inequality increased between 1996 and 2006, changes in wages and salaries appear to have had little effect on the increase in overall income inequality."

[8] Kevin Hassett and Glenn Hubbard, Romney vs. Obama on Corporate Tax Reform, Wall Street Journal, 2012 Mar 14, http://online.wsj.com/article/SB10001424052970203986604577257210244410318.html?mod=WSJ_Opinion_LEADTop (accessed 2012 Mar 14). Note that the op-ed doesn't discuss any effect of their implied tax policy on income inequality. Income inequality is ignored. Their focus is only on the effects of tax policy on business. Mr. Hassett is director of Economic Policy Studies at the American Enterprise Institute. Mr. Hubbard, dean of Columbia Business School, was chairman of the Council of Economic Advisers under President George W. Bush. He is an economic adviser to Mitt Romney.

[9] While the President's budget did provide for some deficit reduction, it was almost exclusively from increased revenues. See An Analysis of the President’s Budgetary Proposals for Fiscal Year 2012, Figure 1-2. at p8.

[10] The President has focused on increasing the tax rate for the "millionaires" and "billionaires". The Economist reports in "Taxing the rich in America" in Jan 21st 2012 print edition that "It would raise revenues of about 0.3% of GDP and do nothing to make America’s grotesquely complicated tax system more efficient. It would be far better to close or limit loopholes and deductions, currently worth up to 7% of GDP, which distort behaviour (by, for example, encouraging people to take out big mortgages) and mostly benefit the affluent."

Appendix A — Other opportunities for Congress in 2012

While this post is concerned only with major reform in the personal income tax code, other opportunities for Congress in 2012 include:

Reform of the business tax code to ensure competitiveness with businesses in other countries.
Pass all appropriations bills, consistent with the budget commitments.
Extend the 2012 payroll tax holiday for 2012 and 2013 with quarterly reductions over 2012 and 2013 to permanently phase out the holiday. The gradual phase-out will not increase the total costs.
Fund the the Social Security Trust Fund for any prior and future payroll tax holidays with appropriate accounting transfers from the general fund to SSTF.
Develop legislative alternatives to address the costs of providing medical and health services.
Enact legislation to eliminate the waste and duplication identified by Senator Colburn, GAO, and others.
Start discussions with members of Congress, governors of the states and others on language for a balanced budget amendment. Build a consensus on the language.
Start negotiations among members of Congress and interested others on an amendment to the Constitution requiring various levels of super-majorities for federal judges including justices of the Supreme Court. Build a consensus on the language. Purpose is to produce focus on judicial qualifications rather than political preferences [A1].
Develop alternative legislation to improve unemployment compensation to help people become qualified for other jobs and to create incentives to find alternate work.
Democratize the rules for both houses of Congress. The rules have changed over time to serve the members of Congress and its leaders rather than the people.
Campaign finance reform to minimize the influence of the wealthy and large corporations/institutions to better serve the people.
Develop legislation for lobbying reform: prohibit contributions and gratuities from lobbyists without exception, no revolving door for prior members of Congress and their staffs, no access to the floor of Congress by prior members of Congress, etc.
Develop alternative legislation to make Social Security permanently solvent. This would result in an annual reduction in the deficit of $6 billion on the long term.
Develop alternative and effective legislation to address waste, abuse and fraud in Medicare and Medicaid. Take advantage of the technologies used by credit card companies to detect fraud.
Establish a policy not to fund production incorporating new and uncompetitive technologies. Rather, enhance the technologies by investing in R&D for making the technologies competitive.
Develop legislative alternatives to address the Patient Protection and Affordable Care Act, and use the alternatives to build consensus with the public.
Develop legislative alternatives to address the Dodd–Frank Wall Street Reform and Consumer Protection Act, and use the alternatives to build consensus with the public. Good, effective laws are required, not the Dodd-Frank Act with its 2000+ pages.

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Appendix Endnotes

[A1] A place to start the discussion is to require approval by 2/3 vote for Justices of the Supreme Court. To obtain such a super-majority, a nominee would have to be well qualified by scholarship and temperament, rather than approval based on judicial activism. Lower super-majorities, such as 60% and 55% for judges of the court of appeals and federal judges, respectively, may be appropriate.

Appendix B — Description of Content for Reform of the Personal Income Taxes

Some of the specific content include:

Broader tax base with lower marginal tax rates, but extended to include lower-income people so they understand they are part of the system. Use the income ranges that existed in the 1990s as a guide.
Eliminate all double taxation. There are many areas involved.
- Dividends and interest should be deductible where paid and income where received. All interest should be deductible. In addition to double taxation, the current income taxes always require declaration of interest income but allow only some interest expense to be deductible. This should be corrected to be neutral regarding loans and investment [B1].
- State and local taxes should be deductible which has the effect of being paid with before-federal-tax income. Otherwise, federal tax would be paid on the income used to pay state and local taxes — double taxation.
Phase out the standard deductions as part of the adjustment in tax rates.
Provide a consistent tax treatment for health-care insurance premiums and other benefits. Currently, the premiums and benefits paid by employers are paid with before-federal-tax income and those paid by individuals are paid with after-federal-tax income. My recommendation is that health-care premiums be paid with after-federal-tax income which would require imputed income for those paid by employers. The result should be lower tax rates.
Eliminate any tax preference for capital gains. Tax all income at the same rates. This should also eliminate the need for an alternative minimum tax.
Eliminate all loopholes, tax preferences, tax credits, and tax expenses. Justify each exception with implementation only by tax credit which provides the mechanism to quantify the costs of each exception. Do same for corporation taxes.
Eliminate the phase-out of the deduction for exemptions which has the effect of increasing the top marginal tax rate, but still allows politicians and others to quote a lesser maximum tax rate than exists in reality.
Examine the inheritance and estate taxes to understand what really exists and how the current law creates methods for avoiding taxes. Require all taxes to be paid based on current value of assets with the basis adjusted for inflation from the time of acquisition. Eliminate all tax forgiveness provisions for unpaid (deferred) taxes. (See The Zuckerberg Tax for an alternate proposal.) Beneficiaries thus would inherent the assets at the current value with no unpaid taxes.
No tax avoidance through use of trusts.
Revise the tax code so that when used to create incentives for preferred activities, the tax expenditures are part of an appropriations bill. If the appropriation is "spent" through reduction in taxes, require that the tax expenditures be applied after calculating the tax due from universal simple tax-code requirements. The tax expenditure would then be in the form of a tax credit. Each tax expenditure would then be itemized to claim the tax credit, which would make the tax-expenditure amounts easier to track and summarize.
Some of these items are in the proposal by the Debt Commission Co-Chairs, Co-Chairs' Proposal, along with others that can simplify the tax code.
A gradual transition (say over 5 years) is required for many of the proposals.

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Appendix Endnotes

[B1] The same should be done for corporations. Both interest and dividends should be expenses for income tax purposes. This requires a similar change to the corporate tax code. This would eliminate the perverse incentive that encourages debt over equity financing for corporations. It would also lower costs for corporations that pay dividends, which should ultimately be reflected as lower prices for products.

Appendix C — Total Revenues and Outlays

From Congressional Budget Office
The Budget and Economic Outlook: Fiscal Years 2011 to 2021 at page 5

Excerpt of Text
"The projected deficits over the latter part of the coming decade are much smaller relative to GDP than is the cur- rent deficit, mostly because, under those assumptions and with a continuing economic expansion, revenues as a share of GDP are projected to rise steadily—from about 15 percent of GDP in 2011 to 21 percent by 2021 (see Summary Figure 1).
As a result, the baseline projections understate the budget deficits that would arise if many policies currently in place were extended, rather than allowed to expire as scheduled under current law. For example, if most of the provisions in the 2010 tax act that were originally enacted in 2001, 2003, and 2009 or that modified estate and gift taxation were extended (rather than allowed to expire on December 31, 2012), and the alternative minimum tax was indexed for inflation, annual revenues would average about 18 percent of GDP through 2021 (which is equal to their 40-year average), rather than the 19.9 percent shown in CBO’s baseline projections. If Medicare’s payment rates for physicians’ services were held constant as well, then deficits from 2012 through 2021 would aver- age about 6 percent of GDP, compared with 3.6 percent in the baseline. By 2021, the budget deficit would be about double the baseline projection, and with cumulative deficits totaling nearly $12 trillion over the 2012– 2021 period, debt held by the public would reach 97 percent of GDP, the highest level since 1946."

Several Observations

The projected trends require much knowledge of the assumptions to correctly interpret the trends shown as the excerpt of the text describes.
Spending was annually reduced during the period from 1991 through 2000.
The surplus in the late 1990s and early 2000s is clearly a special event. The decrease in outlays was the result of reductions in spending advocated by the Republican Congress. Note that the revenues were approximately 21% of GDP — clearly beyond historical trends. Many special economic factors and growth in GDP contributed to the increased revenues.
The growth in spending and the reduction in revenues with the Bush tax cuts in the early 2000s are also obvious.
The increase in revenues in the middle 2000s is sometimes used by Republicans to show that cutting taxes leads to increased revenues. Other factors may also be involved.
The closing of the gap between spending and revenues after 2011 is all forecast and not supported by legislation.

Appendix D — Effect of Fiscal Policy on the Economy, Jobs and Taxes by Use of Multipliers

Another method to estimate the effects of changes in taxes and outlays on the economy, jobs and taxes is through the use of multipliers. The Congressional Budget Office in a 1977 paper, The CBO multipliers project: A methodology for analyzing the effects of alternative economic policies, defines multipliers as:

. . . overall GNP multiplier — the amount of GNP generated per dollar of a spending increase or a tax cut — into a number of key components, . . .

What all is included in the multipliers is not clearly stated, but on its face would include all effects on GDP of the deficit increase (tax decrease or spending increase).
Low and high estimates for the multipliers for various tax cuts and spending increases are provided in "Table 2 — Estimated Output Multipliers and Budgetary Costs of Major Provisions of the American Recovery and Reinvestment Act" in the CBO analysis, Estimated Impact of the American Recovery and Reinvestment Act on Employment and Economic Output as of September 2009, at pp 4-5. The multipliers range from 0.0 for one of the low estimates to 2.5 for another of the high estimates. The table also includes the "Total Budgetary Cost of Provisions, 2009–2019". The analysis does not state whether or not the total cost includes any change in taxes as a result of the increased GDP. Absent any such statement, it appears that it does not.
Others, including Economist Mark Zandi, Table 2: Fiscal Stimulus Bang for the Buck at p9, have used the multiplier concept in their analyses. His multiplier range from 0.30 to 1.73 for the parameters studied. Also see Extend federal tax cuts for several years for more information and references.
The multiplier concept can be used to estimate both the direct and indirect effects of various tax reductions and spending increases to estimate the total effect on the budget deficit or surplus.

[Change in Deficit] = [Direct Effect] - [Indirect Effect] + [Effect of Increased Debt]

where

[Change in Deficit] measures the overall effect on the Deficit;

[Direct Effect] is the cost for the tax reduction or spending increase;

[Indirect Effect] is the tax revenue change related to the change in GDP, which is the change in GDP times the aggregate tax rate related to GDP (typically 18% by history); and

[Effect of Increased Debt].

The result is

[Change in Deficit] = [Cost of Tax Reduction or Spending Increase] - [Change in Revenue as a Result of the Change in GDP] + [Effect of Increased Debt]

Since the [Change in Revenue as a Result of the Change in GDP] is the [Direct Effect] x [the Multiplier], the equation becomes:

[Change in Deficit] = [Cost of Tax Reduction or Spending Increase] x [1 - Multiplier x 18%] + [Effect of Increased Debt]

Several observations from the above equation include:

The factor [1 - Multiplier x 18%] indicates some reduction in the direct effect on the deficit. For example, if the multiplier is 2.0 — a large multiplier based on the CBO analysis — the direct effect is reduced by 36%.

For the indirect effect to equal the direct effect. The [Multiplier] x [the aggregate tax rate related to GDP] must be 1.00. For an aggregate tax rate of 18%, the multiplier must be 5.55. This is more than twice the maximum multiplier in any CBO analysis, and in the analysis by Zandi. However, the CBO has not analyzed the effect of decreasing the top marginal tax rate when that rate is very high, such as 60%. These conditions were those analyzed by Dr. Laffer described in Endnote [4].

Similarly, the effect of the increased debt on jobs, economy and GDP has not been analyzed by CBO. The effect is at least the interest rate on the debt increase. But if confidence in the government is created, the effect can be much larger, as it is for Greece and other European countries with large debt-to-GDP ratios.

The analysis indicates that almost all tax reductions and spending increases create only small increases in GDP. This suggests that other factors such as improving confidence may be the most important.

History:_ Changes are usually identified in the text with the date which facilitates searching by date. Edits are usually noted by add and ~~delete~~ changes.

2012 Mar 11 — Added footnote and link to WSJ op-ed by Hassett and Hubbard.
2012 Feb 07 — Various additions.
2012 Jan 24 — Initial post.

Links: _On the Agenda for Congress: Tax Reform Plus at [http://curntbk.blogspot.com/2012/01/on-agenda-for-congress.html]

A Curmudgeon's Notebook

January 24, 2012

On the Agenda for Congress: Tax Reform Plus

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