TAX REFORM AND THE BUDGET

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1 TAX REFORM AND THE BUDGET Len Burman Daniel Patrick Moynihan Professor of Public Affairs, Maxwell School, Syracuse University OASIS February 9, 2011

2 Part I: About the Budget

3 How did you go bankrupt? Bill asked. Two ways, Mike said. Gradually and then suddenly. Ernest Hemingway, The Sun Also Rises (quoted in Auerbach and Gale, The Economic Crisis and the Fiscal Crisis: 2009 and Beyond ) 3

4 Deficit Projections for Obama Budget, in $billions , % 4.3% 3.8% 4.0% 3.8% 3.4% 3.4% 3.6% 3.8% -1,200-1,400-1, % of GDP 10.0% 9.2% cumulative deficit $8.5 trillion Source: Office of Management and Budget, "Midsession Review: Budget of the United States, Fiscal Year 2011," July 2010.

5 Ratio of Workers to Retirees 5

6 Total Public and Private Spending on Healthcare as Percent of GDP, Source: CBO, 2009, Long-Term Budget Outlook

7 7 Primary Spending as % of GDP, with and without Excess Health Costs,

8 Composition of Nondiscretionary Federal Spending, Percent of GDP Interest Medicare and Medicaid Social Security Source: CBO, The Long-Term Budget Outlook, June 2009.

9 Alternative Projections of Debt Held by the Public, Percent of GDP Alternative 100 Extended Year 9 Source: CBO

10 Alternative Projections of Debt Held by the Public, With GDP response With rate response Percent of GDP Alternative Extended Year 10

11 Federal, State, and Local Non-Interest Spending, as percent of GDP, including GDP Fed, state, and local 30 Federal (excluding Source: CBO, 2009, Long-Term Budget Options; GAO, 2008, "STATE AND LOCAL GOVERNMENTS: Growing Fiscal Challenges will Emerge during the Next 10 Years," GAO-

12 12 Major Foreign Holders of US Debt, in $billions, July China, Mainland Japan United Kingdom Carib Bnkng Ctrs Oil Exporters Brazil Russia Hong Kong Other countries Total = $3.4 trillion, of which about ¼ is T-bills. Source: US Treasury, Major Foreign Holders of Treasury Securities,

13 13 Distribution of Defaults or Restructurings by Debt Level, Middle-Income Countries, External Debt/GNP at end of first year of default or restructuring < > Source: Reinhart and Rogoff (2009), p. 24. % of total defaults or restructurings

14 Debt as Percent of GDP in OECD Countries, Source: OECD Stat.Extracts.

15 Figure 7. Debt Held by Public, by Maturity in Years, as of October , Debt Due in Year, in $Billions 2,500 2,000 1,500 1, Years Until Due Source: US Treasury, Monthly Statement of the Public Debt (MSPD), October 2009,

16 16 Part II. About our Tax System Graphic borrowed from Taxing Ourselves: A Citizen s Guide to Tax Reform, by Joel Slemrod and Jon Bakija.

17 Federal Revenues by Source as a Percentage of GDP, Estate tax and other Excise taxes Corporateincome tax Payroll tax Individual income tax Source: Office of Management and Budget, Budget of the US Government FY 2011, Historical Tables, Table 2.3; are projections.

18 State and Local Taxes by Source as Percentage of GDP Corporate income Personal income Sales Property Source: NIPA Table 3.2 and 1.1.5, accessed 2/4/11.

19 Federal, State, and Local Taxes as Percentage of GDP State and Local Tax Federal Tax Source: NIPA Tables 3.2, 3.3, and 1.1.5, accessed 2/4/11.

20 60 Tax as Percent of GDP, OECD Countries, Source: OECD, 2009, Revenue Statistics

21 Income Tax Rates Required to Cut Deficit to 2% of GDP in 2019, Administration Baseline Current Tax Raise All Raise Top Raise Top Rates Rates Three Rates Two Rates Source: Altshuler, Lim, and Williams, 2010, Desperately Seeking Revenue, Tax Policy Center.

22 Tax Expenditures Compared to Other Spending, FY 2011 Income Tax Expenditure Mandatory Discretionary Defense Nondefense $ Billions 1,177 2,165 1, Percent % of GDP

23 Tax Expenditures Compared to Other Taxes, FY 2011 Income Tax Expenditures Net Individual Income Tax Corporate Income Tax Payroll Tax Other $ Billions 1,177 1, Percent % of GDP

24 100 Shares of Non-Interest Spending FY Non Defense Discretionary 80 Defense Mandatory 20 Tax Expenditures 0 Source: GAO (via Lori Metcalf), FY 11 Budget, and authors' calculations.

25 18 Consumption Tax as Percentage of GDP, OECD Countries, OECD Average

26 26 Who Doesn t Pay Income Tax? Source:

27 27 Income Share of Top 1 Percent, % 25% 20% 15% 10% 5% 0% Source: Thomas Picketty and Emmanuel Saez, "Income Inequality in the United States, ," Quarterly Journal of Economics, 118(1), 2003, Updated data at

28 Tax Policy Center 28 Top Tax Rate on Individual Income, % 90% 80% 70% 60% 50% 40% 30% 20% 10% 0%

29 29

30 Effective Federal Tax Rates by Economic Income Class, Average = Percent Lowest Quintile Second Quintile Middle Quintile Fourth Quintile Top Quintile Top 10 Percent Top 5 Percent Top 1 Percent Top 0.5 Percent Top 0.1 Percent Income Class Source: Estate Corporate Payroll Individual Income

31 What is the AMT? 31

32 Part III. A Reform Plan 32

33 33

34 Overview of Tax Reform Debt reduction sales tax (VAT) at 7% Cut top individual and corporate income tax rates to 27% Return-free 15% PIT for most taxpayers Fully refundable child tax credit and payroll tax credit replace personal exemption, standard deduction, child-related credits (including EITC) 15% withholding on wage&salaries, dividends, interest Nonfilers could receive credits through employers or via smart card

35 Eliminate most tax expenditures, simplify others Mortgage interest, IRA, and charity deductions replaced with 15% refundable credit, payable directly to institutions Like UK gift aid Eliminate state and local tax deduction Replace education tax subsidies with expanded Pell grants and subsidized student loans

36 Restoring America s Future: Breakdown of Budget Savings 200% % of GDP 150% 100% Debt Service Savings Other Spending Healthcare Social Security Savings 50% New 0%

37 Revenue Breakdown 5% % of GDP 4% 3% 2% Net New Revenues Eliminate or restructure most tax Other Tax Debt Reductio n Sales Tax 1% Restructure Itemized Deductions 0% Employer Health Benefit Corporate Tax Rate Cut -1% Income Tax -2%

CBO s January Baseline Sets the Stage. CRFB.org

CBO s January Baseline Sets the Stage 1 Trillion-Dollar Deficits Are Returning $1,600 Billions $1,400 $1,200 $1,000 $800 Deficits Increased Almost 800% Deficits Fell 69% Deficits Triple to Nearly $1.4