TAX REFORM AND THE BUDGET

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

Part I: About the Budget

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

Deficit Projections for Obama Budget, in $billions 0 4-200 -400-600 -800-1,000 5.6% 4.3% 3.8% 4.0% 3.8% 3.4% 3.4% 3.6% 3.8% -1,200-1,400-1,600 9.9% of GDP 10.0% 9.2% 2011-20 cumulative deficit $8.5 trillion 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Source: Office of Management and Budget, "Midsession Review: Budget of the United States, Fiscal Year 2011," July 2010.

Ratio of Workers to Retirees 5

Total Public and Private Spending on Healthcare as Percent of GDP, 1980-2080 50 45 40 35 30 25 20 15 10 5 0 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050 2055 2060 2065 2070 2075 2080 Source: CBO, 2009, Long-Term Budget Outlook

7 Primary Spending as % of GDP, with and without Excess Health Costs, 2062-2080

Composition of Nondiscretionary Federal Spending, 1962-2083 8 70 Percent of GDP 60 50 40 30 Interest 20 10 0 Medicare and Medicaid Social Security Source: CBO, The Long-Term Budget Outlook, June 2009.

Alternative Projections of Debt Held by the Public, 1962-2080 800 700 600 Percent of GDP 500 400 300 200 Alternative 100 Extended 0 1960 1980 2000 2020 2040 2060 2080 Year 9 Source: CBO

Alternative Projections of Debt Held by the Public, 1962-2080 800 700 600 With GDP response With rate response Percent of GDP 500 400 300 200 100 Alternative Extended 0 1960 1980 2000 2020 2040 2060 2080 Year 10

Federal, State, and Local Non-Interest Spending, as percent of GDP, 1980-2050 60 including GDP 50 40 Fed, state, and local 30 Federal (excluding 20 10 0 1980 1990 2000 2010 2020 2030 2040 2050 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 Major Foreign Holders of US Debt, in $billions, July 2009 929.4 115.3 118.0 138.1 800.5 724.5 China, Mainland Japan United Kingdom Carib Bnkng Ctrs Oil Exporters Brazil Russia Hong Kong Other countries 189.2 193.2 220.0 Total = $3.4 trillion, of which about ¼ is T-bills. Source: US Treasury, Major Foreign Holders of Treasury Securities, http://www.treas.gov/tic/mfh.txt

13 Distribution of Defaults or Restructurings by Debt Level, Middle-Income Countries, 1970-2008 External Debt/GNP at end of first year of default or restructuring < 40 19.4 41-60 32.3 61-80 16.1 81-100 16.1 > 100 16.1 Source: Reinhart and Rogoff (2009), p. 24. % of total defaults or restructurings

Debt as Percent of GDP in OECD Countries, 2008 14 180 160 140 120 100 80 60 40 20 0 Source: OECD Stat.Extracts. http://stats.oecd.org/index.aspx?datasetcode=gov_debt

Figure 7. Debt Held by Public, by Maturity in Years, as of October 2009 3,000 15 Debt Due in Year, in $Billions 2,500 2,000 1,500 1,000 500 0 1 2 3 4 5 6 7 8 9 101112131415161718192021222324252627282930 Years Until Due Source: US Treasury, Monthly Statement of the Public Debt (MSPD), October 2009,

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.

25 20 15 10 5 0 17 Federal Revenues by Source as a Percentage of GDP, 1934-2015 1934 1936 1938 1940 1942 1944 1946 1948 1950 1952 1954 1956 1958 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 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; 2010 2014 are projections.

12 10 8 6 4 2 0 18 State and Local Taxes by Source as Percentage of GDP 2005 1929 1931 1933 1935 1937 1939 1941 1943 1945 1947 1949 1951 1953 1955 1957 1959 1961 1963 1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2007 2009 Corporate income Personal income Sales Property Source: NIPA Table 3.2 and 1.1.5, accessed 2/4/11.

Federal, State, and Local Taxes as Percentage of GDP 35 30 25 20 15 10 5 0 19 1995 1929 1931 1933 1935 1937 1939 1941 1943 1945 1947 1949 1951 1953 1955 1957 1959 1961 1963 1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1997 1999 2001 2003 2005 2007 2009 State and Local Tax Federal Tax Source: NIPA Tables 3.2, 3.3, and 1.1.5, accessed 2/4/11.

60 Tax as Percent of GDP, OECD Countries, 2007 50 40 30 20 10 0 Source: OECD, 2009, Revenue Statistics

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 10.0 14.9 10.0 10.0 15.0 22.3 15.0 15.0 25.0 37.2 25.0 25.0 28.0 41.7 60.8 28.0 33.0 49.1 71.7 85.7 35.0 52.1 76.1 90.9 Source: Altshuler, Lim, and Williams, 2010, Desperately Seeking Revenue, Tax Policy Center.

Tax Expenditures Compared to Other Spending, FY 2011 Income Tax Expenditure Mandatory Discretionary Defense Nondefense $ Billions 1,177 2,165 1,415 744 671 Percent 24.7 45.5 29.7 15.6 14.1 % of GDP 7.6 14.0 9.1 4.8 4.3

Tax Expenditures Compared to Other Taxes, FY 2011 Income Tax Expenditures Net Individual Income Tax Corporate Income Tax Payroll Tax Other $ Billions 1,177 1,121 297 935 214 Percent 31.4 29.9 7.9 25.0 5.7 % of GDP 7.6 7.2 1.9 6.0 1.4

100 Shares of Non-Interest Spending FY 1982-2015 Non Defense Discretionary 80 Defense 60 40 Mandatory 20 Tax Expenditures 0 Source: GAO (via Lori Metcalf), FY 11 Budget, and authors' calculations.

18 Consumption Tax as Percentage of GDP, OECD Countries, 2007 16 14 12 10 OECD Average 8 6 4 2 0

26 Who Doesn t Pay Income Tax? Source: http://www.taxpolicycenter.org/taxtopics/federal-taxes-households.cfm

27 Income Share of Top 1 Percent,1913-2008 30% 25% 20% 15% 10% 5% 0% 1913 1916 1919 1922 1925 1928 1931 1934 1937 1940 1943 1946 1949 1952 1955 1958 1961 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 Source: Thomas Picketty and Emmanuel Saez, "Income Inequality in the United States, 1913-1998," Quarterly Journal of Economics, 118(1), 2003, 1-39. Updated data at http://elsa.berkeley.edu/~saez/tabfig2008.xls.

Tax Policy Center www.taxpolicycenter.org 28 Top Tax Rate on Individual Income, 1913 2006 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 1913 1919 1925 1931 1937 1943 1949 1955 1961 1967 1973 1979 1985 1991 1997 2003

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Effective Federal Tax Rates by Economic Income Class, 2006 30 25 20 Average = 18.7 15 10 5 0-5 -10 30 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: http://www.taxpolicycenter.org/t06-0306 Estate Corporate Payroll Individual Income

What is the AMT? 31

Part III. A Reform Plan 32

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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

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

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% 2012 2016 2020 2024 2028 2032 2036 2040

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% 2012 2016 2020 2024 2028 2032 2036 2040