April 15 is stamped in the minds of most Americans as tax day. Many see filing with the Internal Revenue Service as inefficient, inevitable, and sometimes inequitable. Brookings Senior Fellow William Gale, co-director of the Urban-Brookings Tax Policy Center, has often touted simplifying taxes and improving tax administration. Now that health care reform has been completed, will President Obama tackle tax policy?
To discuss problems with U.S. tax policy and proposals for reform, William Gale took your questions in a live web chat moderated by POLITICO Senior Editor David Mark. The transcript of this chat follows.
12:31 David Mark: Good afternoon. Post office lines should be long tonight with folks sending in taxes before the midnight deadline - for those who didn't file electronically. Bill Gale of Brookings joins us to discuss tax policy. Welcome, Bill.
12:31 William Gale: Thanks. I am pleased to be here to discuss these issues. There are some very good questions and I will get to them right away.
12:31 [Comment From Jon Adams: ] Today at the New York Times' Economix blog, Casey Mulligan described the upside of income tax complexity - that it encourages outrage among taxpayers, restraining government growth. Recognizing that this is clearly normative analysis, I would still like to know how you think the benefit (if any) from income tax complexity weighs against the costs.
12:33 William Gale: I think we have enough problems without making the tax system unnecessarily complicated.
12:33 [Comment From Fred: ] What do you think of the tax reform plan created by Senators Wyden and Gregg?
12:34 William Gale: Wyden and Gregg have offered a serious plan that has two key features -- it is bi-partisan and it is a reform plan, not just another tax cut. We can't afford more long-term tax cuts right now. Indeed, even if Wyden-Gregg passes we will need to consider new tax revenues, because W-G is revenue neutral.
12:35 [Comment From Jessica Rettig: ] What would the implementation of a value-added tax plan do? Do you see a future for it in the United States?
12:38 William Gale: Right now, a VAT has no political legs. The Republicans want no new taxes at all, the Democrats want no new taxes for households in the bottom 95% of the income distribution. Neither of those positions takes seriously the fiscal problem the country faces. There are only two ways to solve that fiscal problem -- cut spending or raise revenues. If you look at spending, 70% of federal spending (rising to 80% by the end of the decade) will be on one of five things -- defense, net interest, social security, Medicare and Medicaid. It is unlikely we are going to cut those by much if at all. We can't cut net interest unilaterally. Defense will remain high with Afghanistan and Iraq. SS is not on the table, and we just reformed Medicare and Medicaid. The remaining 20-30% of federal spending could be cut but even if we cut it by a massive 20% it would only reduce the deficit by 1% of GDP and that would still leave deficits of 5% or more throughout the decade. So, we will have to look at tax increases and when you do, the VAT is "where the money is." So, I think sooner or later, a VAT will be in our future.
12:38 [Comment From David: ] Do you think we need to raise taxes?
12:39 William Gale: We should not raise taxes that people pay right now, because we are still in the beginning phase of a recovery and the economy needs all of the support it can get. In the near future, though -- say, the next 3-5 years-- we are going to face the prospect of either big deficits or the need to raise taxes. See previous answer. This does not have to be catastrophic. Taxes can be raised slowly and placed on consumption. But I think it will be necessary because I don't see any way that the necessary spending cuts will take place.
12:40 [Comment From Pamela: ] Do you happen to know what percentage of AMericans pay income taxes?
12:43 William Gale: There is a number floating around (developed by the Tax Policy Center, by the way :)), that 47% of households face no net income tax liability in a given year. That number is technically correct but it needs to be understood. First, there is nothing illegal going on. Second, almost all of these households are low-income or moderate-income, including many for example who are poor and elderly. I don't think people really ought to get upset about such people not paying income taxes. Third, the main reason households don't pay income tax is either that (a) their income is not very high or (b) they are using incentives -- to work more, to save, to obtain child care (so they can work) or they are getting benefits (like for having kids) that command widespread public support and that Congress put in place precisely so that people would use them. The 47% figure has created an enormous outcry and I think has been made controversial in ways that have been inappropriate and unfortunate.
12:43 [Comment From Nicole Duarte: ] Have there been any whispers about when this administration might take up tax reform? This year? This term? Next term, assuming there is one?
12:45 William Gale: I would not hold my breath on this. The best bet is that the fiscal commission comes up with some plan that politicians can get behind. But, as I noted above, both parties currently have tax positions that I would describe as delusional. There is little public education on the issue -- people seem outraged at the idea that taxes might have to go up and equally outraged at the idea that their spending benefits might have to go down, but something has to give.
12:45 [Comment From Liana: ] When was the last time our country did a tax overhaul and what did that overhaul accomplish?
12:46 William Gale: 1986. It broadened the tax base (tax-geek-ese for removing a lot of deductions), and then used the revenue that was generated by that to reduce income tax rates and take a significant number of people off the tax rolls.
12:46 [Comment From Wes: ] Do you think there were any missed opportunities in terms of simplifying taxes with the passage of the health care bill?
12:48 William Gale: Not so much in simplifying taxes but in getting the right financing. The right way to finance health care would have been to curtail the employer deduction for health insurance -- convert it to an individual refundable credit. That would be less expensive, less regressive than the current system, and would give people more incentive to pay attention to medical costs and procedures. Instead, they used a number of taxes that (a) are gimmicky and (b) will be used to finance new health benefits and hence can't now be used for deficit reduction
12:49 [Comment From Tim: ] What specifically about the tax system could be simplified?
12:51 William Gale: Where do we start :)? There are a number of specific areas -- family credits, education, retirement saving, etc. -- that could be simplified and consolidated. We could eliminate the AMT and move whatever features were needed into the regular tax. A favorite suggestion of mine (talked about at a Taxpolicycenter.org conference on April 8) is have the IRS fill out as much of the tax form as possible for you and send it to you as a draft. Taxing capital gains at the same rate as ordinary income would also make a huge difference for simplicity. And on and on. There are a number of good government publications on this (JCT, GAO) and a lot of stuff on the TPC website, too.
12:51 [Comment From Andrew (Falls Church): ] What can you say about the usefulness of the AMT?
12:52 William Gale: Not much. I think the presence of a second income tax is essentially an acknowledgement of the failure of the first. If there are parts of the AMT that we think are good tax policy we should just introduce them into the income tax and get rid of the AMT. The AMT is also artificially making our budget picture look better than it really is because the budget projections that CBO does include the AMT under current law, but under current law the AMT would grow to cover tens of millions of households and no one expects that to happen.
12:53 [Comment From Dan Barrett: ] Instead of maintaining multiple tax collection tools (i.e. having income taxes, payroll taxes, SS taxes, possible VAT, etc.), what would a unified tax collection system look like?
12:56 William Gale: That's an interesting question. It probably does make sense to have multiple collection tools, since taxes that are only collected in one place (like retail sales taxes) are historically easy to avoid. But still the tax system could be much more unified and integrated. We tax some forms of labor income twice, some once, some not at all, ditto for capital income, we tax some things that aren't income, and the tax system is laden with loopholes (which are, essentially, created from different parts of the system that are not well-integrated). A unified system would tax as much income (and/or consumption) as possible at the lowest rates possible, given a desire for progressivity and would do as little as possible to discriminate against different types of income or consumption, except where there are social benefits that are favorable (eg, charity) or unfavorable (eg, pollution).
12:56 [Comment From Derek: ] Can you explain what kind of a role tax reform might play in closing the deficit?
12:58 William Gale: We need better taxes (taxes that are fairer, simpler, more conducive to economic activity) -- that's the "tax reform" part. We also need more revenues -- that's the closing the deficit part. Traditionally, these two issues have been addressed separately, but we don't really have that luxury right now. We need to both improve the income tax -- reduce deductions, etc. -- and create new tax instruments -- presumably a VAT, but also possibly or instead a carbon tax or cap and trade system.
12:59 [Comment From Susan: ] Could we achieve any of our climate change goals by changing the tax system?
1:01 William Gale: Climate change IS A TAX ISSUE. If ever there were a case for a tax on a commodity, it applies to carbon emission, which creates general costs that are not borne (exclusively) by the emitter. But we need to be careful how we go forward. We need world-wide action on this, not just US action, since strong unilateral US action would be offset to some extent by a relocation of carbon emitting activities offshore. (And to be clear, a carbon tax and a cap and trade system would have equivalent effects. I would prefer a tax but I would take a well-functioning version of either system, with international coordination.)
1:01 [Comment From Nicole Duarte: ] Many people have said that tax reform won't become a political priority until politicians' and citizens' hands are tied. Between the deficit and the economy, I see a lot of people tied. Why hasn't the political will materialized?
1:06 William Gale: Good question (Don't get me wrong, they've all been good, this one just touches a nerve for me). The problem is precisely what you say at the beginning -- people's hand are not tied yet. Politicians can always wait one more day, month, year....until there is a crisis. I have grown increasingly pessimistic about whether Congress will do anything on their own, in the absence of external pressure, and I am almost as pessimistic about whether the fiscal commission can come up with proposals that would be acceptable -- this is not a shortcoming of the commission, it is a reflection of the delusional nature of what political leaders are saying. I think not much is going to happen until or unless there is a real crisis. I don't know what that would be -- but I could imagine scenarios where the Chinese or other international groups decide to back out of some of their dollar holdings. I am aware of all of the reasons people say that this wouldn't be likely to happen. I think it will take some extremal "push" for Congress to move ahead. Also, by the way, the level of public education on this is very weak. It is sort of a chicken and egg thing -- the public doesn't push politicians to take strong stands because the public is not aware of the problem and the politicians don't tell them about it (instead they promise tax cuts) because they don't want to be vilified. We need a modern-day Ross Perot.
1:07 [Comment From Dave: ] How do taxes figure into the long-term sustainability of our economy?
1:08 William Gale: If the government is not on a sound fiscal path it will undermine any private sector efforts to invest, work, etc. So, taxes need to be aligned with spending priorities in the long-term. Whether we get there by cutting spending (a lot), raising taxes (a lot) or some combination is a key question.
1:09 [Comment From Susan: ] Are there any tax messages in Palin's tea parties that should be heeded?
1:10 William Gale: That is a very interesting question. It is ironic if not bizarre that the TEA party got going during a time when federal taxes were at their LOWEST in about 60 years. So, I am not seeing that people are taxed too much right now. I think the message that government should not take its power to tax lightly is always appropriate. But I don't see any sort of recognition in the TEA party statements that if we don't want to raise taxes we will need to cut spending by enormous amounts and where they are willing to cut spending.
1:10 [Comment From Nadia: ] Our government needs money. How can the administration justify the prolonging of Bush's tax cuts? Is there a way we can increase revenue while cutting taxes? This seems totally counterintuitive.
1:14 William Gale: This is a big sore point in many circles. Obama campaigned against Bush, called his tax cuts unfair and expensive and regressive, and now wants to extend most of them (not all, he does want to let the tax cuts at the top end expire). The leader of the argument you are making is Diane Lim Rogers, who blogs at economistmom.com and who speaks very eloquently and forcefully on this (and many other) topics. The Administration is saying that it wants fiscal responsibility, it wants PAYGO rules, etc., but only AFTER it lets $3.7 trillion of tax cuts out the door in the next 10 years. This is far bigger than the gross cost of the health care bill just passed, by the way. And, just to top it off, even if the administration did want to pursue the tax cuts (the dollar amounts) in the Bush tax cuts, why wouldn't they put in their own tax changes, rather than continue the Bush proposals? Not only does the administration want to extend the tax cuts, they want to do so without paying for it.
1:15 [Comment From Collin: ] How do American tax rates compare to those in other nations? Do we get fewer services (in health care and education) because we pay lower taxes?
1:17 William Gale: While it is not easy to generalize, our burden is lower than in almost all other industrialized countries. In exchange, we receive fewer services, particularly in regard to public health care. Our income tax rates are also lower than in most countries, however our statutory corporate tax rate is higher than in almost all countries and could be reduced in a package that broadened the corporate tax base and reduced the rate.
1:17 [Comment From allen: ] What happened to the Obama Administration's proposals last summer regarding taxes on foreign earnings and offshore subsidiaries?
1:17 William Gale: Still dead.
1:17 [Comment From Mark: ] Can you talk a little about Obama's decision to use tax credits as a main feature of the stimulus? Was this a good choice?
1:20 William Gale: Sure. The main thing to remember was that the economy was on the edge of a potentially disastrous downturn. So, we needed a stimulus package that was sustained (because the downturn and recovery were going to take awhile), that was large (because the downturn was large) and that was diversified (because we really aren't sure what works best). Tax credits were part of that whole package. I can't say they were the most effective part or least effective part, but what should be emphasized was the need to move rapidly on a number of fronts and tax credits were part of the solution.
1:20 [Comment From Mike: ] You mentioned before that we need a VAT or a carbon tax (or maybe both) to close the deficit. wouldn't just increasing taxes across the board help accomplish this?
1:22 William Gale: It works in the right direction, yes. I was writing maybe a little too quickly though. We need to raise probably 3-5% of GDP or more in revenues, in addition to the "normal" level of 18-20% (we are way below the normal level right now because the economy and recent legislation). Even that 3-5% increase would require significant spending cuts to keep the deficit on a sustainable path. We can get some more money from reform of the income tax, but we can't get as much as will be needed. So, we will need to look for other sources -- and VAT and carbon tax are the obvious candidates.
1:23 [Comment From Troy: ] Is tax evasion a big problem in the US?
1:25 William Gale: The extent to which tax evasion occurs depends very much on how income is reported and taxes are withheld. For wage income, which is reported by firms to the government and on which taxes are withheld, evasion rates are very low -- less than 1%. For income that is not reported to the government separately -- like small businesses, capital gains, or tips -- evasion rates are much higher -- on the order of 20-40%. This is one reason why almost all tax experts feel that a value added tax is strongly superior to a retail sales tax -- in the latter case, there is no third party reporting of taxes to the government, so evasion could well run rampant. The VAT does not have this problem.
1:26 David Mark: Thanks for the chat folks. Get look getting your taxes in.