Transcript
W. Gale: [In progress] — flurry of interest relating to filing deadline, there?s also relative outrageous claims tossed out about taxes in the press, or among people that try to get the press to make outrageous claims. Proposals get passed in about August and then in the fall everyone takes a break and tries out their new crazy ideas for the next year.
So this year we had the President making a series of tax proposals in January, Republicans proposing the across the board income tax cuts, a different group of Republicans proposing targeted tax cuts. Now we?re into the April phase, and I guess taxes aren?t quite as white hot this year as they were in busiest years, but they?re still pretty close to the top of the domestic agenda. So, we at Brookings thought it would be useful to bring together a panel to do a couple of things. One is to take stock at a current debate and what are the economic merits of some of the proposals. We?re all economists here, but that also won?t stop us from making comments about the political likelihood of some of their proposals as well.
A second issue, I think one where we can provide sort of a significant amount of value added relative to other forums, is to discuss some background issues that help set the stage. If we want to make taxes simpler, it helps to understand why taxes are complex in the first place. If we want to eliminate the marriage penalty, it helps to understand why we have a marriage penalty in the first place. If we want to justify tax cuts on the grounds that people are over taxed or that the surplus merits a tax cut. It pays to look behind the numbers and the claims, and try to understand the justification. So I think probably, that?s where we will provide you with the most information. We?re not really structured as a debate, although, we?re likely to get some different viewpoints up here. But, I guess our goal here is to help you help the American people raise the level of debate on tax policy. And I was going to read you the most recent correspondence I got on tax policy from the American people, hand scrawled, no return address, something about a bastard in Washington, but I couldn?t, I left it upstairs, so. But, anyway let?s suffice it to say that —
Participant: You, or —
W. Gale: No, I didn?t write to myself, so —
[Laughter]
Participant: No, I mean were you supposedly the —
W. Gale: It was my evil twin, yea. Anyway, suffice it to say, there?s plenty of room to raise the level of debate on tax policy.
My name is Bill Gale. I?m a senior fellow here at Brookings. I?m pleased to have on the panel two friends and co-authors, and two very good economists. For some reason on my left, Kevin Hassett from AEI, formerly of Columbia — the only time you?ll ever see Kevin on my left — and Eric Engen from the Federal Reserve Board, formerly from UCLA, on my right. Let me emphasis a couple of points. First we?re on the record, second, with regard to Eric in particular, Eric is not here to state Federal Reserve Board policy, he?s not here on behalf of Alan Greenspan, and no questions to him should start, "what does Alan Greenspan think about — blah?" He?s here as an economist representing his own views.
We thought that what we?d do is just each of us talk for 10 or 15 minutes on various aspects of the current situation, highlighting some points that we thought were important, and then just open the floor up for questions or discussion. Probably before we do that, since there aren?t many people it would be useful to us, and maybe for you to just sort of know who?s here. And so, if we could go around and introduce who you are and where you?re from, that would be helpful. Why don?t we start over here?
[Off mic]
Kevin, why don?t we start? You want the overheads?
K. Hassett: Yea, I'll tell you when to — and is this the microphone?
[Cross talk]
I'll stay seated. I think one of the reasons that Bill is — likes me as a conservative, an economist that Bill is going to invite to Brookings, is that I'm a particularly politically ineffective conservative. So I believe strongly that we should move toward something like flat tax, but I don't think that we should base the arguments on such a movement on sort of stupid claims. I want to base it on the facts.
And my objective today is to sort of talk about what I think is going on right now in the tax debate, to try to present something of what — my views of the Republicans are saying and talk about the things that they're saying that I agree with. And I think that sound economics can back up in the things that they're saying that I disagree with. And so, in some sense, I'll be taking points during my short presentation, the Republicans to task. I won't really be talking about the Democrats too much. And it will be clear why in a moment, because I sort of will view the Democrats in my talk as the protectors of the status quo. And that's a gross simplification, but if you want to sort of put the tax debate in context, it's probably not a ridiculous one.
And so, why is it that Republicans think that we should have a tax cut right now, or tax reform and this is my first slide. This is a slide that you'll see many of them. They might not show you the slide. Let's make it so that the end is on the — because that?s the most interesting part. This is the —
Participant: [Off mic]
[Laughter]
This is the proportion of federal budget receipts to GDP for the period beginning in 1965. And right now, federal budget receipts are about, actually a little higher than this latest date, probably around 21 percent of GDP, higher than they've ever been. And so, people point to this and they say, "Well gees, that's big government. We've got big tax receipts, and so therefore, you know, if we can't have a tax cut now, then we are we ever going to have a tax cut?"
Let's go to the next slide. Another thing that folks will point to is a ratio of non-defense outlays, this includes Social Security and transfer payments and so on to GDP, and you'll see that those are also pretty high compared to historical experiences. If you look at just government outlays, federal government outlays, it doesn't look quite so striking, which is perhaps one reason why people don't show that graph, and the reason it doesn?t look quite so striking is that defense spending has been going down relative to GDP. It?s sort of a peace dividend. And so, the big government arguments would point to these two things and say that we need to do something about it. We need to have a tax reform that reduces tax rates and constrains this big government that?s eating, you know, more than 16 percent of every dollar that we — let?s go to the next slide.
Of course, the problem with that is that the shared — now I'm not doing it relative to GDP, I'm doing it relative to federal expenditures — the share of transfers in federal outlays has been going up and up and up and up. And so, if you think of sort of pork as being discretionary spending that?s not transfer related, then pork actually hasn?t been booming. The reason that government shared GDP is so high is that the transfer payments are so high and — don?t go quite to the next slide yet. And so this really shows the sort of tricky economics of the situation we have right now. We?re taking in a lot of revenue and we?re spending a lot. But the lion share of the spending is going to transfer programs that are growing rapidly and that are forecast to grow at unbelievable rates over the next 30 years.
Eric?s going to talk more about the nuts and bolts of these issues in his presentation, but the bottom line of it is that, while the share of receipts and government spending look pretty darned high right now, and indeed are high, that until we figure out what to do about these transfer payments, it?s not really honest to say that we?re in a surplus situation. The only reason that there?s a very obvious surplus right now is that people are sort of stealing money from Social Security trust funds and calling it surplus. You know, I find that profoundly dishonest. It?s a game the Republicans and Democrats play, because you know, if you claim that you have a Social Security trust fund, then in some sense you're trying to maintain the fiction that the money is going someplace and you're leaving it alone. And if at the same time, you're then going to take that money and use it to claim that you have a surplus, then you're just being dishonest. And the President plays that game, and I think virtually every politician in town plays that game.
So, that said, I think that you couldn?t really base an argument for tax reform on the surplus without also having a solution to this transfer payment surge. And so, it?s just not logically consistent, really. And so, what would an argument be for having a tax reform right now? And I think this is something that Bill and I would agree on.
Well, the argument should be — I'll tell you in just a second. You can put it up so they can look at it while I'm talking.
The current system that we have is profoundly crazy and something needs to be done. This is a chart that we've put together of the marginal tax rate schedule under the 97 Taxpayer Relief — which is kind of a misnomer — Act, and the line that's not full is this set of statutory rates as you go up by income. So the statutory rate for somebody making about $100,000 is just 28 percent.
The dark line is the set of marginal tax rates that we have in the current system because of all of the credits and scholarships and IRAs and everything else that are all phased out in the range between about $60,000 and $120,000. And those phase-outs effectively increase the marginal tax rates.
Now Bill and I often disagree about tax policy. I think that we should have a flat tax. I think that we get just about any degree of progressivity you want with the flat tax by increasing exemption and Bill sort of likes having marginal rates go up.
So, I think Bill, who can speak for himself, doesn't think that the pattern of statutory rates is so crazy. I would prefer to see a flatter one, but neither one of us thinks that a system like this bold line is a logical or a sensible system.
So, you have to ask yourself, well, how did we get to this crazy — Diana Furst [sp], Scott, Rob and I called this in an article in the Weekly Standard — a skyline tax. Some people say you should have a flat tax. Some people say you should have a progressive tax, but nobody says you should have a skyline tax, but that's what we have.
So, how did we get to the point where we have a skyline tax? And I think that the marginal rates — before I answer that question — the marginal rates, in fact, understate the problem. Right now, the internal revenue code has a little more than 1.3 million words.
Okay, so we have this code that's just going crazy, and here the marginal tax rates in the tax code are going crazy too, but this complexity spreads, you know, far beyond marginal rates — the thing that hit closest to home.
You know, I'm certainly not a millionaire. I don't have diverse assets or anything like that, but my tax return this year was 33 pages, 33 pages counting, you know, the addenda that you have to put to prove that you, you know, paid for day care expenses and things like that — 33 pages! So, you've got this system that's spinning out of control, in terms of complexity what it asks of its taxpayers, and indeed, the marginal rates that it makes them pay.
So, why is it doing that? I think that the reason that the tax system is spinning out of control — well, there are really two reasons. The first reason is that the spending caps that we put on discretionary spending make it so that politicians have to make difficult choices if they have a program that they want to put on the spending side.
So, suppose that you wanted to, rather than give people a tax credit for education expenditures, you wanted to just sort of expand some program that subsidizes student loans on the spending side. Why not do the former, instead of making everybody who doesn?t take the education credit fill out that part of their form too? Why do you have to keep adding it to the tax? Well, the reason is that on the discretionary side they have spending caps. And politicians being what they are, they tend to operate close to the spending caps, right? I mean if I get a spending cap, I might spend less, but we can?t count on our politicians to do that. And so, because of the spending caps, if they?re going to do something like have a favorite program, a Hope Scholarship Program, and put it on the discretionary spending side, then they got to find something else to cut.
And the problem is that the thing that they?re going to cut is going to be some highway in West Virginia or some other thing that some other politician cares religiously about. And the whole sort of pork trading system makes it so that it?s very difficult on the spending side to get a program. On the tax side to have [Inaudible] rules that make it so that indeed they also have to find some way that they give people a tax credit for educational spending or something. They have to find a way to pay for it. And so they might do something like increase the cigarette taxes to pay for it.
[Crosstalk]
But it seems like the politics has intersected in a really nasty way with the economics, because for some reason it?s easier to do it on the tax side. They can get these through, perhaps, because the changes in the rules are so difficult to understand that political constituencies don?t arise to fight them. You pay for something on the spending side by cutting some guys highway project then that guy knows exactly what happened and he wails and he?s probably a congressman and so it doesn?t happen. But if you make a random selection of 30,000 people pay an extra $1,000 in taxes then they won?t notice until tax time when you?ll get the bill through. So, there?s some kind of political thing like that going on.
And so, we?re in this system where they tax code is the place where politicians are allowed to tinker now. And this is what the tax code looks like now and there?s no sign to me that this process is abating. I think that if we look at the skyline two years from now, or three years from now, its going to look much more like the New York skyline than it already does. And this is a very dangerous thing, because Bill and I and Eric all agree that it?s the marginal tax rate that really matters.
If you?re a second earner in your household and your kids are going to college and you need to make some extra money, and so you decide instead of working five hours a week you?re going to work 20 hours a week — well, you know, shucks that 55 percent marginal tax rate might be the one that affects you your decision. You could well be in that range and that could have a big affect on your decision if you actually think it through carefully and look at how much money you?re going to be taking home after taxes. So, the distortions to the economy come from the marginal rates. And the system that we have now is one that is pushing the marginal rates higher and higher. And so, while I don?t think that there?s a sound argument to be made that the surplus justifies a big tax cut right now, because I don?t really think there is a surplus, I do think that we as citizens need to think carefully about this horrible system that we?ve somehow stumbled upon that?s creating a very, very bizarre tax cut.
And if I had to make a policy recommendation, it would be to quickly — now, I guess we?re not really going to do anything before the election. But, quickly, even if we have a democratic president after the next election, move back towards something like the 1986 tax act where we had nice sensible marginal tax rates. You know, the progressivity is something that Bill and I can fight over, but we could certainly both agree to go back to the ?86 act or something, which didn?t have a vastly different distributional impact of the current system. It didn?t have all of these crazy marginal rates. But, if we do that I think that we also need — and this is very important to emphasize — to keep in mind that we had an ?86 act and it turned into the Skyline Act.
Okay. And so if we have an ?86 act again, we go back to a system that is sort of simple and has the low marginal rates and the broad base. Then the politicians are likely to just start again moving us towards the Skyline tax.
And so we really need to think about ways, be they super majority rules or what, to ensure that the system itself that makes it so that all political tinkering now happens through the tax code change. Because if we don?t change that as well then we?re going to end up having a very, very short run benefit from our efforts because we?ll clean the state and then everybody will start tinkering again.
So, that?s my presentation. I?ll hand it over to Eric.
E. Engen: In some ways, I?m sure my presentation will suffer, after in comparison to Kevin?s fine discussion. But, in some ways I?m going to benefit from the fact that a few of the points that I?m going to be talking about. We?ll build on some of the points that Kevin highlighted in his talk.
My remarks here at the beginning of the briefing will focus on three topics here. First of all talk about the current levels of taxation in the US, and then I?ll talk about some issues of tax simplification and then some points about prospects for new tax legislation.
First, I?ll turn to the question are Americans overtaxed. I?d like to make several points here. First of all, in total, income taxes provide more revenue for the federal government than payroll taxes. But for most working Americans payroll taxes take a bigger chunk out of their income than income taxes do. So, in some sense, rather than April 15th being the day of reckoning for the bulk of taxes that households pay, it?s instead every payday when they have the FICA taxes deducted.
And indeed payroll taxes take a bigger bite out of earnings than individual income taxes for approximately two-thirds of all working households. Now, total income taxes are then again higher because the high-income taxpayers pay a lot more. People that are retired are paying income taxes and not payroll taxes. But, for many people the important thing to keep in mind is that the payroll tax is as important or more important in terms of what the government has a claim on and from their income.
Now, in this light here, what I show is essentially breaking down the two important taxes that caused the — have been causing most of the change in federal tax receipts as a percentage of GDP that you saw from Kevin?s first slide.
Okay, essentially over the last four decades, the big movement — the big increase in taxes in the US have come from the individual income tax, but also from social insurance taxes. These are primarily Social Security, Medicare, a little bit of unemployment tax, but Social Security and Medicare make up the primary amount, and these are all averages over these decades as percentages of the size of the economy as measured by GDP.
Now we can see here is that although individual income taxes, as a share of GDP have been rising, it hasn?t been anywhere near as fast as the increase in payroll taxes. And indeed, if you take the decade as a whole, the ?90s have been quite similar to what we saw in the 1980?s, only slightly higher share. Now, as I said before, we can see here in total individual income taxes take more than payroll taxes, but that?s not the case for every individual. Okay.
Now, one thing though to note is that part of the political debate and part of the political concern about taxes in the ?90s, say relative to the ?80s, have been the differences in trends within the decade. In the 1980?s, we started out the decade with very high average tax rates and taxes fell. Where as in the ?90s, we started with very low tax rates and they tended to rise.
Next slide please.
You can see this on the next slide here. This just shows the individual income tax as a percentage of GDP. And where as you can see here, you go to 1980, one point right here you can see throughout the ?80s, the average tax rate was tending to fall. The ?90s, we sort of started at about that same level, but it has been rising ever since.
Now, I?d like to point your attention to other peak times here in the individual income tax, and one thing you can see here is that this individual income tax share of GDP does bounce around a lot. Okay, and it might be useful for informing the debate as to what?s going on now, where we clearly are at another peak, as to what happened earlier in post World War II economy in the US.
Well, back in 1969, when taxes hit — individual income taxes hit 9.2 percent of GDP — the primary cause was that was the peak of the Vietnam surcharge. Okay, that was temporary. That was the peak surcharge. It declined the next year and was off the following year and we can see individual income taxes came off at that time. So clearly, there was a temporary reason why taxes hit that peak.
The other peak was in 1981, when individual income taxes took up 9.4 percent of GDP in the second big peak up there. Now, what was the cause then? Well, a primary cause was, at that time, we had raging inflation through the end of the 70s, and we had a tax code that was not indexed for inflation. And so there was something that everyone at that time knew as bracket creep, because people?s incomes were just trying to keep up with prices and so they were moving up into ever and ever higher tax brackets. Okay.
Now, I sort of chalk it up to the fact that in some sense there was a tax revolt at that time to this fact to also what I found in teaching students these days. If I talk about bracket creep, most of them don?t even know what that refers to.
[Crosstalk]
They have no idea what it referred to. But certainly in the early ?80s, anyone that had any familiarity with paying taxes or what not was familiar with the term. Now what we see now is that, particularly these last two years, ?97, we were up to the individual income tax at 9.2 percent of GDP. This last year, ?98, it was 9.9, an historical high. You know the question is okay, what has caused that? Well there?s a lot of debate among people that look at tax revenues and try to forecast them as to what has caused it, although all of the bits and pieces haven?t been sorted out.
A couple of things that are pretty much agreed upon is that one, is we?ve had a big surge in capital gains income that is declared on taxes. The roaring stock market certainly has contributed to that. And I just would note as an important point here, capital gains where as it goes on to your income taxes, and you have to pay taxes on it which are included in here, capital gains income is not part of GDP. So anytime you have more and more taxes paid on capital gains, that?s going to raise the measure of taxes paid relative to GDP, because you?re adding something to the top of this ratio, but you?re not adding anything to the bottom.
Okay. Also another factor that has caused this rate to go up is that significantly more income has been received by high-income, high tax bracket people. Some of this probably is also associated with the stock market in terms of higher salaries, bonuses and commissions to those people in the financial industry.
Okay, now the question though is, at least in my assessment, why, at least as of yet, has this, you know, very high pick up in tax rates not sort of lead to the same kind of tax revolt, or at least the intensity of the tax revolt, as we had back in the early 80?s?
Well, I think one thing is just sort of looking at the different times then. Back in the early ?80s, we were in the midst of a recession. We had double digit employment, double digit inflation. We had very high mortgage rates, stock market had been stagnant for about a decade, people really felt that bite coming out because a lot of people viewed the economy as not performing very well at that time.
Currently, well it?s been a number of years of very good times. You know, we?ve had real growth of about 4 percent over the last three years. Unemployment is low, inflation is low, mortgage rates are low, stock markets been booming, and some feel that it has a lot of room to continue to boom. We don?t know that but in any case we don?t know that —
K. Hassett: Something like that.
E. Engen: There?s very much a difference in economic times now. And so, one of the things I would sort of put forward is that, although taxes are at a very high historical place, I don?t think people sort of view them as quite as bad as back in the 80s. That?s purely a subjective view, but it does raise I think a question in terms of can we learn anything at these other times when taxes were very high.
As an aside, and something I will return to in a few minutes, I want to note that the current projection here and this is the congressional budget office projections for taxes out over the next ten years. And if we looked at the administration?s they?d be very similar on this, their projections don?t differ much in this case. What we can see is the projections are, well the good times are going to continue to roll. Okay, we?re going to remain at a very high level of taxes relative to our GDP, and I think that?s important and I?ll come back to that.
Now, the ultimate answer to the question of whether Americans are under taxed depends on whether essentially what we?re paying for what we demand from government in the form of spending. And some have argued that the government is currently taxing more than we are demanding in terms of spending. Or in other words, as Kevin talked about and I'll talk about it here a little bit more. You know, we have a surplus, well certainly shouldn?t we give it back at some point? However, I think that this conclusion is based, at least in part, on sort of a misleading use of budget accounting.
If you could put up the next slide, John.
Now, what we have here is, on the top line, is we have the total budget balance for the federal government measuring billions of dollars or the budget surplus, or what we use to call the deficit. Okay, so these are the numbers that regularly are bandied about in discussion. We saw last year, we had a total budget surplus of $70 billion. Now, the thing that some people realize, but others often times either don?t know, or many people tend to somewhat hide, is that that was solely do to the surplus that we run is Social Security. Effectively, if we separate Social Security, and the accumulation to the Social Security Trust Fund, into what?s called the "off- budget items", and effectively that?s what makes up the off-budget component of the federal budget. The Postal Service is also in there, but that?s small enough that we can essentially ignore another little item.
What we can see is that Social Security was running a surplus, but on budget, we were still running a deficit. Okay, taxes were still not high enough to pay for the spending that we were undertaking on budget. And we can see that actually over the next couple years, and its not until 2001, do we even project that the on-budget component of the budget would be on a surplus.
K. Hassett: That?s probably changed too, Freddie, with the market going —
E. Engen: Possibly, and I?ll deal with that issue in a minute, okay?
Now, so, let?s look at how we might determine whether taxes are high enough or should be lower, looking at this. What we?re looking at here, it says first of all, in terms of on-budget items, everything other than Social Security, were still not collecting enough revenue to meet spending demands, okay. Now, there may be issues of — well, what this means is we need to cut spending and I think those are all fair arguments. And as well, I think that those should be issues that have to be addressed. But, I?m sort of starting from a benchmark here that, you know, American people, at least as a given, are satisfied with the spending that we?re undertaking right now. Well, at least for this year projected and for next year, at least the latest projections that are published, still show a deficit.
Now, off-budget, which is dominated here by Social Security, well, we know from the current report of the trustees, that have said the same thing as they have over the last 15 years or so, that in the long-run, Social Security is not financial solvent. That over the long run, benefits that we have promised have gone lower down than taxes. So, in some sense, this off-budget surplus here is not great enough to meet the demands that Social Security benefits will place on this system. So another way to look at this right now is, well, the Social Security surplus is not big enough and the on-budget component of the budget is still running a deficit. So if we want to take the amount of spending as given, as being what people want, my assessment would be is we?re still not covering all of our spending obligations, okay, if we looked at this appropriately.
Now the other thing I want to mention, and this touches on the point that Kevin mentioned, if you actually look in the Congressional Budget Resolution that just passed this year, they actually have a line in that that says, "we?ll update all our numbers when revenues come in stronger later on in the year." Okay, once again we?re expecting higher revenues than were just projected by CBO in January or the administration in February.
Now, being a tax revenue forecaster for the Federal Reserve, I know what the experience has been like in the last several years, okay. And that is, we?ve constantly been surprised on the upside, and those are good surprises. Surpluses have appeared and the budget situation looks better than we thought.
But, I want to note that in the early ?90s, it was just the opposite, okay. We were projecting revenues that weren?t showing up, okay. And the general experience over the long-term is that we have both positive and negative surprises in terms of budget forecast. And so the bottom line is, although I wouldn?t say that, well, we?re going to see a negative budget surprise, say this year or next year. In all likelihood, it?s going to happen somewhere out there. And I think it is somewhat dubious to rely on taxes staying at historically high levels permanently out into the future.
Now, I?d like to turn to the next issue that I wanted to talk about and that?s tax simplification. Here, I?ll give a more straightforward answer to some of these questions. Can taxes be simplified? Yes, certainly. Will taxes be simplified? No. [Laughter] Okay, now, why are individual — and I challenge anyone to argue with my answers to the first two. I think one is —
Participant(?): What?s the timeframe for the — ?
E. Engen: Time frame of two is right — is this year. Okay? And I think, almost any economist would argue, that the current tax code could be simplified in some form. I don?t think anyone, regardless of their place on the political spectrum, is real happy with the tax code in terms of its simplification aspects.
Now, the question to ask is why are individual income taxes so complicated? First thing I want to point out here is that in some sense the tax code, there?s sort of two different experiences that different people have coming to the tax code. Okay, first of all, about 40 percent of taxpayers file either the 1040EZ form or the 1040A tax form. These are pretty straightforward and uncomplicated forms. Okay?
Also, as I noted earlier, most working households pay more in payroll taxes then they pay in income taxes and most individuals? payroll taxes are pretty simple. Okay? Their employer just does the deduction. Obviously, the payroll tax does introduce some filing and administrative burdens on businesses, so I certainly do not want to imply that there are no complexity issues with the payroll tax. But for most individuals, their taxes are for, at least, some segment of individuals — I won?t say most — some segment, let?s say approximately half of the population, their burden of paying taxes is pretty straightforward in terms of complexity.
On the other hand, you have the other half of the population, Kevin being in one with his 33 page tax form, that has much more complex financial arrangements generally, but not always are in a high income high wealth group, that certainly bear the brunt of much of the complication in the current tax code. And what I wanted to talk about here is just at least my views real quickly, why do we still have a significant number of taxpayers that face the complicated tax code? Some miss it, but there are still a very significant number of people that spend a lot of time, a lot of money, a lot of hours, figuring out what?s going on with the tax code.
Now, first is we want to — one reason why the tax code?s complicated is we simply want to tax people differently — different people differently, okay? This is basically on the notion of fairness. It would be very simple to give everyone, you know, the same tax bill. That would very substantially simplify the tax code, but everyone would view that that is simply not fair and, in fact, you know, in Britain in years past, when poll taxes were levied they rioted in the street. So certainly, we wouldn?t suggest that as an alternative, but one of the things we have to realize is at least some of the complication is due to the fact that we want to have some notions of equity or fairness, that we want to tax people differently.
Okay, we also along these same lines have different treatment of different types of incomes and deductions — some things are allowed to be deducted, some things are not. Certain types of income, capital gains, are treated differently than other types of income, wages and salaries, and there are many different reasons why that is the case. But it?s our choices to do these kinds of things that enter some of the complexity into the code.
Okay, now, finally though, I think a big reason, and Kevin I think really made the point well on this, is that a lot of the complexity simply comes from political considerations, okay. And I essentially will agree with that, the points that Kevin made along those lines, and just highlight that, you know, the tax code has always been used as a way to give certain political benefits to specific groups, and it probably always will, at least under our current system. And whereas it would be nice to remove that incentive, I find it difficult to imagine a way that we could, even though I would think that would be possible.
As well, under recent budget environments, okay, it?s been much easier to enact certain types of public policy with targeted tax cuts, where you can propose them as tax cuts that you might be more likely to get both sides of the political aisle to agree on them, as opposed to proposing spending increases, which particularly Republicans have argued that they?re firmly against, okay.
So, I mean, I think there?s in some sense, some good reasons why the code is complicated because, you know, we do try to make some nods to equity and fairness arguments, but I think the bulk of the complexity comes from the last item here, and that is pure political consideration, which I think are not good economically for the tax code or the economy.
Okay, the last thing — and you can take the slide off — I just want to talk about it briefly, are just what are some of my views on the prospects for new tax legislation, okay. In particular, the prospects for either across-the-board tax cuts or targeted tax cuts.
First, I think the prospects for enactment of significant tax changes this legislative cycle are not very strong, to say the least. You know, foreign policy issues are dominating the news, and I think even when we turn to the domestic agenda, my assessment of the political tea leaves is that Social Security and Medicare reform are ahead of tax cuts in terms of priority among politicians. I think across-the-board tax cuts, unfortunately, would be hard to pass, because I believe the opponents of them would use distributional tables that will show that high-income tax payers receive a larger share of the reduction in tax dollars. This is an inevitable outcome of the fact that high-income taxpayers pay a bigger share of taxes, so to give the same percentage reduction across the board, higher income, higher tax burden taxpayers are going to get a larger share of dollars. And I think that, unfortunately, distributional analysis oftentimes outweighs good, sound tax policy, and I think this is one case that it will.
In any case, if any tax legislation is passed, I think, unfortunately, it might be in the form of some type of targeted tax credit, which I think is poor tax policy. And again, I agree with Kevin on this, it?s just one more step in rolling back the helpful tax simplifications that were enacted in 1986, and I think that is a shame.
Okay, sort of finally, what do I think should be done? Well, my first preference would be to raise national saving by simply using the surpluses to pay down public debt. And my view is that budget forecasts are very imperfect and I think we?re far too soon into the good times here in terms of budget surpluses to be thinking about ways of spending or cutting taxes, unless we?re thinking about both cutting, spending and cutting taxes, which I think in some ways may be very sensible. But I just want to remind you that budget forecasts are imperfect and I think it would be better to err on the side of being surprised by bigger surpluses rather than being surprised by unexpected deficits.
If surpluses must be used for something, my view is that the second best alternative would be to have some tax cut across the board, that reductions and marginal rates, either from an across-the-board reduction or a smoothing out of the skyline taxes that Kevin showed, provides a much greater stimulus to private saving and work effort and reduces the effect of the high marginal tax rates on avoidance behavior, than do targeted tax cuts with very inefficient phase-outs in terms of the imposition of high marginal rates.
That?s my story and I?m sticking to it.
W. Gale: All right, okay well, Eric and Kevin have said a lot of what I was planning on saying, so I?ll cut to the chase.
I want to us to take a step back from particular policy issues, but they?re going to start out with goals or tax policy —
Can we lower that a little? Yeah, just shrink it with revenues up.
There?s actually — tax policy starts from a tremendous sense of consensus. I know that seems like a crazy thing to say given the vitriolic and never-ending debate about tax policy, but the consensus is about the goals of tax policy, and in particular the goals I?ve listed: simplicity, fairness, economic growth or efficiency, incentives in social policy by which I mean the tax system should discourage things we dislike and encourage things we like — stability, visibility and clarity and of course revenue — just to meet the rate of a certain amount revenue. Stated at an abstract level and stated individually, I think there?s pretty widespread agreement that these are the goals of tax policy.
So if that?s the case, why is tax policy so contentious? Why is it so difficult? And that?s because there?s disagreement among three, at three levels. First of all, what do the goals mean? One person?s fairness is another person?s complexity. One person?s incentive is another person?s shelter. Fairness, you know, is classically in the eyes of the beholder just like beauty. Also, there?s disagreement about what the various abstract goals mean.
The second level is even if we agree on what the goals mean, there?s disagreement on the best way to achieve a goal. Suppose we?re trying to help a poor person, do we give them cash? Do we give them inclined assistance like health care? Do we give them job training? Do we help them set up a saving account so that we can accumulate wealth? These are issues — the best way to do it, the most appropriate way to do it — are issues that are that are — simply have not being resolved in technical literature.
So even if we agree on the goals, we can disagree on the best way to achieve the goal, and even if we agree on the best way to achieve their goals, the biggest problem or the biggest source of contention, is that different people value these goals in different ways. Some people care most about economic growth, some people care most about simplicity, some people care most about their definition of fairness, et cetera, and these tradeoffs against these various goals is basically the source of contention in tax policy. And tax complexity is a good example.
I want to talk about two examples of these tradeoffs, and one is complexity; the other is the marriage penalty. There?s no doubt that taxes are complicated for a sizable portion of the population, that the income tax is a very complex system. As Eric mentioned, for many people, though, taxes are not that complicated. Over half of the population filed either one of the simplified forms, the 1040A or the 1040EZ, or it files the 1040, but does not have itemized deductions or business income, or what?s missing on the slide, capital gains, which are three sources of complexity. So over half have what some objectives that look like pretty simple concerns. They can get complicated of course. But a study by Marsha Blumenthal and Joel Slimride [sp] found that 30 percent of tax filers spent less than five hours on their taxes; another 15 percent spent five to ten hours. So almost half the taxpayers spent less than 10 hours. Fifty percent had no out-of-pocket costs, and 17 percent paid less than $50. So two-thirds of the population paid less than $50 for tax preparation.
So now what?s not mentioned here is the other half in terms of hours and the other third in terms of out-of-pocket expenses, and there?s no doubt that some people have very complicated returns, and a sizable minority have very complicated returns. But the only point I want to make is I want to distinguish aggregate levels of complexity from the distribution of complexities.
So let?s turn to the next slide. Why our taxes complicated? Again, this is going to overlap with Eric a little bit. The analogy I like is that tax complexity is like pollution. Nobody likes pollution, per se, but no one would argue that we should get rid of all pollution in the economy. We recognize implicitly that there are benefits to pollution. What I mean by that is pollution is a byproduct of producing things that we want. It's an unfortunate byproduct and we try to minimize it, but if we eliminated all pollution we'd have to eliminate a lot of things that we also like to have. And so the reason this is important is the right issue is not how complex is the tax system, although that gets all the attention. The right issue is are we getting good value for the complexity that we have.
So, again, the analogy with pollution is pretty much one to one. If we're going to pollute some amount, we want to pollute in the most efficient or fair or effective way. That is, we want the most output for the least amount of pollution, but we?ve never tried other things. We've never tried to just eliminate other things not equal. We've never tried to just eliminate all pollution from the system. That would take us back, you know, 200 years or 500 years.
So the real key is are we getting good value for the complexity that we have? And I think everyone up here agrees the answer to that is a resounding no. And there?s a couple of reasons why — well, a couple; let me give you a couple of examples.
One is the important difference between social gains and individual gains. Suppose you have to fill out two extra lines of your tax form, or ten extra lines, and that saves you a thousand dollars in taxes. You, as an individual, would likely think of that as good complexity. "Gee, this is great. I spent five more minutes writing down these numbers; I get a thousand bucks." Okay? But now let's say everyone does that, everyone spends five more minutes sorting their numbers; everyone gets a thousand bucks. Well, the money's got to come from somewhere, right? So somehow the underlying level of tax revenues has to be up to then finance that thousand dollars back to every person.
So what looks like good complexity for each person is actually completely useless complexity at a social level. So when you look at a lot of these programs — education, or the education subsidies, child credits. We could argue about whether capital gains fits in here. A lot of these people like these programs because they fill out a few extra lines and they get a big benefit for filling out those few extra lines.
But if everybody does that, if everyone goes to their congressman and gets their particular subsidy put in and fills out a few extra lines, then, in the aggregate, nobody's better off. In fact, everyone is worse off. Subsidizing everyone is the equivalent of subsidizing no one, but it adds administrative costs. Okay? So everyone — taxpayers are focused on their individual gains and losses from complexity, but what policy-makers and analysts should be concerned about is the social gains and cost.
All right. Political lobbies or political factors is another issue that both Kevin and Eric have mentioned. I don't want to downplay the role of the budget rules at all. I think they're very important, and I agree with everything Kevin and Eric said. I do want to point out that we had a complicated system before 1990, which was when the budget rules came into effect. So the budget rules are definitely not pushing us in the right direction, but there's more to it than the budget rules. In particular, you know, lobbyists don't make campaign contributions to the Ways and Means members or the Finance committees? members because they're deeply respectful of the concept of a clean tax code. You know, they're there to make good investments, and the evidence suggests that they do make very good investments. A few million dollars in lobbying or campaign contributions can turn into billions of dollars in tax cuts. And that's an even higher rate of return than you can earn in the stock market, unless you invested in Amazon.
There's another reason why taxes are complex, and that is people like complex taxes. You go back to this example of filling out 10 more lines that gives you a tax cut of a thousand dollars. Most people would say, sure, I would do that. All right. So a politician who gives his constituents a tax cut, a targeted tax cut, is reading his voters preferences correctly, in my view. There aren?t many people — many people will bitch and moan about how complicated the child credit is and how complicated the new capital gains rules are, but you don?t hear many people volunteering to give up the tax savings that they get from those credits.
So one of the — I would like to see a survey some day that — there?re lots of surveys that ask people how much they hate the tax system, et cetera. I would like to see a survey that one day asks people how much more would you be willing to pay to eliminate all tax complexity. That is, take your tax payments now and what you pay your accountant, whatever: how much more would you willing to pay to get tax complexity out of your life? I bet you, if people think about it, the answer is not very much. And that alone tells you why we have a complex system. That?s not defending it. It?s just trying to explain where it comes from.
Also, one other comment on tax complexity. We should care about the complexity of governments, generally, not just taxes, but taxes versus spending, taxes versus regulation, and taxes versus mandates. And so although some of these recent programs make the tax code more complicated, they may actually be less — it may be less complex to do that than to create them as independent spending programs. The reason is you?ve already got 120 million people filing tax returns. Adding a couple of lines and running the administration — adding a couple of lines to tax forms and running the administration of that program through the IRS, which is already processing the tax forms, may in fact be cheaper than setting up an entirely new eligibility apparatus, agency, bureaucracy, et cetera.
Again, this is not to defend tax complexity. It?s to put it in context, that there are reasons — there can be both good and bad reasons why the system ends up more complicated.
All right. Let?s turn to the marriage penalty. The marriage penalty is a stupid thing to have in a tax code. No one would design a tax code that deliberately penalized people for getting married. I think everyone agrees with that. But that tends to be where the analysis stops and politicians start carping about taxes on love and et cetera. The problem is that?s where the analysis should start. If a marriage penalty is a crazy thing to have in a tax code, and it?s in our tax code, we have to ask why it?s there. And it turns out it?s there because it?s bumps up against two other things that we also think ought to be in a tax code. One is the proposition that you can call fairness or horizontal equity, and that?s roughly the idea that families with equal income should pay equal taxes.
A second is progressivity, but, more precisely, the notion that we have more than one positive tax rate. You know, if you go to a 15 and 28 percent system, you?ll still end up with the problem. The problem is if you have progressivity and you have horizontal equity or fairness, you have to end up with a marriage penalty or a marriage subsidy. It?s an arithmetic certainty. It?s not politics; it?s not projection or forecasting. It?s just arithmetic. You can't have the first two without the third, either a marriage penalty or a marriage subsidy.
And so the reason we have a marriage penalties for some people is because we believe, we tend to believe in a progressive system, and we tend to believe in the notion that families with equal income should pay equal taxes. So that should tell you that the only way to get rid of the marriage penalty is to eliminate one or the other two features. Either eliminate the more than one positive tax rate idea, or eliminate the notion that families with equal incomes should pay equal taxes. All right?
And, no, again, I don?t want to defend the marriage penalty, but it?s important to understand what the marriage penalty is getting you or why it?s there, and it?s there to have a progressive system that most people think is fair in other regards.
Let's look at the next one. As I mentioned, you can have a marriage penalty or a marriage bonus. In fact, more couples get marriage bonuses. That is, they get tax cuts when they get married rather than tax increases. You tend to get marriage penalties when couples have equal earnings and marriage bonuses when they have unequal earnings. But about 51 percent of couples get bonuses, 42 percent get penalties.
Turning to the next slide, and if you look at the far right column, the cost of the bonuses is about 29 billion a year. I'm sorry. The cost of the penalties is about 29 billion a year. The benefits or the bonuses is about 33 billion. And so the net effect of tax liability in the current treatment of marriage versus single is it costs us 4 billion per year. There?re a variety of ways to eliminate the marriage penalty. I think what you want to keep your eye out for is it's better to eliminate the marriage penalty and not increase marriage bonuses at the same time than it is to eliminate the penalty and raise bonuses. Okay? And some ways of adjusting the marriage penalty don't increase the bonus; they just eliminate the penalty. Other ways increase the bonus and eliminate part of the penalty. And that turns out to be far more — increasing the bonus would be far more expensive. And it's probably not even worthwhile venture.
E. Engen: But people look at the marriage penalty, they are all sorts of this, tables like this, but if you're thinking about getting married or not, then what you care about is the present value of penalties. And so, you can think of it as being like a dowry. It's something that you have to pay in order to get married. And the present value can, if you do the calculation and look at those numbers and make reasonable forecasts can easily exceed $200,000 for a couple with income above 100,000. And so that really, I think, emphasizes how big the marriage penalty is. You know, it doesn't look so huge if you're thinking about it in terms of $7,000. But if you think about — hopefully you're going to stay married for 50 years. And if you are, then the present value of those payments is just enormous.
W. Gale: All right. Now let's turn to tax cuts, briefly. This slide is called don't cut taxes, but basically just sets up the framework. There's a $2.6 trillion surplus; 800 billion of it?s on budget; 1.8 billion is off budget. Certainly the three of us agree that the off-budget surplus should be allocated to Social Security, some sort of Social Security reform plan. Eric and Kevin have spoken about the general picture. I want to make a few points about the on-budget surplus of $800 billion that's out there.
First is that, you know, it turns out that over 400 billion of the 800 billion is in government pension accumulation and Medicare Trust funds now. All right? Now the logic of not spending the 1.8 trillion in Social Security funds is that those are monies promised to current workers when the retire. That is they?re earmarked. Well, I would submit that the same logic applies for the 363 in government pension reserves and the 55 billion in the Medicare Trust Fund. All right? If so, that's 53 percent of the roughly 800 billion. I think it's 787 billion. So we start out with a number that's not really 800 billion. It really ought to be thought of as about 370 billion, or something like that, over the 10 years. The numbers that Eric showed that delayed — that showed that the on-budget portion of the budget is not in surplus until 2001 or 2002 does get pushed back about three or four more years if you take out the government pensions and Medicare Trust Fund.
The second key issue about this $800 billion is that the underlying forecast assumes very steep cuts in discretionary spending. Eric mentioned that Americans — let?s start from the premise that Americans are satisfied with the current level of spending. Well, the budget surpluses are premised on the idea that we?re going to cut discretionary spending in real terms by $600 over 1999. That is, if you just held to the discretionary spending concept in real terms ...
E. Engen: Six hundred billion.
W. Gale: Billion. What did I say?
E. Engen: Six hundred.
W. Gale: Oh, okay. All right. Six hundred billion dollars over the next 10 years. So, essentially, if we just held spending where it was in real terms and didn?t tax, didn?t use government pension reserves for tax cuts, there?d be nothing left for tax — I mean no surplus available for tax cuts. If we held discretionary spending constant as a percent of GDP instead of being constant in real terms, that actually would cost $1.4 trillion. So the existence of the on-budget surplus is heavily premised on steep cuts in discretionary spending. We can argue about whether that would be appropriate or not, but, from a political perspective, the issue is whether Congress has the will to make those cuts, in particular ...
E. Engen: How do those compare to the cuts — do you remember my slide ...?
W. Gale: The next three years require nominal spending cuts to stay within the targets, and I don?t think we?ve had nominal spending cuts.
The third issue about the on-budget forecast is one that Eric made, [that] most of the recent revenue surge is permanent. The calculations I?ve done in an article out on the tables, co-authored with Aaron Auerbach, suggest that the estimates imply that about 84 percent of the tax credit is permanent, of the recent ...
[Tape Change.]
W. Gale: All right. Let me just turn briefly to a couple of comments about the tax cuts, whether Americans are over-taxed. Why don?t we go to Figure 8. Figure 8?s based on CBO figures. It includes all federal taxes, in the sense that it measured cash incomes. And it shows average tax rates by quintile in selected years in CBO reports over the last 20, 22 years. Basically, if you start at the bottom of the graph, you can see for the first three quintiles — that?s the bottom 60 percent of households — average tax rates have gone down, not up. For the next quintile, the 61st to 80 percentile, the average tax burden is about constant. And it?s only in the top quintile that the average tax rate has increased from the perspective of the 70s? increases. There was a big cut in 1980 to 1985 for that group, and then an even larger increase from ?85 to ?99. So that, again, the sources of revenue increase is not higher taxes on the average American family. It?s two things financially. One is higher tax rates in the top quintile. And then if you look at the next, the last table, it?s higher income growth in this quintile as well.
Using the CBO numbers, average income in the top quintile is, even after taxes, was 37 percent higher in '99 than it was in '77. These are all in real terms, where the average income in the next quintile was only 5 percent and averaging higher in '99. An average income in the bottom three quintiles was lower in '99 after taxes, despite the fact that taxes went down, than it was in '77.
You can look at these numbers by the increasing cuts of the top 1 percent — of the top 20 percent. For example, the top 1 percent had basically their pre-tax and post-tax incomes double over this period. That's what the table shows. And so remember that in a progressive tax system, when your income, when your real income goes up, your average tax rate is supposed to go up. So, again, it?s not that necessarily that the tax system itself imposed higher burdens on high income taxpayers over the 22 year period, it's that the income of higher income taxpayer was much higher than it has been in the past, and so you expect your average tax burden to rise for that reason.
All right. Let me stop there. I think we've all talked long enough, and you?ve been very patient. And let's just open the floor for questions or clarifying questions, other questions, you know, comments that we're all nuts or what.
Participant: Kevin, a couple of years ago when there was tax reform and [Inaudible]?
K. Hassett: I think that the Republicans have given up taking on Clinton, Mr. Shields. You know, the sad fact is that we could envision a reform that we would all agree would be great for the country, that would not be attackable by the Democrats. I mean, the '86 Tax Act, for example, the Democrats offered it up on the Hill. And so we could actually have something like that, but you have to have a democratic will to do it. It's clearly not that.
I mean President Clinton's tax policy has been just inexplicable. He just wants to get sound bites. He doesn't care about sound policy, and it must drive the economists in the administration crazy. But when you have a player who?s so important in the game that just has no will to do the right thing, then there?s nothing you can do, you know, unless you get the two-thirds majority, or something, to override the veto.
So I think they've given up because I think that they don't have a person that they can work with. I think that either a new Democratic or a new Republican President could easily be convinced, if he sort of thought about it, by Bill or by me to pursue tax reform in the spirit of the '86 Tax Act. You could ...
Participant: [Inaudible.]
E. Engen: By Rostenkowski and — that?s right.
K. Hassett: And Packwood, yes.
E. Engen: That's exactly right. I've talked to Norm Ornstein about this. And please don't quote what I'm about to say that Norm told me, because he might — I don?t know, he wasn?t necessarily on the record. But I?m sure he said this in public too. He thinks that because in Congress the majority of the seats are labeled Republican or Democrat now that it?s moved people to the extremes. And so now that there?s like a seat that?s in a place that the Democrat always wins, then winning the Democrats? primary is the only thing that matters. And to win the Democratic primary you have to move left. And if it?s always Republican, then winning the Republican primary is all that matters, and then you move right. And so what happens is the Congress gets more polarized and it?s harder to find a majority of people, like we had in ?86, who are willing to work together and do the right thing.
But you?re right. I mean if we had more people in the middle willing — see, I think part of the problem is not just, you know, not just the Democrats. I think the Democrats are far too much to the left, but also the Republicans wouldn?t sign onto an ?86 Tax Act right now because they sort of are very adamant about a flat tax. And so we don?t have the people in the middle willing to work together.
K. Hassett: I think the Republicans have actually shot themselves in the foot a little bit on this by making taxes the thing that they?re going to stand for come hell or high water. And that makes it easy for the President. All he does is stop them on taxes, which, as Kevin indicates, he?s very good at, and, you know, they?ve got nothing left.
In ?86, both sides wanted tax reform. And I think you?re right. Congressional leadership at that point was crucial. But I think Kevin?s right, too. You cannot engage in large-scale tax reform without the President behind the effort now, in particular, because there are thousands of man-hours at Treasury that have to be spent working out all the numbing details. Congress is not equipped. They just aren?t deep enough to do that type of thing.
Participant: [Inaudible.]
W. Gale: Right. When times are good, that?s certainly right. There are times when it?s harder to sell.
Participant: They can afford it. They?re making a lot of money.
W. Gale: I think that?s what I alluded to, and we can talk about the leaders getting behind this. But they have to make the case to the American people. And I think at this point the case has not been made effectively, because tax cuts are not up near the top of what people are concerned about. Or tax simplification.
K. Hassett: You?re talking about fundamental reform, a flat tax.
W. Gale: I mean right now, you know, concerns are more on Social Security, Medicare and education. And a lot of the tax debate has been around the idea of, well, do we cut or not and the idea of, well, let?s, say, keep, as in ?86, revenue neutral, but try to simplify. That case hasn?t been made.
E. Engen: I think also a lot, if you?re talking about fundamental reform, I think, you know, the bloom is off the rose on a lot of these plans. All these plans sound wonderful when they first come out, like, my God, a postcard and a low rate. That?s really great. And then, you know, analysis suggests that there?d be, from the flat tax, for example, a paper by two MIT economists suggests that the increase in the number of uninsured, people without health insurance, would rise by 10 million, which is more than it rose in the whole decade of the 1980s.
Hall and Rebushka [ph], the authors of the flat tax, indicate that if we had gone into the flat tax in 1993, General Motors? tax liability would have gone from $110 million to $2.7 billion. All right? So you can ...
W. Gale: Yeah. But this is kind of not fair.
E. Engen: Wait. Whoa. No, no.
W. Gale: ... Because it?s moving stuff from the shareholders to ...
E. Engen: No, no, no, no. That?s a fine economic point. But if you?re talking about why the political force is not there for the flat tax, General Motors doesn?t give a damn that economists say that businesses don?t bear the burden of taxes; shareholders do. But the corporate treasurer at General Motors is not going to walk into the boardroom and say this tax plan is going to raise our taxes by $2.6 billion, and therefore, we should support it. And the business community, in fact, has been very mixed on the flat tax for that reason.
You know, there?s this issue with mortgage. I?m not arguing the economics here. I?m arguing political perspectives. The idea, if the flat tax ever gets serious, you?re going to see ads that show people sitting on yachts, you know, Steve Forbes lookalikes saying, you know, these people make umpteen billion dollars a year and, quote, "pay no taxes." The answer, the reason being their taxes are being paid at the business level, whereas you, poor Joe Six-pack, are paying 20 percent in the flat tax, five percent state tax, 15 percent Social Security. You?re paying 40 percent of your income in taxes at the margin, and these guys are paying nothing. And by the standards of the tax debate, that will be an accurate statement. I mean, from an economic perspective, it?s completely misleading. But given the standards that prevail, that ad?s going to be out there.
W. Gale: Yeah. But that highlights one of the real problems, politically, with the flat tax, is the reason why fair-minded people can get something fairly close to a flat tax and be convinced that it?s not bad for people at the bottom income distribution is, one, when there?s unemployment, it?s the people at the bottom who suffer. And so if you?re getting economic stimulus, then the people at the bottom are benefiting. But, two, you know, wages go up. The reason that the flat tax does anything for the economy is that it spurs capital formation. It does that. And capital formation goes into wages. But that?s like an indirect thing, right? So we say, oh, well, your firm is going to hire, you know, more machines, and you are going to become more productive, and history tells us that your wage is going to go up. That?s not the kind of level that the debate would ever happen politically.
E. Engen: Right.
Participant: Is part of the problem right now that everything is working so well economically and that [Inaudible]?
W. Gale: That?s why they can?t overcome Clinton?s opposition. But I don?t think that if you had a President, Democrat or Republican in there who sort of thought — I mean if we?re doing well, we could even do better if we would just get rid of the skyline. You know, we could just get rid of this skyline, and we?ll do better. But the problem is that getting of the skyline means that all those great things Gene Sperling thought of have to be removed from the system, right? So all these things. You go out and you make a great speech because it sounds good, the Hope Scholarship credit; you care about kids; what an empathetic guy. "I?m going to vote for you." Right? But it?s bad tax policy. And so to sort of run against that right now, you have to remove all those clever ideas they came up with at Renaissance Weekend for the tax code. And, you know, they?re not going to do that. Okay?
Participant: You?ve got an economy that?s creating new jobs, creating jobs, creating wealth, creating ...
E. Engen: And that?s a good thing. Okay? But I think that?s the fundamental difference between ?81, you know, or the ?80s as a whole ...
W. Gale: You?re right.
E. Engen: ... and now.
W. Gale: The Clinton administration would be pressured to do something if we were in a recession. That?s exactly right. But a fair-minded Democratic administration might well come in after the next election and say, gosh, look at this mess. And they could redesign the system and not change distribution one iota and make all of us up here a lot happier. And I think ...
K. Hassett: But note. Also ?86 was a relatively prosperous time. And that?s when we got structural reform. The big problem with ?86 was the deficit, and, of course, the cash flow didn?t anything about that. But I think even in bad times, I think even with a Republican Congress and a Republican President, it?s going to be extremely difficult to pass the flat tax. I think it?s possible to move to an ?86 type scheme in the right set of circumstances. But, you know, Clinton and the Democrats in ?92, ?94 could not even get close to health insurance reform. And you know, you?re going to find the same — it?s sort of the same situation if the Republicans control both Houses and the White House. They?re going to — the closer one gets to those issues, the worst the reigning party or the advocating party can be made to look. And I would be very surprised if we have meaningful reform any time soon.
W. Gale: But what would happen, I think, from sort of putting my ear to the train tracks and trying to judge what?s coming, what would happen would be how the Republicans might well go if they take control or can get control of the agenda. They might look to expand IRAs. Because, as I?ve said, a lot of the benefits of the flat tax, the economic benefits that we all agree on comes from sort of removing distortions in capital formation. And one way to do that would be to just expand IRAs, to make them apply to people with higher incomes, to make them more generous, to expand the things you can save for in your IRA. And as you do that, then you can take gradual steps towards a flat tax and not look like you?re trying to push a radical reform that frightens people.
And so my political forecast is that if the Republicans get control, then that?s the way that they try to ...
E. Engen: If there?s any targeted type of tax cut that has a chance really to get through this year, it would be along these lines of expansion of IRAs, expansion of 401-Ks, the kind of bill that Roth has put forth. But I think, you know, the idea of pension expansion, the concern about retirement saving is something that?s shared on both sides of the political aisle. It dovetails with the concerns about Social Security. And so I think, if anything, those possibly would.
But one thing we have ...
Participant: How about the marriage penalty?
E. Engen: I don?t see quite as much, either political support, you know, on both sides. I mean I think one of the issues with the pension expansion here is that it?d be something that both sides, both Democrats and Republicans, could support, you know, without getting far away from, you know, their current platform.
K. Hassett: It has another ...
E. Engen: But one thing we have to keep reminding is that it?s always tempting to say sort of, well, you know, these are some good, small, small things to do. But the further and further we get down the road of initiating more and more of these kind of targeted tax programs, the harder and harder it gets to get back to a more simplified code. Because what you have is all kinds of different constituencies out there that have their tax preferences, and no one wants to give them up once they get used to using them. I mean, as Bill has alluded to, yeah, they?d be willing to undertake some complication as long as they get their tax break. And it makes it harder and harder the further we walk down that road of adding these targeted tax credits or any kind of ...
W. Gale: Let me just add quickly, and then I?ll — that the other thing about the political climate, and it relates to the American economy as well, is that the Social Security — everybody knows that Social Security has a real problem when the baby-boomers start to retire. And until that?s fixed, it?s kind of irresponsible to be tinkering around with, you know, revenue reduction things. And the public has recognized this. So they?re trying to pair the two.
But there?s another political force which we haven?t mentioned, which is really important. And I know this is important. But I know it?s really dominating the debate right now, is that the Democrats are looking at the polls and seeing how badly Al Gore?s doing. And they?re thinking "How the heck are we going to win the presidency if we fix Social Security? Because our natural constituency is one that likes — you know, we can get elderly votes if we?ve got Social Security and Medicare in play, because people, you know, are fearful that the Republicans are going — if you look at the polls, they?re fearful that the Republicans are going to mess with their Social Security.
Participant: So they don?t want to take Social Security off the board.
E. Engen: That?s right. So because of that, the Democrats are trying to take Social Security — or not all of them, but some of them are moving towards taking Social Security just off the table this year, because they want to have it in the next election as something that they can use to get Gore elected. And that horse right now is another reason why I think that any kind of tax reform is not going to really happen, because to get attacked politically, you?ve got to solve the Social Security problem. But the Democrats are becoming fearful. I don?t think this would be true if Gore were ahead 20 points in the polls. But they?re becoming fearful that they?re going to need entitlements to run in the next one, and they want it in play.
W. Gale: Let me follow up on a couple of those.
What Eric said about retirement accounts, I think it?s right that there?s support for that on both sides of the aisle. It has another huge advantage politically, which is that these various Roth saving incentive plans, whatever they involve, allowing people to roll over existing accounts into the Roth and pay the taxes due on the accounts at the point of the roll-over, they generate revenue within the five year budget window. Of course, they lose--they take that revenue from beyond the five year budget window. But for purposes of budget accounting, that?s a huge advantage, because it gives you money to play with.
And so I think it?s quite likely that something will happen there.
I forget who said it, Kevin or Eric. But I agree completely with the proposition that at the end of the year the tax code will be more complicated than it is at the beginning of the year. And retirement accounts are becoming an area of increasing complexity. I think there?s also a prospect for some programs or tax credits relating to education. It?s one of the few things that Republicans are willing to spend resources on, and Democrats, or at least the Clinton administration clearly supports it as well. I don?t know exactly what would happen, but there?re proposals floating around, around out there, and I wouldn?t be surprised to see something there.
The marriage penalty. That?s an interesting issue. The marriage penalty in the IRS may be for the Republicans what Kevin was saying that Social Security is for the Democrats. That is, they may not want to resolve the problem. They may want to keep it out there so they can beat voters over the head with it in the election. I don?t know, but there?s certainly a lot of bluster about the marriage penalty, and there are solutions out there, but they?re expensive. The penalties raise 28 billion a year or 29 billion a year. Getting rid of that, you know, over the next 10 years, when you count the fact that the amount goes up over time when you count the effect that there?s interest losses, that?s probably a $400 billion cost over the next 10 years.
This is Washington arithmetic; ten times 29 equals 400. But I?m just guessing from other calculations I?ve done if you multiply by 12 you get about the right — 12 to 14; you get about the right 10-year estimate. So we?re talking about 350, 400 billion dollars there to completely eliminate it. And I don?t think we?ll completely eliminate it. I think they?ll probably make some move in that direction as part of some grand, you know, omnibus compromise.
Participant: [Inaudible.]
K. Hassett: Yeah, I was going to ask you that. This thing right here. Is that going to phase out? It?s probably the phase-out of the child credit and the education credit.
W. Gale: Yeah, it?s the phase-out of one of the credits.
[Off-mic comments.]
W. Gale: Call me after lunch. My phone number, 202/797-6000. My RA gave me the list of where each button comes from.
Participant: [Inaudible.]
W. Gale: Right. That?s right. So it was just to get it in. So each one — that?s right. It?s for illustration purposes. And it can be higher, too. So if you have five kids or something, you can get a marginal rate of 90%. So it depends on where you are. Everybody?s got their own skyline too. It?s one of the extras.
Well, great. Thank you.
Participant: [Inaudible.]
K. Hassett: Yeah, a marriage penalty ...
E. Engen: You?re trying to get rid of the bonuses. Okay.
Participant: [Inaudible.]
K. Hassett: Right.
E. Engen: Right.
K. Hassett: Right. Yeah, a marriage bonus doesn?t sound like a bad idea until you realize what it is as a single penalty. And then it doesn?t sound like such a great idea either. But ...
W. Gale: Thank you, everybody.
K. Hassett: All right. All right. Well, thank you. We?re all available for phone calls or whatever if you want to chat more. Except you. You have to work on that paper.
[END OF EVENT.]