The Tax Policy Blog

Rep. Luke Messer’s bill, H.R. 668, that would require the president’s annual budget to include the projected cost of deficits per taxpayer passed the house last week. The bill would require a dollar cost per taxpayer, using individuals who file tax returns as the measure. For fun, we’ll look at the cost per person (every man, woman and child), per tax return, and per taxable tax return.

Using historical data and the most recent CBO Budget and Economic Outlook, we’ll take a look what that number would look like in future years, the additional amount Americans would have had to pay in taxes to cover the deficit at current spending levels, and how the deficit has changed over time.

First, a little history: as a percentage of GDP, the graph below shows that with the exception of World War I and II and the Great Depression, the United States’ deficit hovered around 0%, switching between surplus and deficit, until about 1970. From 1971 on, the U.S. experienced an average deficit as a percentage of GDP of 3.1%. Since 2001, our last year of surplus, our average deficit as a percentage of GDP has been 4.7%, with an average of 8.7% over the last four years.

In 2009, the United States’ deficit was 10.1% of GDP. In other words, this means that every American would have had to pay an additional 10.1% of their salary to cover the cost of government - the highest percentage of the average salary in America since 1945 when the deficit was 21.5% of GDP. Over the CBO’s current budget window (2013-2023), we see that ratio drop down to 2.4% in 2017 before it increases each year from 2018 to 2022.

In dollar terms – which the bill uses – the picture looks similar. From 1998 to 2001, the federal government experienced four years of surplus, but from 2002 through the end of the 2023, every year is projected to be in the red (as shown in the Deficit/Surplus Per Person graph below).

When we break this down by cost per person, the greatest the deficit reached was $4,605 per person in 2009. Over the CBO’s current budget window, the deficit would be cut to $1,338 per person in 2015 before increases every year until it reaches $2,864 per person in 2023. 

This means to cover the deficit for 2013, every person counted (projected) in the census would need to pay an additional $2,670 a year. If we only consider those who are liable to pay taxes (i.e. exclude nonpayers), every person with a taxable income tax return would need to pay an addition $8,748.03 in federal income taxes to cover the deficit.

By 2023, the tax increase needed to cover the projected levels of spending is projected as $2,864.37 per person, $5,904.43 per tax return, or $9112.17 per taxable tax return. All three comparisons, over the budget window, are shown in the graph below.

Notes: Population projections taken from U.S. Census. Budget and GDP projections taken from CBO and the Office of Budget and Management. Tax Return data taken from IRS. Methodology on tax returns and taxable tax return projections: For total tax return, the projections are a linear extrapolation based available data of total tax returns (1995-2010). For taxable tax return projection, the percent of taxable tax returns compared to total tax returns was taken from 2003 to 2010. The year 2003 is chosen as start year to reflect tax changes beginning in 2003, the majority of which remain in place through the present day. 

Every speech I give, every panel I’m on, every trends piece I write nowadays includes my prediction that federal aid to the states will drop in future decades. Many people—including many state legislators—are astonished to learn that states rely on federal aid for about one-third of their budgets. (See state-by-state here.) As the feds start looking around for deficit reduction opportunities, I see aid to the states as easily on the chopping block. I try not to run from my past failed predictions, so we’ll all see if I’m right or wrong in a few years.

However, this remains a prediction about the future, as evidenced by new information put out (PDF) by Federal Funds Information for States (FFIS) and forwarded by the National Conference of State Legislatures (NCSL).

FFIS estimates that pre-sequester, federal aid to states in Fiscal Year 2013 would have totaled $607.2 billion, a 2.5 percent increase over the $592.3 billion in 2012. The March sequester “cuts,” fully in effect, would pare that back to $601.2 billion, a 1.5 percent increase over 2012. So it’s not so much “cuts” as a less generous increase.*

Table: Federal Aid to States

Note: Includes both March 1 sequester (reductions due to the “Supercommittee’s” failure to achieve $1.2 trillion in deficit reduction) and the March 27 sequester (reductions due to Congress exceeding FY 2013 spending caps).

Source: FFIS; NCSL.

Apparently NCSL’s executive director didn’t get the memo, as he penned an op-ed today decrying the sequester cuts and calling for higher state taxes “to help ease the burden.” I'm not sure whose burden he's talking about.

*Note: Nine states actually will see a drop in federal aid due to the sequester, primarily because their increase over 2012 had been planned to be so low and the sequester pushes it negative: Illinois, Kentucky, Minnesota, New Mexico, North Dakota, South Carolina, South Dakota, Washington, and Wyoming, as well as the District of Columbia, Guam, the Northern Mariana Islands, and the Virgin Islands. Six states were seeing a cut in federal funds anyway: Connecticut, Indiana, Louisiana, Maine, Massachusetts, and Missouri, as well as American Samoa.

In recognition of International Women’s Day, we would like to honor the contributions that women have made to the advancement of economics and taxation theory and policy. Although many women have facilitated progress in our understanding of economics and taxation, as the first (and only) woman to receive the Nobel Prize in Economics, Elinor Ostrom’s contributions and work provides an excellent example of the critical role women have played in the field. Her work on governance issues continues to be highly relevant as these are addressed in national, state, and local debates.

Dr. Ostrom’s work on common-pool resource problems and her models on public goods and public choice have provided insight for a wide variety of topics including budget appropriations and taxation. For example, budget allocation in academic research has often been described as a budgetary commons. A discrepancy between the perceived and actual costs of a budgetary outlay occurs because participants internalize the full benefit of the outlay, but costs are dispersed through taxation to the whole public. Thus, some claim that a tragedy of a commons results. Ostrom’s work focusing on natural common-pool resources cautioned against this oversimplification because it often results in inappropriate policy enactment. Therefore, she described a variety of factors that distinguish the complex and multiple problems or dilemmas facing common-pool issues like taxation and appropriations.

Finally, her studies of self-governing common resource pools find that characteristics that foster their success include a long time horizon, a lower discount rate, a stable membership, accurate information regarding the resource’s condition, correct projections of future benefits and cost, and consideration of local conditions or norms.

Ostrom’s contributions to our understanding of common-pool resources will continue to facilitate policy making to ensure that appropriate policy prescriptions are enacted by policy makers regarding inlays and outlays of governing bodies and has laid the foundation for many more women economists to influence and change how we perceive economic problems in the future.

At the Tax Foundation, we have been grateful for the contributions of many pioneering women in the fields of economics and tax policy from under our own roof. In the early 1940s, we were joined by several women, including Jo McBay, senior researcher, Phoebe C. Main, junior researcher, and Mary Fernholz, statistician. Since that time, we have strived to ensure that women are not only adequately represented in our field, but also respected in our field. From Elsie Watters’ unparalleled study of unemployment insurance systems in the 1980s to Elizabeth Malm’s current stewardship of our Annual State-Local Tax Burden Rankings and her news-making work debunking bad state tax policy proposals, women have made an indelible mark on our work.

We are pleased on this day, and every day, to honor these path-blazing, brilliant women who continue to demonstrate to the world that, to paraphrase President Obama’s proclamation, no wall or ceiling will keep our daughters, our sisters, our mothers from their dreams.

The IRS just released preliminary data on tax year 2011, showing total returns filed increased to 145.6 million from 142.9 million in 2010.  Taxable returns, those who paid taxes, increased to 91.8 million from 84.5 million in 2010.  That means in 2011 about 63.1 percent of tax filers owed federal income tax, or oppositely, 36.9 percent were nonpayers.

While these numbers are returning to historic norms, as the economy recovers, taxable returns continue to be about where they were in the late 1980s and 1990s (see the chart below).  This is mainly because of successive expansions of refundable tax credits, such as the earned income tax credit and child credit, which have knocked millions from the tax rolls.

The fact that the number of people actually paying federal income tax has been flat for about 20 years, while federal spending has skyrocketed, explains much of our current fiscal predicament.

Follow William McBride on Twitter @EconoWill 

This week's map shows the state sales tax rate, plus the average local rate, for each state in the U.S, as of the beginning of this year.  Tennessee has the highest average combined rate at 9.44%; at the other end are states with no sales tax: Delaware, Montana, New Hampshire, and Oregon.

Click on the map to enlarge it.

View previous maps here.

On February 28, South Dakota Gov. Dennis Daugaard (R) signed legislation withdrawing his state from the Multistate Tax Commission (MTC). South Dakota's move follows similar legislation signed by California Gov. Jerry Brown (D) on June 28 (S.B. 1015), and precedes a bill (S.B. 247) rapidly advancing through the Utah Legislature to do the same.

What is the MTC and why are some of their state members starting to race for the exits?

The MTC was founded in 1967 as part of the Multistate Tax Compact. It was created after Congress became irritated at the utter mess of conflicting and complex rules for interstate business taxation, and threatened to impose a modest basic framework: one standard apportionment formula that all states had to use in divvying up corporate profits for taxation. Fearful that this was the camel's nose into the tent, states set up the MTC to hammer out a self-enforcing rule on their own without Congress's interference.

But not for long: today, as the MTC itself admits, “39 of the 47 states with a corporate income tax” have abandoned this original uniform formula. States, pressured by in-state businesses, have modified their tax rules to measure taxes owed by sales in a state rather than property oremployees, as had been done in the past. Despite eager MTC efforts to draft model legislation and set up working committees on important state tax issues--controversial as the MTC's voting membership consists only of state tax officials--state tax systems have continued to move further and further away from tax base and regulatory uniformity.

That may mean the MTC isn't effective at its mission, but that isn't usually enough reason for states to start leaving. That came about after one company dusted off its copy of the MTC compact and found that it gives taxpayers in MTC member states the option to use the old uniform apportionment formula rather than whatever formula might be in state law. California is an MTC member state, and the Gillette Company says it wants to use that old uniform formula even though it’s not authorized by state law. The courts agreed with Gillette, and to prevent other companies from invoking the provision, California left.

MTC's brief in the case did a disservice to its important mission, contorting itself to downplay the importance of uniformity and the relevance of language in its own founding document. The brief dangerously argued that compacts need not be adhered to by states in full, provoking other multistate compacts to warn that states do not have the power to unilaterally change the terms of a compact. The MTC has also gotten into a war of letters with the National Conference of State Legislatures (NCSL), which is critical of the insular nature of MTC decision-making.

Whether the MTC changes itself to survive or dies out (a two-day meeting later this month will consider watering down uniformity requirements in the Compact), some effort to bring about simplification and uniformity is essential. State tax officials are unlikely to lead such an effort, because despite any lip service to the concept, they shirk from it whenever it means actual changes to how a state does things. With state tax officials clamoring for more authority to tax interstate business income and sales, Congressionally-mandated simplification efforts (and not just vague state-enforced promises of uniformity) need to be a part of the mix.

The sequester saga revealed a lot about how political rhetoric can get detached from reality.  Unfortunately, the sequester is just the beginning of what is likely to be a long and drawn out debate about how best to reduce deficits and debt while growing the economy.  To bring the most recent evidence to bear, today we released Economic Effects of the Sequester and the Proposed Alternatives: What is the Evidence on Spending and Economic Growth?   There are three main conclusions:

1)      The sequester will likely reduce economic growth in the short run, but much less than most are predicting, including the CBO.  The best estimates indicate the sequester will shave about 0.3 percentage points off GDP growth this year, but the economy will quickly recover and within two years will begin to show the positive effects of deficit reduction and a more efficient allocation of resources.

2)      However, even this modest short run pain could be reduced or avoided by broadening the spending cuts to include mandatory spending, such as Social Security, Medicare, and Medicaid.  These long run drivers of spending and debt are simply unsustainable and without reform will continue to take over a larger and larger share of the budget (see chart below).

3)      The worst option of all, according to a huge preponderance of evidence, is to replace the sequester spending cuts with higher income taxes. 

Follow William McBride on Twitter @EconoWill