With the fiscal cliff looming in the near distance, House Speaker John Boehner has signaled a willingness to accept new revenues as a measure of good faith in negotiating a meaningful deal to reducing the federal deficit.
While raising new revenues may be the politically necessary to seal a deal with President Obama, the Speaker and his colleagues must keep in mind that not all revenue raisers are equal. Some methods of raising revenues will have far more harmful economic consequences than others.
Indeed, after careful study, OECD economists have established a hierarchy of which taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. es are most and least harmful for long-term economic growth. They determined that the corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. is the most harmful for long-term economic growth, followed by high personal income taxes. Consumption taxA consumption tax is typically levied on the purchase of goods or services and is paid directly or indirectly by the consumer in the form of retail sales taxes, excise taxes, tariffs, value-added taxes (VAT), or an income tax where all savings is tax-deductible. es and property taxA property tax is primarily levied on immovable property like land and buildings, as well as on tangible personal property that is movable, like vehicles and equipment. Property taxes are the single largest source of state and local revenue in the U.S. and help fund schools, roads, police, and other services. es were found to be less harmful to economic growth relative to taxes on capital and income.
Why this hierarchy? It is determined by which factors are most mobile and, thus, most sensitive to high tax rates. Capital is the most mobile factor in the economy and, therefore, most sensitive to a hike in tax rates. Naturally, land is the least mobile and less sensitive to high tax rates. This is not to say that high taxes won’t affect consumption and property patterns, but simply less so than the impact of taxes on capital and income.
With these rules of thumb in mind, here is a short list of ways of raising new revenues listed from least harmful to most harmful:
#1 Least Harmful: Pro-growth Reform
This may seem like a no-brianer, but whether or not we have enough new economic growth to generate more revenues for the Treasury is directly dependent upon some of the policy choices listed below.
#2 Asset Sales
The U.S. federal government owns hundreds of billions worth of assets that it can, and should, sell off in order to pay down the national debt. As of 2008, the Office of Management and Budget reported public lands worth $833 billion and loans worth $209 billion. Other state-owned enterprises such as Amtrak, the Power Marketing Administration utilities, and the Tennessee Valley Authority could all generate considerable cash on the open market. The biggest benefit of asset sales is turning tax-subsidized enterprises into tax-generating ones.
#3 User FeeA user fee is a charge imposed by the government for the primary purpose of covering the cost of providing a service, directly raising funds from the people who benefit from the particular public good or service being provided. A user fee is not a tax, though some taxes may be labeled as user fees or closely resemble them. s and Leases
Lawmakers could raise billions with no harm to the economy by raising user fees for many of the goods and services it provides (such as flood insurance, inland waterways, National Parks, and loan originations) and opening up more public lands for oil and mineral leasing. In 2008, OMB reported that federal mineral rights were worth $1.062 trillion. They are probably worth more today.
#4 Premium and Co-pay Increases
Increasing Medicare premiums and co-payments are not likely to be politically popular, but asking seniors to contribute more toward their federal health insurance would be far less harmful to the economy than a broad-based income tax. Even if these policies were means-tested, they might actually add a measure of market forces into a system that has few. According to CBO, increasing the Medicare premium for Part B to 35 percent from 25 percent, could raise more than $240 billion over ten years. (Again, Congress’s arcane budget rules count these payments as a reduction in mandatory spending, not new revenues, but the effect is the same.)
#5 A Federal Employee Contributions
As most private employers are now doing, the federal government should ask federal employees to contribute more to their own health care and retirement costs. (Congress’s arcane budget rules also count these contributions as a reduction in spending, not new revenues, but they are good policy anyway.)
#6 Sales/Excise TaxAn excise tax is a tax imposed on a specific good or activity. Excise taxes are commonly levied on cigarettes, alcoholic beverages, soda, gasoline, insurance premiums, amusement activities, and betting, and typically make up a relatively small and volatile portion of state and local and, to a lesser extent, federal tax collections. es
Unlike the states, the federal government does not rely much on sales or excise taxes – excise tax revenues amount to about 3 percent of total federal revenues. The largest of which are the federal gasoline tax ($38.7 billion), tobacco taxes ($16.5 billion), airport and ticket taxes ($11.6 billion), and alcohol taxes ($9.6 billion). Increasing current excises or creating a new one would not be costless, but less so compared to higher income taxes.
This is a tricky one because while everyone talks about broadening the tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. and eliminating “spending” in the tax code, the truth is that not all tax preferences are created equal (see untouchables below). From an economic perspective, eliminating tax preferences produces less harm than increasing marginal tax rateThe marginal tax rate is the amount of additional tax paid for every additional dollar earned as income. The average tax rate is the total tax paid divided by total income earned. A 10 percent marginal tax rate means that 10 cents of every next dollar earned would be taken as tax. s, but caution is also in order.
- Eliminate industry subsidies, targeted tax preferences, and refundable credits first: Industry subsidies can include such things as the special exemption for credit unions, credits for hybrid vehicles and energy efficient windows; and tax-exempt bonds for private nonprofit educational facilities. The IRS now gives out over $100 billion in refundable credits to taxpayers who have no income tax liability. Limiting those to the most needy could save billions.
- Tax employer–provided health care benefits: This exemption is the single largest tax preference at roughly $128 billion per year. Taxing these currently untaxed employee compensation would be good policy, but should be paired with other market-based reforms.
- Restoring PEP and Pease: Tax Foundation economists have estimated that restoring the phase-outs of personal exemptions and itemized deductionItemized deductions allow individuals to subtract designated expenses from their taxable income and can be claimed in lieu of the standard deduction. Itemized deductions include those for state and local taxes, charitable contributions, and mortgage interest. An estimated 13.7 percent of filers itemized in 2019, most being high-income taxpayers. s (the PEP and Pease provisions) for taxpayers with more than $250,000 in AGI (joint filers) and $200,000 (single filers) would lower GDP by 0.03 percent over a five to ten year period. These measures typically raise the effective marginal tax rates by about 1 to 4 percent for families of various sizes while their incomes are in the phase-out range, above which rates return to the normal statutory levels.
- Capping deductions: Mitt Romney’s proposal to cap itemized deductions at $17,000 or $25,000 may have been crude tax policy, but it had the political advantage of avoiding a direct fight with powerful interest groups and it gave taxpayers the choice in deciding which deductions were best for their situation.
- Untouchables: For individuals, don’t eliminate or scale back broad-based savings vehicles such as 401ks, Roth IRAs, or investment incentives such as the reduced rates on dividends and capital gains. For businesses, don’t lengthen depreciationDepreciation is a measurement of the “useful life” of a business asset, such as machinery or a factory, to determine the multiyear period over which the cost of that asset can be deducted from taxable income. Instead of allowing businesses to deduct the cost of investments immediately (i.e., full expensing), depreciation requires deductions to be taken over time, reducing their value and discouraging investment. schedules, eliminate business expensing or depletion, or eliminate deferral.
#8 Allowing “Temporary” Expensing to Expire
The 2010 tax deal gave businesses full expensingFull expensing allows businesses to immediately deduct the full cost of certain investments in new or improved technology, equipment, or buildings. It alleviates a bias in the tax code and incentivizes companies to invest more, which, in the long run, raises worker productivity, boosts wages, and creates more jobs. in 2011 and 50 percent expensing in 2012. These temporary measures are considered “tax cuts,” but in reality they are more like tax shifts. Instead of businesses taking their deductions in future years, they take them now. This timing shift actually produces a long-term revenue loss of nearly zero. The idea behind bonus depreciation is to encourage capital purchases earlier and hopefully encourage the use of that capital to increase production. This is what happened in 2003, leading to an immediate rebound in investment and GDP. But because it was temporary, it mainly borrowed investment from future years when it expired. Full expensing on a permanent basis would permanently shift investment forward, leading to permanently increased production and income. Making full expensing permanent could boost GDP by more than 2.7 percent over the long run, while 50 percent expensing could boost GDP by 1.36 percent.
#9 Raising Top Individual Income TaxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. Rates
In an analysis of President Obama’s tax proposals, Tax Foundation economists estimated that increasing the marginal tax rates in the top two tax bracketA tax bracket is the range of incomes taxed at given rates, which typically differ depending on filing status. In a progressive individual or corporate income tax system, rates rise as income increases. There are seven federal individual income tax brackets; the federal corporate income tax system is flat. s from 33 percent to 36 percent and from 35 percent to 39.6 percent would lower long-term economic growth by 0.44 percent. Our model also showed that for every $1 such a policy would raise for the Treasury, GDP would fall by $2.77. That would seem to be a poor tradeoff.
#10 Raising the Tax Rate on Estates
This ranks worse than raising top individual rates because it is a revenue-loser not a revenue gainer. President Obama’s budget proposed increasing the federal estate taxAn estate tax is imposed on the net value of an individual’s taxable estate, after any exclusions or credits, at the time of death. The tax is paid by the estate itself before assets are distributed to heirs. from the current 35 percent top rate with a $5 million exempt amount to the 2009 levels of a 45 percent top rate and a $3.5 million exempt amount. Tax Foundation economists estimated that this policy would lower GDP by 0.23 percent. While this may seem like a small effect, the loss in GDP is nearly five times the amount of new tax revenue gained from this policy.
#11 Raising Tax Rates on Capital Gains and Dividends
When Tax Foundation economists modeled the long-term effects of increasing the capital gains top rate to 20 percent and letting the tax rate on dividends revert to 39.6 percent for people in the top two brackets, they found that this policy would lower GDP by 2.15 percent and that it would not raise any new tax revenues because of its depressive effects.
#12 Most Harmful: Raising Corporate Income Tax Rates
Because the U.S. currently has the highest corporate income tax rate in the industrialized world, no one is proposing to boost the corporate tax rate. However, President Obama’s Framework for Corporate Tax Reform did contain a number of base-broadening measures to offset his proposed reduction in the corporate tax rate. After modeling these proposals, Tax Foundation economists concluded that these measures would more than erase any of the positive economic benefits of cutting the corporate tax rate.
If lawmakers are convinced that new revenues must be part of any long-term effort to solve the budget crisis, they must choose the least harmful way of raising new revenues or else they risk compounding the crisis by slowing economic growth. The above list of revenue measures is hardly complete, but it should give lawmakers some rules of thumb on how to avoid the most economically harmful revenue options.Share