Why have a Value Added Tax?

As the debate on how to get out of the current debt crisis goes on, the question of whether a Value Added Tax (VAT) will be part of the solution comes up with more frequency that what was expected even a year ago. It is among the main solutions offered by the Bipartisan Policy Commission in its debt reduction plan, among others. As this discussion goes forward, we need to raise the question of whether the VAT will provide enough value added for this to be a good idea.

One key advantage a VAT has is that it makes everyone conscious of being taxed. This is especially important given conservative objections to the fact that 51% of families pay no income tax at all. While most pay payroll taxes, at the lower end, the Earned Income Tax Credit essentially cancels out that payment, provided the primary wage earner actually files taxes. Instituting a VAT makes everyone conscious of paying taxes, especially if the tax is made visible on the receipt, as if it were a retail sales tax, like the proposed Fair Tax.

The key objection to both the Fair Tax and a VAT is that it forces the poor to pay taxes, to which advocates for both plans counter with a proposed “prebate” to give a direct subsidy to some or all families an amount equal to what they would pay in taxes at a subsistence level. Of course, making households file for a prebate may defeat another purpose of the VAT – the desire to spare families, especially poor, less literate, families from having to file any kind of disclosure – which often requires that they pay a preparer to help them – with preparers often offering refund anticipation loans at rates that more savvy borrowers would not pay. Indeed, if a prebate were enacted, would prebate anticipation loans be far behind?

One reason many are for a VAT is the hope that it will increase revenues. This can be done much easier by literally doing nothing and letting the Clinton era tax rates return for everyone on January 1, 2013. Most forecasters predict that would bring the budget into primary balance (where we merely borrow to cover the interest but not operations). I suspect that, because forecasters tend to estimate conservatively, going back to Clinton era rates may even balance the budget and allow the country to begin paying down the debt (and repatriating American jobs, since without a debt to buy, our trading partners would have to start buying American products).

Another major benefit of a VAT is that it functions as a tariff because it is fully collected on imports and zero-rated for exports. It is an implicit transfer to American workers, who could use a transfer right now – especially because many of our trading partners have a VAT which functions in this way, making our income tax based system a hidden tax which makes our products uncompetitive. Labor should be for this tax in a big way, but so far has not been – probably because organized labor has been converted to a movement for workers into an arm of the Democratic Party establishment. This brings us back to the question of why the left has not embraced it?

The reason tax reform with a VAT has not caught fire on the left is because it deals in half measures. It is not enough to simply increase visibility if the cost of doing so keeps the current paperwork burden largely in place, or to merely hold the poor and the middle class harmless, especially given the transition costs for doing comprehensive tax reform.

In Europe, which has a strong VAT and income tax system, families with children receive a sizeable subsidy that goes farther than offsetting tax liability for the VAT – as Bruce Bartlett reports in his New York Times Economix column of June 7, 2011, it offsets nearly all tax liability for the average family and essentially gives everyone a middle class life style. (http://economix.blogs.nytimes.com/2011/06/07/health-care-costs-and-the-tax-burden/). That level of subsidy is what it would take to make the effort of enacting a VAT worthwhile. It must, in effect, raise all families out of poverty or it is simply changing the tax system for the sake of change.

I propose a three pronged system for doing this:
• a VAT that everyone pays, except exporters,
• a VAT-like Net Business Receipts Tax (NBRT) that is paid by employers but, because it has offsets for providing health care, education benefits and family support, does not show up on the receipt and is not avoidable at the border,
• a payroll tax to for Old Age and Survivors Insurance (OASI) (unless, of course, we move from an income based contribution to an equal contribution for all seniors), and
• an income and inheritance surtax on high income individuals so that in the short term they are not paying less of a tax burden because they are more likely to save than spend – and thus avoid the VAT and indirect payment of the NBRT.

The parameters of a VAT are well known, so I will not repeat them here, as are the OASI payroll tax. I will primarily focus on the NBRT, which is less discussed. The NBRT will focus just like a VAT as a tax on all wages and profits, but unlike a VAT, it would be receipt invisible because how much is actually paid depends upon the credits available to the business. The NBRT would replace payroll taxes for Hospital Insurance, Disability Insurance, Survivors Insurance for spouses under 60, Unemployment Insurance, the Business Income Taxes, on corporations, business income taxes now collected under the personal income tax system, as well as most of the revenue collected under the personal income and inheritance taxes, less the amount collected under a VAT. The health insurance exclusion now included in the Business Income Tax and other subsidies under the Affordable Care Act. Most importantly, it would fund an expanded and refundable Child Tax Credit.

The expansion of the Child Tax Credit is what makes tax reform worthwhile. Adding it to the employer levy rather than retaining it under personal income taxes saves families the cost of going to a tax preparer to fully take advantage of the credit and allows the credit to be distributed throughout the year with payroll. The only tax reconciliation required would be for the employer to send each beneficiary a statement of how much tax was paid, which would be shared with the government. The government would then transmit this information to each recipient family with the instruction to notify the IRS if their employer short-changes them. This also helps prevent payments to non-existent payees.

The expansion of the child tax credit to $500 per child per month is paid for by ending the tax exemption for children, the home mortgage interest deduction and the property tax deduction. This is more attractive to the housing industry than the alternative proposal, which is to end or limit the credit and use the proceeds to help bring the budget into primary balance. Shifting the benefit in this way holds the housing industry harmless, since studies show that the most expensive cost of adding a child is the need for additional housing.
Assistance at this level, especially if matched by state governments may very well trigger another baby boom, especially since adding children will add the additional income now added by buying a bigger house. Such a baby boom is the only real long term solution to the demographic problems facing Social Security, Medicare and Medicaid, which are more demographic than fiscal. Fixing that problem in the right way definitely adds value to tax reform.

The last question is whether the income and inheritance surtax can be incorporated into the NBRT, as proposed by Lawrence B. Lindsey. While it is feasible, I reject it because it will either lead some to be overtaxed while others are under-taxed or will require a personal financial reporting system that many employees and investors would regard as intrusive if it came at the hands of employers or investments. While there is resistance to letting the government know all of one’s financial details, I am quite certain letting your employer into all your business would be considered worse. What bartender wants to work for a lower wage (if he or she could even find a job) if part of being hired was the requirement to disclose family trust fund income to management, who would have to pay taxes on behalf of that employee at a higher rate? Better to leave the personal income tax in place so that only the government knows who is really rich.

Perspectives on Deficit Reduction: A Review of Key Issues

Comments for the Record

Perspectives on Deficit Reduction: A Review of Key Issues

United States Senate Committee on Finance

Thursday, June 30, 2011, 10:00 AM

215 Dirksen Senate Office Building

Submitted by:

Michael Bindner

Center for Fiscal Equity

Chairman Baucus and Ranking Member Hatch, thank you for this opportunity to provide comments to the Committee. At the Center we are a bit puzzled as to why what is obviously a summary review of the series is being held at this point, when the hearing on Perspectives on Revenue has been postponed, but we will let that pass for now.

In our view, there is only one key issue to consider for deficit reduction – solvency.

At the end of the day, the General Fund, the Social Security Trust Fund and the Medicare Trust Fund must all be left solvent in the long term without major cost shifting unless this leaves both the Treasury and the beneficiaries better off while at the same time simplifying the tax system.

In order to judge whether this occurs, we must first identify the appropriate baseline.

Baseline Issues for Revenue

The most important fact in determining which baseline to use for deficit reduction, especially when focusing on revenues, is the automatic expiration of the 2001, 2003 and 2010 tax cuts on January 1, 2013. As the Center for Budget and Policy Priorities reports, allowing the Bush/Obama tax cuts to expire on schedule will rather automatically cut the deficit to net interest costs - essentially stopping the need for any cuts at all. This solution will only happen, however, if the President and Congress refuse to compromise on the issue of high income tax cuts. Given that most donors are within that income strata, we do not believe it is wise to count on such a refusal – although it would certainly eliminate the need for hearings on deficit reduction.

That fact must still guide the deliberations of Congress on the issue of deficit reduction. Any solution must be as productive in these terms as letting the tax cuts expire automatically.

The complicating factor in simply letting the tax cuts expire is recent poor economic news, which indicates that the events of 2008 were not simply a recession, but a full blown depression. Low tax rates enacted on capital gains, income and dividends during the Clinton and Bush administrations have created two asset based recessions, the first in the technology sector and the second in housing. The recent recession is more accurately described as a Depression, since the financing of the real estate bubble has still not been resolved, even while economic growth numbers have begun to rebound. Until the underwater mortgage problem is dealt wit, recovery will be elusive and efforts to stimulate it with tax cuts will be a grand waste of money. Giving a general tax cut to most households will inadequately assist those families who are burdened with under water mortgages while providing unneeded benefits to the remainder.

The problem of uncertainty is general, but the solution to this uncertainty is to correct the housing market by providing direct assistance to underwater borrowers, either through bankruptcy reforms allowing “cram-downs” on primary residences or through the Federal Reserve buying mortgage backed securities from Freddie Mac, Fannie Mae and other government entities such as the VA and FHA at the value of the underlying assets and then directing servicers to adjust principal balances. Barring such actions, the only real way out is asset inflation as part of general inflation, which would harm the investing community more than reform.

If tax cuts were really the way to stimulate the economy to produce jobs, recent tax cuts would have led to job growth at an all time high rather than faltering. This is obviously not the case. Those high income individuals and businesses who have benefited from these cuts are still not hiring and have no incentive to do so, as their return on current production and savings is adequate at current tax rates to fund their needs. If their taxes were increased, they would have an incentive to expand operations in order to maintain the same level of income. This phenomenon explains why the 1993 tax legislation resulted in the most sustained economic growth in American history, while the tax cuts in subsequent years have ignited three boom-bust cycles (with the recent oil boom being the third) but very little economic growth.

In order to keep the general fund solvent, housing must be dealt with and some agreement must be reached that the baseline by which we measure sovereignty is not current tax rates, but the rates contained in permanent law. If any cuts are made to those rates, they must be balanced with spending cuts.

Of course, we face an even more urgent problem, the solvency of the United States as a whole due to the imminent breaching of the debt limit. This threatens all trust funds, from debt held by the public, to Social Security.

At the very least, the constraints on borrowing to fund the conversion of Social Security trust fund assets to debt held by the public must be dealt with by enacting a clean debt limit extension, or at the very least, automatically allowing the debt limit to increase to facilitate this conversion. The only alternative to this is immediately increasing income taxes before they go up automatically in 2013. While Social Security may not be a legal obligation to retirees, the funds which back it are such an obligation under the 14th Amendment, so it would be unconstitutional to not give their repayment first priority.

Let us be clear that August 4th is not the real deadline which is of concern, but December 31, 2012. The only leverage against automatic tax increases is a deal in advance of their expiration and the only leverage for such a deal is the debt limit extension.

Tax Reform

Tax reform, if undertaken at all, should have the goal of simplifying the collection of revenue while maintaining or improving its basic progressive structure (which in current law is more honored in its breach, given low taxes on capital gains and dividends). The use of the tax code to provide subsidies to working families must be maintained, but this should occur without requiring that every household file a tax return to receive them, often by paying others to do so and paying a premium for refund anticipation loans which are heavily marketed to those least able to afford the finance costs.

On the other hand, the number of people paying no tax as a result of these benefits has justly drawn criticism that a sense of shared sacrifice has been abandoned. This has led many to demand some form of consumption tax so that all are conscious of some sacrifice. Some form of visible consumption tax will also provide an incentive to save to those who otherwise would not because their incomes are too low to do so. The wealthy, however, need no such incentive – having the ability to satisfy all of their current economic needs with additional income to spare.

The Center for Fiscal Equity again offers a four point plan for reaching a long term deal on revenues.

Part One is a Value Added Tax (VAT), which is suggested because of its difficulty to evade, because it can be as visible to the ultimate consumer as a retail sales tax and because it can be zero rated at the border for exports and collected fully for imports. As this feature has been well explained by others, I will not go into detail on this point. What is more important is to exercise care in delineating what is funded by such a tax.

We believe that VAT funding should be confined to funding domestic discretionary military and civilian spending. Zero rating a tax supporting such spending is totally appropriate, as foreign consumers gain no benefit from these expenditures. Likewise, making imports fully taxable for this spending correctly burdens the consumers who fully benefit from these services. As importantly, making such a tax visible provides an incentive to taxpayers to demand less of such spending.

An extreme example of such spending incentives would be the creation of a regional VAT funding regional appropriations, with varying rates depending upon spending levels. While creation of regional appropriations panels and government agencies can be accomplished under the Constitution as currently written, creation of any regional excise would require a constitutional amendment, as the Constitution requires all excises to be uniform.

In order to fully fund current domestic obligations, the Center calculates that the tax rate should be 13.3%. In order for this to be affordable, during the transition, income tax withholding tables should be adjusted to increase net income by the same percentage, with Social Security beneficiaries receiving a similar bump in payments. This is a “balanced budget” rate. It could be set lower if the spending categories funded receive a supplement from income taxes.

Part Two is a VAT-like Net Business Receipts Tax (NBRT). Its base is similar to a VAT, but not identical. Unlike a VAT, and NBRT would not be visible on receipts and should not be zero rated at the border – nor should it be applied to imports. While both collect from consumers, the unit of analysis for the NBRT should be the business rather than the transaction. As such, its application should be universal – covering both public companies who currently file business income taxes and private companies who currently file their business expenses on individual returns.

The key difference between the two taxes is that the NBRT should be the vehicle for distributing tax benefits for families, particularly the Child Tax Credit, the Dependent Care Credit and the Health Insurance Exclusion, as well as any recently enacted credits or subsidies under the Patient Protection and Affordable Care Act (ACA). In the event the ACA is reformed, any additional subsidies or taxes should be taken against this tax (to pay for a public option or provide for catastrophic care and Health Savings Accounts and/or Flexible Spending Accounts).

The Child Tax Credit should be made fully refundable and should be expanded to include revenue now collected under the dependent exemption, the home mortgage interest deduction and the property tax deduction. Transitioning these deductions will allow a $500 per month per child distribution with payroll. It will likely increase incentives to expand affordable housing and may not decrease housing for the wealthy, who are less likely to forgo vacation housing or purchase of luxury housing for wont of a tax cut, as the richest families likely pay the alternative minimum tax anyway, so that they do not fully use this tax benefit now.

This tax should fund services to families, including education at all levels, mental health care, disability benefits, Temporary Aid to Needy Families, Supplemental Nutrition Assistance, Medicare and Medicaid. If society acts compassionately to prisoners and shifts from punishment to treatment for mentally ill and addicted offenders, funding for these services would be from the NBRT rather than the VAT.

An extreme example of this proposal is to have a differential regional rate and differential benefit levels for this tax, which may or may not require an amendment – as this tax may be far enough removed from the transaction level to be considered an income tax rather than an excise.

Again, in the extreme, this tax could also be used to shift governmental spending from public agencies to private providers without any involvement by the government – especially if the several states adopted an identical tax structure. Either employers as donors or workers as recipients could designate that revenues that would otherwise be collected for public schools would instead fund the public or private school of their choice. Private mental health providers could be preferred on the same basis over public mental health institutions.

Employers receive a tax credit if their retirees opt out of Medicare and Medicaid for seniors by fully employer funding of retiree health care, either by hiring doctors or purchasing comparable coverage, including catastrophic coverage in return for some kind of tax credit.

This proposal is probably the most promising way to decrease health care costs from their current upward spiral – as employers who would be financially responsible for this care through taxes would have a real incentive to limit spending in a way that individual taxpayers simply do not have the means or incentive to exercise. While not all employers would participate, those who do would dramatically alter the market. In addition, a kind of beneficiary exchange could be established so that participating employers might trade credits for the funding of former employees who retired elsewhere, so that no one must pay unduly for the medical costs of workers who spent the majority of their careers in the service of other employers.

Conceivably, NBRT offsets could exceed revenue. In this case, employers would receive a VAT credit.

It is not appropriate for this tax to be zero rated, as doing so would decrease the incentive to pass these tax benefits to employees. As importantly, the tax benefits and government services provided under this tax go to workers and their families. As such, overseas purchasers accrue benefits from these services and should therefore participate in their funding.

If the NBRT is enacted in this way, the United States should seek modification to our trade agreements to require that similar expenditures not be funded with taxes that are zero rated at the border. As foreign consumers benefit from subsidies for American families, American consumers benefit from services provided to overseas workers and their families.

This benefit should be recognized in international tax and trade policy and American workers should not be penalized when other nations refuse to distribute the cost of benefits to foreign workers to the American consumers who receive the benefit of these services. If our trading partners do not match this initiative, some items of spending could be shifted from NBRT funding to VAT funding, so that we are not making unilateral concessions in this area.

The VAT would replace income taxes collected at the lowest rate, while the NBRT would replace disability insurance, hospital insurance, the corporate income tax, business income taxation through the personal income tax and the mid range of personal income tax collection, effectively lowering personal income taxes by 25% in most brackets. Note that collection of this tax would lead to a reduction of gross wages, but not necessarily net wages – although larger families would receive a large wage bump, while wealthier families and childless families would likely receive a somewhat lower net wage due to loss of some tax subsidies and because reductions in income to make up for an increased tax benefit for families will likely be skewed to higher incomes. For this reason, a higher minimum wage is necessary so that lower wage workers are compensated with more than just their child tax benefits.

The NBRT rate is projected to be 27% before offsets for the Child Tax Credit and Health Insurance Exclusion, or 33% after the exclusions are included. This is a “balanced budget” rate. It could be set lower if the spending categories funded receive a supplement from income taxes.

Part Three is the continuation of a payroll tax for Old Age and Survivors Insurance (although insurance for survivors under age 60 may be shifted to the NBRT). Given the across the board decrease in gross income, the tax rate would have to be increased to 6.5% for employees and employers (provided younger survivors are excluded). To improve program progressivity, the employer contribution could be credited on an equal basis, moving redistributive effects from benefit distribution to revenue collection. Additionally, the amount subject to tax should be increased or the income cap eliminated, which would help both program income and support for lower income retirees. I have addressed this issue more fully in prior comments dated May 17, 2011, which I will not repeat here.

Part Four is surtax on high income earners and heirs. It would replace the Inheritance or Death Tax by instead taxing only cash or in-kind distributions from inheritances but not asset transfers, with distributions remaining tax free they are the result of a sale to a qualified Employee Stock Ownership Plan.

In testimony before the Senate Budget Committee, Lawrence B. Lindsey explored the possibility of including high income taxation as a component of a Net Business Receipts Tax. The tax form could have a line on it to report income to highly paid employees and investors and pay a surtax on that income.

We considered and rejected a similar option in a plan submitted to President Bush’s Tax Reform Task Force, largely because you could not guarantee that the right people pay taxes. If only large dividend payments are reported, then diversified investment income might be under-taxed, as would employment income from individuals with high investment income. Under collection could, of course, be overcome by forcing high income individuals to disclose their income to their employers and investment sources – however this may make some inheritors unemployable if the employer is in charge of paying a higher tax rate. For the sake of privacy, it is preferable to leave filing responsibilities with high income individuals.

This surtax could have few rates or many rates, although I suspect as rates go up, taxpayers of more modest means would prefer a more graduated rate structure. The need for some form of surtax at all is necessary both to preserve the progressivity of the system overall, especially if permanent tax law enacted before 2001 is considered the baseline (which it should be) and to take into account the fact that at the higher levels, income is less likely to be spent so that higher tax rates are necessary to ensure progressivity.

This tax would fund net interest on the debt, repayment of the Social Security Trust fund, any other debt reduction and overseas civilian, military, naval and marine activities, most especially international conflicts, which would otherwise require borrowing to fund. It would also fund transfers to discretionary and entitlement spending funds when tax revenue loss is due to economic recession or depression, as is currently the case. Unlike the other parts of the system, this fund would allow the running of deficits.

Explicitly identifying this tax with net interest payments highlights the need to raise these taxes as a means of dealing with our long term indebtedness, especially in regard to debt held by other nations. While consumers have benefited from the outsourcing of American jobs, it is ultimately high income investors which have reaped the lion’s share of rewards. The loss of American jobs has led to the need for foreign borrowing to offset our trade deficit.

Without the tax cuts for the wealthiest Americans, such outsourcing would not have been possible. Indeed, there would have been any incentive to break unions and bargain down wages if income taxes were still at pre-1981 or pre-1961 levels. The middle class would have shared more fully in the gains from technical productivity and the artificial productivity of exploiting foreign labor would not have occurred at all. Increasing taxes will ultimately provide less of an incentive to outsource American jobs and will lead to lower interest costs overall. Additionally, as foreign labor markets mature, foreign workers will demand more of their own productive product as consumers, so depending on globalization for funding the deficit is not wise in the long term.

Identifying deficit reduction with this tax recognizes that attempting to reduce the debt through either higher taxes on or lower benefits to lower income individuals will have a contracting effect on consumer spending, but no such effect when progressive income taxes are used. Indeed, if progressive income taxes lead to debt reduction and lower interest costs, economic growth will occur as a consequence.

Using this tax to fund deficit reduction explicitly shows which economic strata owe the national debt. Only income taxes have the ability to back the national debt with any efficiency. Payroll taxes are designed to create obligation rather than being useful for discharging them. Other taxes are transaction based or obligations to fictitious individuals. Only the personal income tax burden is potentially allocable and only taxes on dividends, capital gains and inheritance are unavoidable in the long run because the income is unavoidable, unlike income from wages.

Even without progressive rate structures, using an income tax to pay the national debt firmly shows that attempts to cut income taxes on the wealthiest taxpayers do not burden the next generation at large. Instead, they burden only those children who will have the ability to pay high income taxes. In an increasingly stratified society, this means that those who demand tax cuts for the wealthy are burdening the children of the top 20% of earners, as well as their children, with the obligation to repay these cuts. That realization should have a healthy impact on the debate on raising income taxes.

Again, thank you for the opportunity to submit these comments for the record.

Complexity and the Tax Gap

Comments for the Record

Complexity and the Tax Gap:

Making Tax Compliance Easier and Collecting What’s Due

United States Senate Committee on Finance

Tuesday, June 28, 2011, 10:00 AM

215 Dirksen Senate Office Building

Submitted by:

Michael Bindner

Center for Fiscal Equity

Chairman Baucus and Ranking Member Hatch, thank you for this opportunity to provide comments to the Committee. We will leave it to other expert witnesses to describe how such options as the Value Added Tax (VAT) and a VAT-like Net Business Receipts Tax (NBRT) can be useful in providing incentives to accurately report taxes at every stage of the production process.

It is likely that for many, this unavoidability of payment is one of the reasons such taxes are opposed. These features are also one of the main reasons that these options are superior to the so-called Fair Tax, which will likely increase the tax gap because many items which are in fact purchased for end use will be accounted for as wholesale in order to avoid taxation. If taxes are paid at each stage of production, this problem does not exist. Of course, analysis of how VAT systems are actually implemented suggests that the VAT is no panacea in stemming tax avoidance, especially if multiple rates and loopholes are present in the system.

At the Center for Fiscal Equity, we marvel at strength of the myth that if only the Tax Gap were eliminated, all would be right with the world of federal finance. Indeed, part of the mythos behind the Fair Tax is that finally prostitutes and drug dealers would be paying their fair share of taxes under this plan.

This assertion is patently false and misunderstands the relationship between consumption taxes and income taxes. Income taxes are essentially a hidden consumption tax, especially when one is purchasing from a business with federal and state tax identification numbers. Most employees in these cases never see that portion of their earnings which go to pay Federal Income, State Income, FICA, and Hospital Insurance payroll taxes. These monies essentially go from sales or other revenues right to federal and state governments, along with any sales taxes collected.

Unless prostitutes and drug dealers obtain tax ID numbers and report taxes as businesses under a Fair Tax, a VAT or a VAT-like NBRT, their payment of such taxes as consumers will likely be no different than their current indirect payment of the income and payroll taxes of those from whom they purchase goods and services.

Waiters, bartenders and the self-employed are also no more likely to pay more under tax reforms designed to eliminate the tax gap. Rather, these reforms can best close the tax gap by simply trying to collect taxes from them if their income falls under a certain threshold. This allows the government to set appropriate rates without the expectation that better enforcement might lead to a balanced budget.

There one more issue we would like to put on the record in this debate, however: the question of who is an employee and who is an independent contractor. Waiters are often considered semi-independents, especially when tips are left in cash rather than added to the bill and paid with credit cards. In many more advanced companies, part time contractors and even essentially full time employees are hired as contractors or independent brokers, even though all of their efforts are dedicated to a single wholesaler or customer. The insurance and home cosmetic industries are prime examples of workers who are essentially employees operating and reporting as if they were independents. This is done to minimize benefits paid and to force the burden of tax reporting onto these employees, thus fueling the problem of low compliance.

Limits on revenue could be used to essentially keep these vendors outside the tax collection system. It could be called an Avon Lady exemption. In a VAT system, enacting such an exemption would lead to little tax loss, as the entire supply chain leading up to these vendors would still pay tax. This would not be the case under a Fair Tax system. Indeed, in a Fair Tax system, Congress would likely be required to consider such vendors employees of the supplying firm in order to realize all potential tax revenue from these industries.

The Center has outlined the NBRT to this Committee and its companion in the other body on more than one occasion. One of the strengths of this tax is that it can be used to preserve both the health insurance exclusion and an expanded child tax credit – and potentially could lead to a wide variety of tax expenditures designed to shift the funding of social services from the public sector to the private sector. This strength cannot be realized, however, when the sales force or consultants are considered outside vendors, nor would leaving such individuals outside the franchising company eliminate the need for them to file taxes as business owners. To the extent that ease of compliance is a goal of tax reform, reconsidering the issue of who is considered an employee must take place.

Thank you for this opportunity to provide comments to the Committee.

Hearing on Social Security’s Finances

Comments for the Record

House Ways and Means Committee

Subcommittee on Social Security

Hearing on Social Security’s Finances

Thursday, June 23, 2011

by Michael Bindner

The Center for Fiscal Equity

Chairman Johnson and Ranking Member Becerra, thank you for the opportunity to submit my comments on this topic.

The sources of Social Security’s revenues

We will leave it to the government’s witnesses to explain how Social Security was initially funded with payroll taxes, to the extent that revenues were used by the general fund until original participants retired or the general agreement on increasing tax rates with time in order to build up revenue streams to so that the program would be self funding.

We will add, however, that Social Security was part of a new social compact which, along with very high marginal tax rates and partnership with organized labor, built the middle class while keeping corporate capitalism in place. In a very real way, these programs were a reaction to not only the Great Depression, but a preventative to a very real movement toward more direct employee control and ownership of the workplace by the union movement. The passage of Taft-Hartley Act restrictions on concentrated ownership of the workplace were set in place as much to protect management from being swept away as they were a desire to diversify pension assets to protect workers.

This social context is important to understanding options for the future of Social Security.

How those sources have changed over time

As the advisory for this hearing stated, payroll taxes began at the 2% level for employers and employees, with increasing rates and income caps over time to accommodate the growth of the number of covered retirees from zero to entire generations.

In the early 1980s, Social Security was close to having to draw from the General Fund. Ronald Reagan’s conservatism was ascendant, with recently passed income tax cuts being phased in over a three year period and a beginning of the end of the bargain with the union movement to maintain labor peace in exchange for not pushing for a larger ownership share. Indeed, for all practical purposes, labor had become de-radicalized over time. It had moved to seeking to preserve benefit levels rather than advancing the interests of workers into the management suite.

In this context, a new grand bargain was created to save Social Security. Payroll taxes were increased to build up a Trust Fund for the retirement of the Baby Boom generation. The building of this allowed the government to use these revenues to finance current operations, allowing the President and his allies in Congress to honor their commitment to preserving the last increment of his signature tax cut, where the only other realistic option at the time was to abandon some or all of them, which was politically unacceptable given Republican control of the White House and the Senate.

Options for change and their impacts

Actions should be taken as soon as possible, especially when they must be phased in, as it is a truism that a little action early will have a larger impact later.

This trust fund is now coming due, with the expectation that shortfalls in Social Security payroll taxes will be covered by both income from interest income from the Social Security trust fund and eventually revenue from the general fund. The cash flow problem currently experienced by the Trust Fund is not the Trust Fund’s problem, but a problem for the Treasury to address, either through further borrowing – which will require a quick resolution to the debt limit extension or through higher taxes on those who received the lion’s share of the benefit’s from the tax cuts of 1981, 1986, 2001, 2003 and 2010. At some point, Congress must ignore the interests of its major donors (to both parties) and honor the bargain it made to shore up the trust fund. This is entirely appropriate, given the fact that much of the Trust Fund was built up in order to preserve the income tax cuts of 1981.

As luck would have it, adequate personal income tax increases to finance repaying the Trust Fund will occur automatically on January 1, 2013. This revenue profile, not current tax rates, must be considered the baseline on which any new bargain is formed.

The complication, and there are always complications, is that low tax rates enacted on capital gains, income and dividends during the Clinton and Bush administrations have created two asset based recessions, the first in the technology sector and the second in housing.

The recent recession is more accurately described as a Depression, since the financing of the real estate bubble has still not been resolved, even while economic growth numbers have begun to rebound. This new has both temporary and permanent effects on the trust fund’s cash flow. The temporary effect is a decline in revenue caused by a slower economy and the temporary cut in payroll tax rates to provide stimulus.

The permanent effect is the early retirement of many who had planned to work longer, but because of the recent recession and slow recovery, this cohort has decided to leave the labor force for good when their extended unemployment ran out. This cohort is the older 99ers who need some kind of income now. The combination of age discrimination and the ability to retire has led them to the decision to retire before they had planned to do so, which impacts the cash flow of the trust fund, but not the overall payout (as lower benefit levels offset the impact of the decision to retire early on their total retirement cost to the system).

At the very least, the constraints on borrowing to fund the conversion of Social Security trust fund assets to debt held by the public must be dealt with by enacting a clean debt limit extension, or at the very least, automatically allowing the debt limit to increase to facilitate this conversion. The only alternative to this is immediately increasing income taxes before they go up automatically in 2013. While Social Security may not be a legal obligation to retirees, the funds which back it are under the 14th Amendment, so it would be unconstitutional to not give their repayment first priority.

Let us be clear that August 4th is not the real deadline which is of concern, but December 31, 2012. The only leverage against automatic tax increases is a deal in advance of their expiration and the only leverage for such a deal is the debt limit extension.

It would be entirely inappropriate to renege on promises to the baby boomers to fund further income tax cuts by further extending the retirement age, cutting promised Medicare benefits or by enacting an across the board increase to the OASI payroll tax as a way to subsidize current spending or tax cuts. The current fiscal crisis should not be an excuse to use regressive Old Age and Survivors Insurance payroll taxes to subsidize continued tax cuts on the top 20% of wage earners who pay the majority of income taxes. Retirement on Social Security for those at the lowest levels is still inadequate. Any change to the program should, in time, allow a more comfortable standard of living in retirement.

The ultimate cause of the trust fund’s long term difficulties is not financial but demographic. Thus, the solution must also be demographic – both in terms of population size and income distribution. The largest demographic problem facing Social Security and the health care entitlements, Medicare and Medicaid, is the aging of the population. In the long term, the only solution for that aging is to provide a decent income for every family through more generous tax benefits.

The free market will not provide this support without such assistance, preferring instead to hire employees as cheaply as possible. Only an explicit subsidy for family size overcomes this market failure, leading to a reverse of the aging crisis.

The recommendations for raising net income are within the context of comprehensive tax reform, where the first 25-28 percent of personal income tax rates, the corporate income tax, unemployment insurance taxes, the Hospital Insurance payroll tax, the Disability Insurance payroll tax and the portion of the Survivors Insurance payroll tax funding survivors under the age of 60 have been subsumed by a Value Added Tax (VAT) and a Net Business Receipts Tax (where the net includes all value added, including wages and salaries).

Net income would be adjusted upward by the amount of the VAT percentage and an increased child tax credit of $500 per child per month. This credit would replace the earned income tax credit, the exemption for children, the current child tax credit, the mortgage interest deduction and the property tax deduction. This will lead employers to decrease base wages generally so that the average family with children and at an average income level would see no change in wage, while wages would go up for lower income families with more children and down for high income earners without children.

Gross income would be adjusted by the amount of tax withholding transferred from the employee to the employer, after first adjusting net income to reflect the amount of tax benefits lost due to the end of the home mortgage and property tax deductions.

This shift in tax benefits is entirely paid for and it would not decrease the support provided in the tax code to the housing sector – although it would change the mix of support provided because the need for larger housing is the largest expense faced by growing families. Indeed, this reform will likely increase support for the housing sector, as there is some doubt in the community of tax analysts as to whether the home mortgage deduction impacted the purchase of housing, including second homes, by wealthier taxpayers.

Within twenty years, a larger number of children born translates into more workers, who in another decade will attain levels of productivity large enough to reverse the demographic time bomb faced by Social Security in the long term.

Such an approach is superior to proposals to enact personal savings accounts as an addition to Social Security, as such accounts implicitly rely on profits from overseas labor to fund the dividends required to fill the hole caused by the aging crisis. This approach cannot succeed, however, as newly industrialized workers always develop into consumers who demand more income, leaving less for dividends to finance American retirements. The answer must come from solving the demographic problem at home, rather than relying on development abroad.

This proposal will also reduce the need for poor families to resort to abortion services in the event of an unplanned pregnancy. Indeed, if state governments were to follow suit in increasing child tax benefits as part of coordinated tax reform, most family planning activities would be to increase, rather than prevent, pregnancy. It is my hope that this fact is not lost on the Pro-Life Community, who should score support for this plan as an essential vote in maintaining a perfect pro-life voter rating.

Obviously, this proposal would remove both the mortgage interest deduction and the property tax deduction from the mix of proposals for decreasing tax rates while reducing the deficit. This effectively ends the notion that deficit finance can be attained in the short and medium term through tax reforms where the base is broadened and rates are reduced. The only alternatives left are a generalized tax increase (which is probably necessary to finance future health care needs) and allowing tax rates for high income individuals to return to the levels already programmed in the law as of January 1, 2013. In this regard, gridlock is the friend of deficit reduction. Should the President show a willingness to let all rates rise to these levels, there is literally no way to force him to accept anything other than higher rates for the wealthy.

This is not to say that there is no room for reform in the Social Security program. Indeed, comprehensive tax reform at the very least requires calculating a new tax rate for the Old Age and Survivors Insurance program. My projection is that a 6.5% rate on net income for employees and employers (or 13% total) will collect about the same revenue as currently collected for these purposes, excluding sums paid through the proposed enhanced child tax credit. This calculation is, of course, subject to revision.

While these taxes could be merged into the net business income/revenue tax, VAT or the Fair Tax as others suggest, doing so makes it more complicated to enact personal retirement accounts. My proposal for such accounts differs from the plan offered in by either the Cato Institute or the Bush Commission (aka the President’s Commission to Save Social Security).

As I wrote in the January 2003 issue of Labor and Corporate Governance, I would equalize the employer contribution based on average income rather than personal income. I would also increase or eliminate the cap on contributions. The higher the income cap is raised, the more likely it is that personal retirement accounts are necessary.

A major strength of Social Security is its income redistribution function. I suspect that much of the support for personal accounts is to subvert that function – so any proposal for such accounts must move redistribution to account accumulation by equalizing the employer contribution.

I propose directing personal account investments to employer voting stock, rather than an index funds or any fund managed by outside brokers. There are no Index Fund billionaires (except those who operate them). People become rich by owning and controlling their own companies. Additionally, keeping funds in-house is the cheapest option administratively. I suspect it is even cheaper than the Social Security system – which operates at a much lower administrative cost than any defined contribution plan in existence.

Safety is, of course, a concern with personal accounts. Rather than diversifying through investment, however, I propose diversifying through insurance. A portion of the employer stock purchased would be traded to an insurance fund holding shares from all such employers. Additionally, any personal retirement accounts shifted from employee payroll taxes or from payroll taxes from non-corporate employers would go to this fund.

The insurance fund will save as a safeguard against bad management. If a third of shares were held by the insurance fund than dissident employees holding 25.1% of the employee-held shares (16.7% of the total) could combine with the insurance fund held shares to fire management if the insurance fund agreed there was cause to do so. Such a fund would make sure no one loses money should their employer fail and would serve as a sword of Damocles’ to keep management in line. This is in contrast to the Cato/ PCSSS approach, which would continue the trend of management accountable to no one. The other part of my proposal that does so is representative voting by occupation on corporate boards, with either professional or union personnel providing such representation.

The suggestions made here are much less complicated than the current mix of proposals to change bend points and make OASI more of a needs based program. If the personal account provisions are adopted, there is no need to address the question of the retirement age. Workers will retire when their dividend income is adequate to meet their retirement income needs, with or even without a separate Social Security program.

No other proposal for personal retirement accounts is appropriate. Personal accounts should not be used to develop a new income stream for investment advisors and stock traders. It should certainly not result in more “trust fund socialism” with management that is accountable to no cause but short term gain. Such management often ignores the long-term interests of American workers and leaves CEOs both over-paid and unaccountable to anyone but themselves.

Progressives should not run away from proposals to enact personal accounts. If the proposals above are used as conditions for enactment, I suspect that they won’t have to. The investment sector will run away from them instead and will mobilize their constituency against them. Let us hope that by then workers become invested in the possibilities of reform.

Indeed, real reform is only possible if workers become more radicalized to the possibilities of workplace ownership and democracy. The purpose of this testimony is to remind workers of the bargain struck in the Roosevelt era, which I mentioned at the outset, to allow capitalism to exist in exchange for moving workers into the middle class. As that bargain has been abandoned on one side, there is no reason for workers not to pick up old demands for workplace democracy. Indeed, it is essential that they do so in order to quit losing ground.

All of the changes proposed here work more effectively if started sooner. The sooner that the income cap on contributions is increased or eliminated, the higher the stock accumulation for individuals at the higher end of the age cohort to be covered by these changes – although conceivably a firm could be allowed to opt out of FICA taxes altogether provided they made all former workers and retirees whole with the equity they would have otherwise received if they had started their careers under a reformed system. I suspect, though, that most will continue to pay contributions, with a slower phase in – especially if a slower phase in leaves current management in place.

Thank you for this opportunity to share these ideas with the subcommittee.

Health Care Entitlements: The Road Forward

Comments for the Record

Health Care Entitlements: The Road Forward

United States Senate Committee on Finance

Thursday, June 23, 2011, 10:00 AM

215 Dirksen Senate Office Building

Submitted by:

Michael Bindner

Center for Fiscal Equity

Chairman Baucus and Ranking Member Hatch, thank you for this opportunity to provide comments to the Committee. Now that we have been informed by the Trustees Report, it is up to the Congress and the advocacy community to map out the road forward. There are many issues which need to be addressed, with possible solutions inherent in each. We will address the impact of the Affordable Care Act (ACA), the impact of premiums and co-pays, the possibilities of tax reform and the funding of Medicaid.

Health Care Reform

While the Trustees must offer their projections under law, the real story on what will happen in the future has yet to be written. The entire debate on cost shifting is premature until the impact of pre-existing condition reforms on the market is known. The issue that no one is talking about the likelihood that the mandates under the ACA may be inadequate to keep people from dropping insurance - and will certainly not work if the mandate is rejected altogether (which is now Dogma in the GOP).

If people start dropping insurance until they get sick – which is rational given the weakness of mandates – then private health insurance will require a bailout into an effective single payer system. The only way to stop this from happening is to enact a subsidized public option for those with pre-existing conditions while repealing mandates and pre-existing condition reforms.

In the event that Congress does nothing and private sector health insurance is lost, the prospects for premium support to replace the current Medicare program is lost as well. Premium support also will not work if the ACA is repealed, since without the ACA, pre-existing condition protections and insurance exchanges eliminate the guarantee to seniors necessary for reform to succeed. Meanwhile, under a public option without pre-existing condition reforms, because seniors would be in the group of those who could not normally get insurance in the private market, the premium support solution would ultimately do nothing to fix Medicare’s funding problem.

Ultimately, fixing health care reform will require more funding, probably some kind of employer payroll or net business receipts tax – which would also fund the shortfall in Medicare and Medicaid (and take over most of their public revenue funding). This will be discussed below.

Premium and COLA Reform

Bruce Bartlett wrote in the New York Times Economix Blog on May 17 on the nature of the Medicare financial problem and how to fix it. The information he imparted is invaluable, however I disagree with his solution, which is to stop doing the Doc Fix. He relates that the ACA expansion of funding brought the Hospital Insurance Trust Fund (Part A) into balance, with parts B (doctor visits) and D (Drug coverage) responsible for most of the unsustainable cost growth, as patient premiums have declined from 50% of spending to 25% and with Drug coverage not at all close to covering program costs. (The CBPP states that premiums were always 25%, though if true, they are inadequate to control cost).

Stopping doctor bills from going up on the demand side will not work. We know that because it did not work for Medicaid - since restricting payments have stopped most doctors from taking Medicaid). This finding has a great deal of impact on what is possible in preventing the doctor fix.

The problem with Medicare Part B is that increases cannot keep up with costs, like they do in the private market, because doing so violates the commitment to not cut Social Security benefit checks. The cost of living adjustment must be high enough to cover the premium increase each year - although for many that is all it does. Further cuts bring up the specter of seniors eating cat foot to make ends meet, hence the reason that the Fiscal Commission was called the Cat Food Commission by progressives.

Premium support and not patching doctor fees are attempts to make doctors restrict their costs - both to seniors and overall. Prices naturally rise more quickly than inflation because these services are subsidized, so any co-pay must be increased to slow demand from users in exactly the same way the market would without subsidies or insurance. The desire to make doctors pay more is a recognition that the main impact of both insurance and subsidies (and subsidies for insurance) is higher income for doctors and a larger medical care sector than would otherwise occur in a free market.

Our hybrid system is the most expensive option - either going to much less comprehensive insurance for everyone or an entirely governmental system would be cheaper, but is politically untenable (at least until private insurance collapses or is eventually supplanted by an ever expanding public option).

Going after doctors still won't work, however, as the Medicaid experience clearly shows. Premium support is a way to have insurance companies go after doctors instead, but that will likely yield the same result. Shifting the financial obligation to employers and past employers as part of a Net Business Receipts Tax would likely control doctor fees, although such a proposal will face resistance from both the medical and insurance sectors, even though it is the most likely to save money. Even if such a program is adopted, some employers are too small to support a medical staff or support retiree health care, so some kind of public program is still necessary, with reform all the more crucial.

Making patients more conscious of their care might do the trick, both with more realistic premiums for Part B and Part D, with both rising to absorb half the cost - although premiums could be lowered by increasing co-pays and providing seniors with Flexible Spending and/or health savings accounts. The problem is that this is untenable when dealing with a population with largely fixed incomes. That problem, however, is not unsolvable.

The obvious solution, which no one has yet suggested, is to change how COLAs are calculated, moving from the wage index to an index based on what seniors actually buy - especially health care. If premiums were increased quickly, COLA changes would have to be as rapid.

Such a proposal would hasten the date that the Old Age and Survivors Insurance fund needs rescue. It also impacts lower income seniors to a greater extent than higher income seniors, since they have less left over after any mandatory co-pay. Either bend points would have to be reset or the entire complicated system of bend points would have to be replaced a new method of crediting contributions, where employer contributions are credited equally rather than as a match to the employee contribution - thus moving redistribution from the benefits side to the revenue side.

An average employer contribution would provide even more incentive for increasing the amount of income subject to benefits - or even eliminating the cap altogether. Of course, if you do the latter, we might as well simply use a Net Business Receipts Tax or a VAT to replace the employer contribution (which captures all income with the latter burdening imports as well)

Tax Reform

The committee well understands the ins and outs of increasing the payroll tax, so I will confine my remarks to a fuller explanation of Net Business Receipts Taxes (NBRT). Its base is similar to a Value Added Tax (VAT), but not identical. Unlike a VAT, and NBRT would not be visible on receipts and should not be zero rated at the border – nor should it be applied to imports. While both collect from consumers, the unit of analysis for the NBRT should be the business rather than the transaction. As such, its application should be universal – covering both public companies who currently file business income taxes and private companies who currently file their business expenses on individual returns.

The key difference between the two taxes is that the NBRT should be the vehicle for distributing tax benefits for families, particularly the Child Tax Credit, the Dependent Care Credit and the Health Insurance Exclusion, as well as any recently enacted credits or subsidies under the ACA. In the event the ACA is reformed, any additional subsidies or taxes should be taken against this tax (to pay for a public option or provide for catastrophic care and Health Savings Accounts and/or Flexible Spending Accounts).

The Child Tax Credit should be made fully refundable and should be expanded to include revenue now collected under the dependent exemption, the home mortgage interest deduction and the property tax deduction. Transitioning these deductions will allow a $500 per month per child distribution with payroll. It will likely increase incentives to expand affordable housing and may not decrease housing for the wealthy, who are less likely to forgo vacation housing or purchase of luxury housing for wont of a tax cut, as the richest families likely pay the alternative minimum tax anyway, so that they do not fully use this tax benefit now.

This tax should fund services to families, including education at all levels, mental health care, disability benefits, Temporary Aid to Needy Families, Supplemental Nutrition Assistance, Medicare and Medicaid. If society acts compassionately to prisoners and shifts from punishment to treatment for mentally ill and addicted offenders, funding for these services would be from the NBRT rather than the VAT.

This tax could also be used to shift governmental spending from public agencies to private providers without any involvement by the government – especially if the several states adopted an identical tax structure. Either employers as donors or workers as recipients could designate that revenues that would otherwise be collected for public schools would instead fund the public or private school of their choice. Private mental health providers could be preferred on the same basis over public mental health institutions.

If cost savings under and NBRT, allow companies to offer services privately to both employees and retirees in exchange for a substantial tax benefit. Employers who fund catastrophic care would get an even higher benefit, with the proviso that any care so provided be superior to the care available through Medicaid. Making employers responsible for most costs and for all cost savings allows them to use some market power to get lower rates, but no so much that the free market is destroyed.

This proposal is probably the most promising way to decrease health care costs from their current upward spiral – as employers who would be financially responsible for this care through taxes would have a real incentive to limit spending in a way that individual taxpayers simply do not have the means or incentive to exercise. While not all employers would participate, those who do would dramatically alter the market. In addition, a kind of beneficiary exchange could be established so that participating employers might trade credits for the funding of former employees who retired elsewhere, so that no one must pay unduly for the medical costs of workers who spent the majority of their careers in the service of other employers.

Conceivably, NBRT offsets could exceed revenue. In this case, employers would receive a VAT credit.

The NBRT would replace disability insurance, hospital insurance, the corporate income tax, business income taxation through the personal income tax and the mid range of personal income tax collection, effectively lowering personal income taxes by 25% in most brackets. Note that collection of this tax would lead to a reduction of gross wages, but not necessarily net wages – although larger families would receive a large wage bump, while wealthier families and childless families would likely receive a somewhat lower net wage due to loss of some tax subsidies and because reductions in income to make up for an increased tax benefit for families will likely be skewed to higher incomes. For this reason, a higher minimum wage is necessary so that lower wage workers are compensated with more than just their child tax benefits.

The Center calculates an NBRT rate of 27% before offsets for the Child Tax Credit and Health Insurance Exclusion, or 33% after the exclusions are included. This is a “balanced budget” rate. It could be set lower if the spending categories funded receive a supplement from income taxes.

Medicaid

In the event of comprehensive tax reform, which would include tax simplification at the higher end and individual income tax elimination at the lower end, the subsidies provided to high income tax states and municipal bond issuers would vanish. In order to soften the blow for ending this subsidy, Len Burman, late of the Tax Policy Center, and I both agree that Medicaid should be entirely federalized.

In the event that the NBRT includes tax subsidies for covering retired workers and workers in remedial and job training programs – whether they are operated by the employer or merely funded by them through private sources, the impact on federalizing Medicaid funding will be profound as caseloads drop, and with them local government payrolls.

If states governments mirror federal tax reform, the other possibility is for the federal NBRT to be lowered while states raise their rates to compensate for the lack of federal funding – but with those states gaining from employers picking up the cost in exchange for a tax benefit.

The most profound cost savings available to lower Medicaid costs, however, comes from the replacement of current federal nutrition programs, which can be quite parsimonious in their funding, with participation in the expanded Child Tax Credit as part of remedial training. Such participation allows people who now struggle at the end of the month to feed themselves and their children to afford a diet with more meat, fruit and vegetables and less cheap starches – which are often the staple of diets for those on public assistance due to their low cost. A healthier diet will quickly lower the rate of obesity among the poor, and with it the costs related to early onset diabetes and its complicating prevalence of heart attack, hypertension and stroke. This will, in turn, lower health care costs for both public Medicaid and for private insurance offered to clients of remedial education programs.

Government nutrition and welfare programs have often been penny-wise and pound foolish – for example lowering doctor reimbursements while driving people to Emergency Room care and refusing to mandate sick leave for all so that workers can take their children to the doctor rather than dragging them to the ER at night. The tax reform proposals I have outlined reverse that trend and will, in the long run, save money.

Thank you for the opportunity to address the committee.

Hearing: Medicare Trustees Report

Comments for the Record

House Committee on Ways and Means

Subcommittee on Health

Hearing: 2011 Medicare Trustees Report

June 22, 2011, 9:30 AM

by Michael G. Bindner

The Center for Fiscal Equity

Chairman Herger and Ranking Member Stark, thank you for the opportunity to submit my comments on this topic. The Trustees are quite correct in providing an alternative scenario, where they estimate the impact of what Congress is likely to do. In our opinion, they are still overly optimistic. The Center offers two scenarios to consider – one which relies on tax reform and a second which reforms how premiums and COLAs are calculated.

Option 1 – Tax Reform

While the trustees must offer their projections under law, the real story on what will happen cannot be determined. The entire debate on cost cutting is premature until the impact of pre-existing condition reforms on the market is known. The issue with the pre-existing condition reforms, which no one is talking about, is that the mandates under the Affordable Care Act (ACA) may be inadequate to keep people from dropping insurance - and will certainly not work if the mandate is rejected altogether (which is now Dogma in the GOP).
If people start dropping insurance until they get sick – which is rational given the weakness of mandates – then private health insurance will require a bailout into an effective single payer system. The only way to stop this from happening is to enact a subsidized public option for those with pre-existing conditions while repealing mandates and pre-existing condition reforms.
In the event that Congress does nothing and private sector health insurance is lost, the prospects for premium support to replace the current Medicare program is lost as well. Premium support also will not work if the ACA is repealed, since without the ACA, pre-existing condition protections and insurance exchanges eliminate the guarantee to seniors necessary for reform to succeed. Meanwhile, under a public option without pre-existing condition reforms, because seniors would be in the group of those who could not normally get insurance in the private market, the premium support solution would ultimately do nothing to fix Medicare’s funding problem.
Ultimately, fixing health care reform will require more funding, probably some kind of employer payroll or net business receipts tax – which would also fund the shortfall in Medicare and Medicaid (and take over most of their public revenue funding).
The committee well understands the ins and outs of increasing the payroll tax, so I will confine my remarks to a fuller explanation of Net Business Receipts Taxes (NBRT). Its base is similar to a Value Added Tax (VAT), but not identical. Unlike a VAT, and NBRT would not be visible on receipts and should not be zero rated at the border – nor should it be applied to imports. While both collect from consumers, the unit of analysis for the NBRT should be the business rather than the transaction. As such, its application should be universal – covering both public companies who currently file business income taxes and private companies who currently file their business expenses on individual returns.
The key difference between the two taxes is that the NBRT should be the vehicle for distributing tax benefits for families, particularly the Child Tax Credit, the Dependent Care Credit and the Health Insurance Exclusion, as well as any recently enacted credits or subsidies under the ACA. In the event the ACA is reformed, any additional subsidies or taxes should be taken against this tax (to pay for a public option or provide for catastrophic care and Health Savings Accounts and/or Flexible Spending Accounts).
The Child Tax Credit should be made fully refundable and should be expanded to include revenue now collected under the dependent exemption, the home mortgage interest deduction and the property tax deduction. Transitioning these deductions will allow a $500 per month per child distribution with payroll. It will likely increase incentives to expand affordable housing and may not decrease housing for the wealthy, who are less likely to forgo vacation housing or purchase of luxury housing for wont of a tax cut, as the richest families likely pay the alternative minimum tax anyway, so that they do not fully use this tax benefit now.
This tax should fund services to families, including education at all levels, mental health care, disability benefits, Temporary Aid to Needy Families, Supplemental Nutrition Assistance, Medicare and Medicaid. If society acts compassionately to prisoners and shifts from punishment to treatment for mentally ill and addicted offenders, funding for these services would be from the NBRT rather than the VAT.
This tax could also be used to shift governmental spending from public agencies to private providers without any involvement by the government – especially if the several states adopted an identical tax structure. Either employers as donors or workers as recipients could designate that revenues that would otherwise be collected for public schools would instead fund the public or private school of their choice. Private mental health providers could be preferred on the same basis over public mental health institutions.
If cost savings under and NBRT, allow companies to offer services privately to both employees and retirees in exchange for a substantial tax benefit. Employers who fund catastrophic care would get an even higher benefit, with the proviso that any care so provided be superior to the care available through Medicaid. Making employers responsible for most costs and for all cost savings allows them to use some market power to get lower rates, but no so much that the free market is destroyed.
This proposal is probably the most promising way to decrease health care costs from their current upward spiral – as employers who would be financially responsible for this care through taxes would have a real incentive to limit spending in a way that individual taxpayers simply do not have the means or incentive to exercise. While not all employers would participate, those who do would dramatically alter the market. In addition, a kind of beneficiary exchange could be established so that participating employers might trade credits for the funding of former employees who retired elsewhere, so that no one must pay unduly for the medical costs of workers who spent the majority of their careers in the service of other employers.
Conceivably, NBRT offsets could exceed revenue. In this case, employers would receive a VAT credit.
The NBRT would replace disability insurance, hospital insurance, the corporate income tax, business income taxation through the personal income tax and the mid range of personal income tax collection, effectively lowering personal income taxes by 25% in most brackets. Note that collection of this tax would lead to a reduction of gross wages, but not necessarily net wages – although larger families would receive a large wage bump, while wealthier families and childless families would likely receive a somewhat lower net wage due to loss of some tax subsidies and because reductions in income to make up for an increased tax benefit for families will likely be skewed to higher incomes. For this reason, a higher minimum wage is necessary so that lower wage workers are compensated with more than just their child tax benefits.
The Center calculates an NBRT rate of 27% before offsets for the Child Tax Credit and Health Insurance Exclusion, or 33% after the exclusions are included. This is a “balanced budget” rate. It could be set lower if the spending categories funded receive a supplement from income taxes.
If less radical reform is desired, the Committee should consider premium increases.
Option 2 – Premium and COLA Reform
Bruce Bartlett wrote in the New York Times Economix Blog on May 17 on the nature of the Medicare financial problem and how to fix it. The information he imparted is invaluable, however I disagree with his solution, which is to stop doing the Doc Fix. He relates that the ACA expansion of funding brought the Hospital Insurance Trust Fund (Part A) into balance, with parts B (doctor visits) and D (Drug coverage) responsible for most of the unsustainable cost growth, as patient premiums have declined from 50% of spending to 25% and with Drug coverage not at all close to covering program costs. (The CBPP states that premiums were always 25%, though if true, they are inadequate to control cost).
Stopping doctor bills from going up on the demand side will not work. We know that because it did not work for Medicaid - since restricting payments have stopped most doctors from taking Medicaid). This finding has a great deal of impact on what is possible in preventing the doctor fix.
The problem with Medicare Part B is that increases cannot keep up with costs, like they do in the private market, because doing so violates the commitment to not cut Social Security benefit checks. The cost of living adjustment must be high enough to cover the premium increase each year - although for many that is all it does. Further cuts bring up the specter of seniors eating cat foot to make ends meet, hence the reason that the Fiscal Commission was called the Cat Food Commission by progressives.
Premium support and not patching doctor fees are attempts to make doctors restrict their costs - both to seniors and overall. Prices naturally rise more quickly than inflation because these services are subsidized, so any co-pay must be increased to slow demand from users in exactly the same way the market would without subsidies or insurance. The desire to make doctors pay more is a recognition that the main impact of both insurance and subsidies (and subsidies for insurance) is higher income for doctors and a larger medical care sector than would otherwise occur in a free market.
Our hybrid system is the most expensive option - either going to much less comprehensive insurance for everyone or an entirely governmental system would be cheaper, but is politically untenable (at least until private insurance collapses or is eventually supplanted by an ever expanding public option).
Going after doctors still won't work, however, as the Medicaid experience clearly shows. Premium support is a way to have insurance companies go after doctors instead, but that will likely yield the same result. Shifting the financial obligation to employers and past employers as part of a Net Business Receipts Tax would likely control doctor fees, although such a proposal will face resistance from both the medical and insurance sectors, even though it is the most likely to save money. Even if such a program is adopted, some employers are too small to support a medical staff or support retiree health care, so some kind of public program is still necessary, with reform all the more crucial.
Making patients more conscious of their care might do the trick, both with more realistic premiums for Part B and Part D, with both rising to absorb half the cost - although premiums could be lowered by increasing co-pays and providing seniors with Flexible Spending and/or health savings accounts. The problem is that this is untenable when dealing with a population with largely fixed incomes. That problem, however, is not unsolvable.
The obvious solution, which no one has yet suggested, is to change how COLAs are calculated, moving from the wage index to an index based on what seniors actually buy - especially health care. If premiums were increased quickly, COLA changes would have to be as rapid.
Such a proposal would hasten the date that the Old Age and Survivors Insurance fund needs rescue. It also impacts lower income seniors to a greater extent than higher income seniors, since they have less left over after any mandatory co-pay. Either bend points would have to be reset or the entire complicated system of bend points would have to be replaced a new method of crediting contributions, where employer contributions are credited equally rather than as a match to the employee contribution - thus moving redistribution from the benefits side to the revenue side.
An average employer contribution would provide even more incentive for increasing the amount of income subject to benefits - or even eliminating the cap altogether. Of course, if you do the latter, we might as well simply use a Net Business Receipts Tax or a VAT to replace the employer contribution (which captures all income with the latter burdening imports as well)

Thank you for the opportunity to address the committee.

Perspectives on Deficit Reduction: Revenues

Comments for the Record

Perspectives on Deficit Reduction: Revenues

United States Senate Committee on Finance

Tuesday, June 7, 2011, 10:00 AM

215 Dirksen Senate Office Building

Submitted by:

Michael Bindner

Center for Fiscal Equity

 

Chairman Baucus and Ranking Member Hatch, thank you for this opportunity to provide comments to the Committee. In these comments, we will address the appropriate baseline for deficit reduction when considering revenue issue, the most pressing problem in the short term, proposals for dealing with health care finance with a focus on the revenue side and our plan for long term tax reform.

Baseline Issues for Revenue

The most important fact in determining which baseline to use for deficit reduction, especially when focusing on revenues, is the automatic expiration of the 2001, 2003 and 2010 tax cuts on January 1, 2013. As the Center for Budget and Policy Priorities reports, allowing the Bush/Obama tax cuts to expire on schedule will rather automatically cut the deficit to net interest costs - essentially stopping the need for any cuts at all. This solution will only happen, however, if the President and Congress refuse to compromise on the issue of high income tax cuts. Given that most donors are within that income strata, we do not believe it is wise to count on such a refusal – although it would certainly eliminate the need for hearings on deficit reduction.

That fact must still guide the deliberations of Congress on the issue of deficit reduction. Any solution must be as productive in these terms as letting the tax cuts expire automatically.

Short Term Concerns

Given recent economic news, there may be some justification for extending the entire mix of tax cuts. If the impending down-turn were a simple business cycle recession, such action might be justified. This is not such a recession, however, but a down-turn within an asset-based depression. Indeed, giving a general tax cut to most households will inadequately assist those families who are burdened with under water mortgages while providing unneeded benefits to the remainder.

The problem of uncertainty is general, but the solution to this uncertainty is to correct the housing market by providing direct assistance to underwater borrowers, either through bankruptcy reforms allowing “cram-downs” on primary residences or through the Federal Reserve buying mortgage backed securities from Freddie Mac, Fannie Mae and other government entities such as the VA and FHA at the value of the underlying assets and then directing servicers to adjust principal balances. Barring such actions, the only real way out is asset inflation as part of general inflation, which would harm the investing community more than reform.

Additionally, tax cuts have been seen as a way to stimulate the economy to produce jobs. If that were true, however, job growth would be at an all time high rather than faltering. Those high income individuals and businesses who have benefited from these cuts are still not hiring and have no incentive to do so, as their return on current production and savings is adequate at current tax rates to fund their needs. If their taxes were increased, they would have an incentive to expand operations in order to maintain the same level of income. This phenomenon explains why the 1993 tax legislation resulted in the most sustained economic growth in American history, while the tax cuts in subsequent years have ignited three boom-bust cycles (with the recent oil boom being the third) but very little economic growth. This accounting includes the Tech Bubble, which occurred after capital gains tax rates were cut during the second term of the Clinton Administration.

Tax cuts must be resisted at all costs. If Congress has the courage of conviction rather than the desire to please donors and partisans, any deficit reduction must focus mostly on the revenue side. When revenues are increased, the incentive to cut spending is more pronounced, as recent history shows. When revenues are cut, the pain in society from higher taxes offers no incentive to demand more spending, such as the current round of defense modernization and prescription drug coverage under Medicare Part D or comprehensive health care reform. We will now move to the latter.

Health Care Finance and Revenues

Premium support is an oft mentioned proposal for controlling Medicare costs, both within the House budget and in proposals from the Tax Policy Center and its fans in the Bipartisan Policy Committee, although premium support will only work if the Affordable Care Act (ACA) is left in place, which Chairman Ryan does not do for partisan reasons, even though the pre-existing condition reforms and exchanges under it would guarantee that seniors will be covered and repealing them will not.

The entire debate is premature until the impact of pre-existing condition reforms on the market is known. The issue with the pre-existing condition reforms, which no one is talking about, is that the mandates under the ACA may be inadequate to keep people from dropping insurance - and will certainly not work if the mandate is rejected altogether (which is now Dogma in the GOP).

If people start dropping insurance until they get sick – which is rational given the weakness of mandates – then private health insurance will require a bailout into an effective single payer system. The only way to stop this from happening is to enact a subsidized public option for those with pre-existing conditions while repealing mandates and pre-existing condition reforms. Of course, since seniors would be in the group of those who could not normally get insurance in a premium support reform, the premium support solution would ultimately do nothing to fix Medicare’s funding problem.

Ultimately, fixing health care reform will require more funding, probably some kind of employer payroll or net business receipts tax – which would also fund the shortfall in Medicare and Medicaid (and take over most of their public revenue funding). Such a tax proposal is addressed in the next section.

If cost savings are desired within such a formulation, allow companies to offer services privately to both employees and retirees in exchange for a substantial tax benefit. Employers who fund catastrophic care would get an even higher benefit, with the proviso that any care so provided be superior to the care available through Medicaid. Making employers responsible for most costs and for all cost savings allows them to use some market power to get lower rates, but no so much that the free market is destroyed.

Bruce Bartlett wrote in the New York Times on May 17 on the nature of the Medicare financial problem and how to fix it. The information he imparted is invaluable, however I disagree with his solution, which is to stop doing the Doc Fix. He relates that the ACA expansion of funding brought the Hospital Insurance Trust Fund (Part A) into balance, with parts B (doctor visits) and D (Drug coverage) responsible for most of the unsustainable cost growth, as patient premiums have declined from 50% of spending to 25% and with Drug coverage not at all close to covering program costs. (The CBPP states that premiums were always 25%, though if true, they are inadequate to control cost).

Stopping doctor bills from going up on the demand side will not work. We know that because it did not work for Medicaid - since restricting payments have stopped most doctors from taking Medicaid).

The problem with Medicare Part B is that increases cannot keep up with costs, like they do in the private market, because doing so violates the commitment to not cut Social Security benefit checks. The cost of living adjustment must be high enough to cover the premium increase each year - although for many that is all it does. Further cuts bring up the specter of seniors eating cat foot to make ends meet, hence the reason that the Fiscal Commission was called the Cat Food Commission by progressives.

Premium support and not patching doctor fees are attempts to make doctors restrict their costs - both to seniors and overall. Prices naturally rise more quickly than inflation because these services are subsidized, so any co-pay must be increased to slow demand from users in exactly the same way the market would without subsidies or insurance. The desire to make doctors pay more is a recognition that the main impact of both insurance and subsidies (and subsidies for insurance) is higher income for doctors and a larger medical care sector than would otherwise occur in a free market.

Our hybrid system is the most expensive option - either going to much less comprehensive insurance for everyone or an entirely governmental system would be cheaper, but is politically untenable (at least until private insurance collapses or is eventually supplanted by an ever expanding public option).

Going after doctors still won't work, however, as the Medicaid experience clearly shows. Premium support is a way to have insurance companies go after doctors instead, but that will likely yield the same result. Shifting the financial obligation to employers and past employers as part of a Net Business Receipts Tax would likely control doctor fees, although such a proposal will face resistance from both the medical and insurance sectors, even though it is the most likely to save money. Even if such a program is adopted, some employers are too small to support a medical staff or support retiree health care, so some kind of public program is still necessary, with reform all the more crucial.

Making patients more conscious of their care might do the trick, both with more realistic premiums for Part B and Part D, with both rising to absorb half the cost - although premiums could be lowered by increasing co-pays and providing seniors with Flexible Spending and/or health savings accounts. The problem is that this is untenable when dealing with a population with largely fixed incomes. That problem, however, is not unsolvable.

The obvious solution, which no one has yet suggested, is to change how COLAs are calculated, moving from the wage index to an index based on what seniors actually buy - especially health care. If premiums were increased quickly, COLA changes would have to be as rapid.

Such a proposal would hasten the date that the Old Age and Survivors Insurance fund needs rescue. It also impacts lower income seniors to a greater extent than higher income seniors, since they have less left over after any mandatory co-pay. Either bend points would have to be reset or the entire complicated system of bend points would have to be replaced a new method of crediting contributions, where employer contributions are credited equally rather than as a match to the employee contribution - thus moving redistribution from the benefits side to the revenue side.

An average employer contribution would provide even more incentive for increasing the amount of income subject to benefits - or even eliminating the cap altogether. Of course, if you do the latter, we might as well simply use a Net Business Receipts Tax or a VAT to replace the employer contribution (which captures all income with the latter burdening imports as well) - unless of course the Government adopted Personal Retirement Accounts.

Comprehensive Tax Reform

Tax reform, if undertaken at all, should have the goal of simplifying the collection of revenue while maintaining or improving its basic progressive structure (which in current law is more honored in its breach, given low taxes on capital gains and dividends). The use of the tax code to provide subsidies to working families must be maintained, but this should occur without requiring that every household file a tax return to receive them, often by paying others to do so and paying a premium for refund anticipation loans which are heavily marketed to those least able to afford the finance costs.

On the other hand, the number of people paying no tax as a result of these benefits has justly drawn criticism that a sense of shared sacrifice has been abandoned. This has led many to demand some form of consumption tax so that all are conscious of some sacrifice. Some form of visible consumption tax will also provide an incentive to save to those who otherwise would not because their incomes are too low to do so. The wealthy, however, need no such incentive – having the ability to satisfy all of their current economic needs with additional income to spare.

To satisfy both demands, the Center proposes a four part tax structure.

Part One is a Value Added Tax (VAT), which is suggested because of its difficulty to evade, because it can be as visible to the ultimate consumer as a retail sales tax and because it can be zero rated at the border for exports and collected fully for imports. As this feature has been well explained by others, I will not go into detail on this point. What is more important is to exercise care in delineating what is funded by such a tax.

We believe that VAT funding should be confined to funding domestic discretionary military and civilian spending. Zero rating a tax supporting such spending is totally appropriate, as foreign consumers gain no benefit from these expenditures. Likewise, making imports fully taxable for this spending correctly burdens the consumers who fully benefit from these services. As importantly, making such a tax visible provides an incentive to taxpayers to demand less of such spending.

An extreme example of such spending incentives would be the creation of a regional VAT funding regional appropriations, with varying rates depending upon spending levels. While creation of regional appropriations panels and government agencies can be accomplished under the Constitution as currently written, creation of any regional excise would require a constitutional amendment, as the Constitution requires all excises to be uniform.

In order to fully fund current domestic obligations, the Center calculates that the tax rate should be 13.3%. In order for this to be affordable, during the transition, income tax withholding tables should be adjusted to increase net income by the same percentage, with Social Security beneficiaries receiving a similar bump in payments. This is a “balanced budget” rate. It could be set lower if the spending categories funded receive a supplement from income taxes.

Part Two is a VAT-like Net Business Receipts Tax (NBRT). Its base is similar to a VAT, but not identical. Unlike a VAT, and NBRT would not be visible on receipts and should not be zero rated at the border – nor should it be applied to imports. While both collect from consumers, the unit of analysis for the NBRT should be the business rather than the transaction. As such, its application should be universal – covering both public companies who currently file business income taxes and private companies who currently file their business expenses on individual returns.

The key difference between the two taxes is that the NBRT should be the vehicle for distributing tax benefits for families, particularly the Child Tax Credit, the Dependent Care Credit and the Health Insurance Exclusion, as well as any recently enacted credits or subsidies under the Patient Protection and Affordable Care Act (ACA). In the event the ACA is reformed, any additional subsidies or taxes should be taken against this tax (to pay for a public option or provide for catastrophic care and Health Savings Accounts and/or Flexible Spending Accounts).

The Child Tax Credit should be made fully refundable and should be expanded to include revenue now collected under the dependent exemption, the home mortgage interest deduction and the property tax deduction. Transitioning these deductions will allow a $500 per month per child distribution with payroll. It will likely increase incentives to expand affordable housing and may not decrease housing for the wealthy, who are less likely to forgo vacation housing or purchase of luxury housing for wont of a tax cut, as the richest families likely pay the alternative minimum tax anyway, so that they do not fully use this tax benefit now.

This tax should fund services to families, including education at all levels, mental health care, disability benefits, Temporary Aid to Needy Families, Supplemental Nutrition Assistance, Medicare and Medicaid. If society acts compassionately to prisoners and shifts from punishment to treatment for mentally ill and addicted offenders, funding for these services would be from the NBRT rather than the VAT.

An extreme example of this proposal is to have a differential regional rate and differential benefit levels for this tax, which may or may not require an amendment – as this tax may be far enough removed from the transaction level to be considered an income tax rather than an excise.

Again, in the extreme, this tax could also be used to shift governmental spending from public agencies to private providers without any involvement by the government – especially if the several states adopted an identical tax structure. Either employers as donors or workers as recipients could designate that revenues that would otherwise be collected for public schools would instead fund the public or private school of their choice. Private mental health providers could be preferred on the same basis over public mental health institutions.

Employers receive a tax credit if their retirees opt out of Medicare and Medicaid for seniors by fully employer funding of retiree health care, either by hiring doctors or purchasing comparable coverage, including catastrophic coverage in return for some kind of tax credit. This proposal is probably the most promising way to decrease health care costs from their current upward spiral – as employers who would be financially responsible for this care through taxes would have a real incentive to limit spending in a way that individual taxpayers simply do not have the means or incentive to exercise. While not all employers would participate, those who do would dramatically alter the market. In addition, a kind of beneficiary exchange could be established so that participating employers might trade credits for the funding of former employees who retired elsewhere, so that no one must pay unduly for the medical costs of workers who spent the majority of their careers in the service of other employers.

Conceivably, NBRT offsets could exceed revenue. In this case, employers would receive a VAT credit.

It is not appropriate for this tax to be zero rated, as doing so would decrease the incentive to pass these tax benefits to employees. As importantly, the tax benefits and government services provided under this tax go to workers and their families. As such, overseas purchasers accrue benefits from these services and should therefore participate in their funding.

If the NBRT is enacted in this way, the United States should seek modification to our trade agreements to require that similar expenditures not be funded with taxes that are zero rated at the border. As foreign consumers benefit from subsidies for American families, American consumers benefit from services provided to overseas workers and their families. This benefit should be recognized in international tax and trade policy and American workers should not be penalized when other nations refuse to distribute the cost of benefits to foreign workers to the American consumers who receive the benefit of these services. If our trading partners do not match this initiative, some items of spending could be shifted from NBRT funding to VAT funding, so that we are not making unilateral concessions in this area.

The VAT would replace income taxes collected at the lowest rate, while the NBRT would replace disability insurance, hospital insurance, the corporate income tax, business income taxation through the personal income tax and the mid range of personal income tax collection, effectively lowering personal income taxes by 25% in most brackets. Note that collection of this tax would lead to a reduction of gross wages, but not necessarily net wages – although larger families would receive a large wage bump, while wealthier families and childless families would likely receive a somewhat lower net wage due to loss of some tax subsidies and because reductions in income to make up for an increased tax benefit for families will likely be skewed to higher incomes. For this reason, a higher minimum wage is necessary so that lower wage workers are compensated with more than just their child tax benefits.

The NBRT rate is projected to be 27% before offsets for the Child Tax Credit and Health Insurance Exclusion, or 33% after the exclusions are included. This is a “balanced budget” rate. It could be set lower if the spending categories funded receive a supplement from income taxes.

Part Three is the continuation of a payroll tax for Old Age and Survivors Insurance (although insurance for survivors under age 60 may be shifted to the NBRT). Given the across the board decrease in gross income, the tax rate would have to be increased to 6.5% for employees and employers (provided younger survivors are excluded). To improve program progressivity, the employer contribution could be credited on an equal basis, moving redistributive effects from benefit distribution to revenue collection. Additionally, the amount subject to tax should be increased or the income cap eliminated, which would help both program income and support for lower income retirees. I have addressed this issue more fully in prior comments dated May 17, 2011, which I will not repeat here.

Part Four is surtax on high income earners and heirs. It would replace the Inheritance or Death Tax by instead taxing only cash or in-kind distributions from inheritances but not asset transfers, with distributions remaining tax free they are the result of a sale to a qualified Employee Stock Ownership Plan.

In testimony before the Senate Budget Committee, Lawrence B. Lindsey explored the possibility of including high income taxation as a component of a Net Business Receipts Tax. The tax form could have a line on it to report income to highly paid employees and investors and pay a surtax on that income. We considered and rejected a similar option in a plan submitted to President Bush’s Tax Reform Task Force, largely because you could not guarantee that the right people pay taxes. If only large dividend payments are reported, then diversified investment income might be under-taxed, as would employment income from individuals with high investment income. Under collection could, of course, be overcome by forcing high income individuals to disclose their income to their employers and investment sources – however this may make some inheritors unemployable if the employer is in charge of paying a higher tax rate. For the sake of privacy, it is preferable to leave filing responsibilities with high income individuals.

This surtax could have few rates or many rates, although I suspect as rates go up, taxpayers of more modest means would prefer a more graduated rate structure. The need for some form of surtax at all is necessary both to preserve the progressivity of the system overall, especially if permanent tax law enacted before 2001 is considered the baseline (which it should be) and to take into account the fact that at the higher levels, income is less likely to be spent so that higher tax rates are necessary to ensure progressivity.

This tax would fund net interest on the debt, repayment of the Social Security Trust fund, any other debt reduction and overseas civilian, military, naval and marine activities, most especially international conflicts, which would otherwise require borrowing to fund. It would also fund transfers to discretionary and entitlement spending funds when tax revenue loss is due to economic recession or depression, as is currently the case. Unlike the other parts of the system, this fund would allow the running of deficits.

Explicitly identifying this tax with net interest payments highlights the need to raise these taxes as a means of dealing with our long term indebtedness, especially in regard to debt held by other nations. While consumers have benefited from the outsourcing of American jobs, it is ultimately high income investors which have reaped the lion’s share of rewards. The loss of American jobs has led to the need for foreign borrowing to offset our trade deficit. Without the tax cuts for the wealthiest Americans, such outsourcing would not have been possible. Indeed, there would have been any incentive to break unions and bargain down wages if income taxes were still at pre-1981 or pre-1961 levels. The middle class would have shared more fully in the gains from technical productivity and the artificial productivity of exploiting foreign labor would not have occurred at all. Increasing taxes will ultimately provide less of an incentive to outsource American jobs and will lead to lower interest costs overall. Additionally, as foreign labor markets mature, foreign workers will demand more of their own productive product as consumers, so depending on globalization for funding the deficit is not wise in the long term.

Identifying deficit reduction with this tax recognizes that attempting to reduce the debt through either higher taxes on or lower benefits to lower income individuals will have a contracting effect on consumer spending, but no such effect when progressive income taxes are used. Indeed, if progressive income taxes lead to debt reduction and lower interest costs, economic growth will occur as a consequence.

Using this tax to fund deficit reduction explicitly shows which economic strata owe the national debt. Only income taxes have the ability to back the national debt with any efficiency. Payroll taxes are designed to create obligation rather than being useful for discharging them. Other taxes are transaction based or obligations to fictitious individuals. Only the personal income tax burden is potentially allocable and only taxes on dividends, capital gains and inheritance are unavoidable in the long run because the income is unavoidable, unlike income from wages.

Even without progressive rate structures, using an income tax to pay the national debt firmly shows that attempts to cut income taxes on the wealthiest taxpayers do not burden the next generation at large. Instead, they burden only those children who will have the ability to pay high income taxes. In an increasingly stratified society, this means that those who demand tax cuts for the wealthy are burdening the children of the top 20% of earners, as well as their children, with the obligation to repay these cuts. That realization should have a healthy impact on the debate on raising income taxes.

The distribution of tax benefits and burdens relates directly to the question of the distribution of the national debt, both among individuals and between the several states. I am including a separate paper on this topic as a supplement to my statement.

Again, thank you for the opportunity to submit these comments for the record.